UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549  FORM 10-K (Mark One) x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the fiscal year ended December 31, 2006 OR  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 Number0-23346  EMAK WORLDWIDE, INC. (Exact name of registrant as specified in its charter)  Delaware

(State or other jurisdiction of

incorporation or organization)
13-3534145

(I.R.S. Employer Identification No.)
 6330 SAN VICENTE BLVD. LOS ANGELES, 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 registered
 None
None
  Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
 (Title of class)  Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes
NoX
 Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes
NoX
 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.YesXNo __ 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.x Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):  Large accelerated filer [ ]
Accelerated filer [ ]
Non-accelerated filerx
  Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yeso
Nox
  As of June 30, 2006, the aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was $23,971,460. Number of shares outstanding of registrants common stock, $.001 par value, as of March 29, 2007: 5,853,290 shares Documents Incorporated by Reference: Portions of the registrants definitive Proxy Statement relating to registrants 2007 annual meeting of stockholders are incorporated by reference into Part III of this Form 10-K. 
   EMAK WORLDWIDE, INC.  INDEX TO ANNUAL REPORT ON FORM 10-K FILED WITH THE SECURITIES AND EXCHANGE COMMISSION YEAR ENDED DECEMBER 31, 2006  ITEMS IN FORM 10-K   PagePart IItem 1.
Business
2Item 1A
Risk Factors
8Item 1B
Unresolved Staff Comments
10Item 2.
Properties
10Item 3.
Legal Proceedings
10Item 4.
Submission of Matters to a Vote of Security Holders
10Part IIItem 5.
Market for Registrants Common Equity, Related Stockholder Matters

and Issuer Purchases of Equity Securities
11Item 6.
Selected Financial Data
13Item 7.
Managements Discussion and Analysis of Financial Condition and Results of Operation
14Item 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
61Item 9A(T).
Controls and Procedures
61Item 9B
Other Information
61Part IIIItem 10.
Directors and Executive Officers and Corporate Governance
61Item 11.
Executive Compensation
61Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related

Stockholder Matters61Item 13.
Certain Relationships and Related Transactions, and Director Independence.
61Item 14.
Principal Accounting Fees and Services
62Part IVItem 15.
Exhibits, Financial Statement Schedules
62
   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 Risk Factors.  2  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, meansEMAK 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. EMAK is headquartered in Los Angeles, with operations in Chicago, Frankfurt, London, Paris, the Netherlands, Hong Kong and Shanghai.  We are a client-driven global organization serving as a strategic marketing partner for our clients by 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 strive:  
To properly position our agencies for relevance with our clients;
To leverage the expertise of our employees;
To consistently drive sustainable growth; and
To effectively manage our operating expenses.
  We provide our clients with access to a broad range of intellectual properties from the worlds of entertainment, music and sports. We maintain an infrastructure that can deliver unique, high-quality and cost-effective products and services in a very tight time frame, with stringent quality control.  We also develop and market consumer products, based on emerging and evergreen licensed properties, which are sold through mass-market and specialty retailers.  Our History and Vision  Over the last five years we acquired five agencies in pursuit of a strategy to diversify and grow our Marketing Services skills and client base. Our acquisitions included Logistix (July 2001), Upshot (July 2002), SCI Promotion (September 2003), Johnson Grossfield (February 2004) and Megaprint Group (November 2004). While these acquired agencies leveraged our infrastructure, added new clients and complementary service offerings, and offered new channels of distribution or territories, as reflected in the non-cash goodwill and other intangibles impairment charges recorded in 2004 and 2005 which total $37,282, our historical efforts at integration met with limited success. In 2006, our efforts turned to the true integration of our acquired agencies and the streamlining of the organizations cost structure in order to optimize the sharing of intellectual assets and the leveraging of our infrastructure. These efforts had a
visible impact in 2006, with operating expenses decreasing by over 50% to better align our cost model with current client needs. We have streamlined the organization and established a more efficient operating structure that can be leveraged to support profitable growth.  As we move forward, our focus for 2007 and beyond is the organic growth of our family of agencies. We expect spending on marketing services to outpace that of traditional advertising for the foreseeable future. We are working to position our agencies to take advantage of this trend and to drive long-term growth in our business over the next several years at rates that exceed the averages of traditional advertising businesses.  Business Segments  Our business is currently classified into three reportable business segments, namely Agency Services, Promotional Products and Consumer Products. These business segments have been defined in a manner consistent with EMAKs current organizational structure, internal reporting, allocation of resources and operational decision-making.  Our Agency Services revenues for the years ended December 31, 2004, 2005 and 2006 were $19,252, $20,766 and $30,133, or 8%, 9% and 16% of total revenues, respectively. Our Promotional Products revenues for the years ended December 31, 2004, 2005 and 2006 were $192,274, $176,416 and $141,083, or 81%, 79% and 78% of total revenues, respectively. Our Consumer Products revenues for the years ended December 31, 2004, 2005 and 2006 were $25,135, $26,215 and $10,181, or 11%, 12% and 6% of total revenues, respectively.  3   A single client, Burger King, accounted for approximately 51%, 52% and 48% of our total revenues for the years ended December 31, 2004, 2005 and 2006, respectively.  Agency Services  Our Agency Services has the expertise in promotional, event and collaborative marketing, retail design and environmental branding. We have experience across a broad array of industries, including apparel, automotive, beer, candy, consumer packaged goods, financial services, greeting cards, home electronics, hospitality, government services, pharmaceuticals, soft drinks, spirits, telecommunications and timeshares.  We perform a wide range of creative, design and development 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;
 
providing creative services for packaging and point-of-sale advertising;
 
developing experiential marketing campaigns to allow target consumers to directly experience our clients brands;
 
using the internet to complement promotional programs being conducted in the physical world,
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developing collaborative marketing programs between retailers and manufacturers; and
 
creating three-dimensional environments to influence consumers purchasing behavior including environmental planning, store design, space planning and visual merchandising.
  Promotional Products  Our largest Promotional Products 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.  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.  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;
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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;
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developing promotional concepts and designs based on the property;
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providing the development and engineering necessary to translate the property, which often consists of two-dimensional artwork, into finished products;
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obtaining or coordinating licensor approval of product designs, prototypes and finished products;
  4  
contracting for and supervising the manufacture of products;
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arranging for safety testing to customer and regulatory specifications by independent testing laboratories;
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arranging insurance, customs clearance and, in most instances, the shipping of finished products to the client;
 
providing warehousing, fulfillment and billing services.
  In some instances, customers obtain license rights or develop promotions concepts independently and engage us only to design and produce specific products. 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 running 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, specialty market retailersand 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.  In May 2002, the Company entered into a licensing agreement,which runs through December 2008, with Binney & Smith, the maker of Crayola® products. The Company designs and produces a full line of Crayola®-branded bath toys, bath activities and bath art sets for distribution to mass and specialty markets. Incorporated into this line are Crayola®-branded versions of the effervescent water coloring tablets which were previously marketed under the Tub Tints® brand. The first products developed under this agreement were distributed in Fall 2002. Binney & Smith is the worlds leading producer of childrens art products.  The Consumer Products business typically requires a significant investment in inventory, which, since it is not made to order, is at risk of obsolescence. In addition, this business requires large commitments for royalty guarantees which have resulted in significant losses in previous years.  In accordance with a planned wind down, during 2005 we significantly scaled back our Consumer Products business. Therefore, as of December 31, 2006, Crayola® remained the only licensed property. Based upon the current economics of the toy industry, we do not anticipate making additional continued investments in the Consumer Products business due to its unfavorable economics and because it no longer complements our core marketing services offerings.  Backlog  Order backlog at March 29, 2006 and 2007 was approximately $110,000. The Company expects the 2007 order backlog to be filled by December 31, 2007.  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 ourselves 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 2006, 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  5  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  Our Agency Services, Promotional Products and Consumer Products businesses operate in highly competitive domestic and international markets.  In our core domestic Agency 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 and Creata Promotion and Wunderman (a subsidiary of WPP). Competition in the international marketing services industry includes the companies listed above as well as local companies in each market. We believe the principal competitive factors affecting our Agency Services business are the development of client marketing and promotional strategies, unique consumer insights, creative execution, license selection, price and service quality.  In our core domestic Promotional Products business, EMAK competes with Marketing Store Worldwide, Creata Promotion, Premium Surge, Maxx Marketing and Determined Productions. 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 Promotional Products business are the development of client 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.  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, and may also be subject to the requirements of the Flammable Fabrics Act or the Food, Drug and Cosmetics Act, and the regulations promulgated pursuant to such statutes. The Consumer Product Safety Act and the Federal Hazardous Substances Act 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.  6  Employees  As of December 31, 2006, EMAK employed a total of 342 individuals, including 240 individuals located in the United States, 56 individuals located in Europe and 46 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
PositionJames L. Holbrook, Jr.

Teresa L. Tormey

Michael W. Sanders

Emily Shannon Brown

Duane V. Johnson

Roy Dar

Peter Boutros

Brian D. Kristofek
47

42

37

42

57

35

43

38
Chief Executive Officer

Chief Administrative Officer and General Counsel

Chief Financial Officer

Sr. Vice President, Worldwide Operations

Sr. Vice President, Human Resources

Sr. Vice President, Controller, and Principal Accounting Officer

Chief Executive Officer, Logistix

Chief Executive Officer, Upshot
  James L. Holbrook, Jr.joined EMAK in November 2005 and is currently our Chief Executive Officer and a member of our Board of Directors. Prior to joining EMAK, Mr. Holbrook was President and CEO for a portfolio of agencies at the Interpublic Group, one of the worlds largest advertising and marketing holding companies. From 1996 to 2004, Mr. Holbrook was CEO and part-owner of Zipatoni, a marketing agency, which was sold to Interpublic in 2001. From 1984 to 1996 he held various sales and marketing posts with Ralston Purina Co. and from 1981 to 1984 was in brand management at Procter & Gamble. Mr. Holbrook has a Master of Business Administration from Washington University and a Bachelor of Science in economics and philosophy from Vanderbilt University.  Teresa L. Tormeyjoined EMAK in November 2002 and is currently our Chief Administrative Officer and General Counsel, as well as our corporate Secretary. Ms. Tormey was promoted to her current position in February 2006. Ms. Tormey joined EMAK in November 2002 as Senior Vice President, General Counsel and Secretary and was later promoted to Executive Vice President in April 2004. Ms. Tormey is responsible for the supervision of the Companys centralized corporate departments, including business affairs, corporate product integrity, human resources, information technology, investor relations and office administration. Ms. Tormey is also responsible for our global regulatory compliance, board administration and corporate governance functions. Ms. Tormey was previously in private law practice as a partner in the corporate finance and transactions group of Oppenheimer Wolff
& Donnelly LLP. Ms. Tormey 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.  Michael W. Sandersjoined EMAK in 2002 and is currently our Senior Vice President and Chief Financial Officer. Mr. Sanders was promoted to his current position in March 2007. Prior to joining the Company, Mr. Sanders spent ten years with Ernst & Young LLP, serving as a Senior Manager for Ernst & Young LLPs Transaction Support Group. Mr. Sanders holds a Bachelors of Accountancy from the University of San Diego and is a registered Certified Public Accountant.  Emily Shannon Brownjoined EMAK in 1995 and has risen over the past decade through EMAKs product development, operations and client services organization. Since September 2004, Ms. Brown has served as Chief Operating Officer for the Equity Marketing subsidiary, responsible for client handling, operational processing and financial management of the Burger King account. In February 2006, Ms. Brown was promoted to the additional role of SVP, Worldwide Operations. Prior to joining EMAK, Ms. Brown was General Manager for EPI Marketing, a marketing firm which delivered sponsorships and partnerships, promotional marketing, and premiums to corporate clients, as well as operated a retail toy and gift business. Prior to EPI, Ms. Brown held marketing, operational and business management posts in the publishing and apparel industries, including Van Dam Publishing, Beth Schaeffer
Design, and Tracy Mills Inc.  Duane V. Johnsonjoined EMAK in 2004 and is currently Senior Vice President, Human Resources. Mr. Johnson was promoted to his current position in March 2007. Mr. Johnson joined EMAK in 2004 as Vice President, Human Resources. Prior to joining EMAK, Mr. Johnson was a human resources consultant from January 2003 to February 2004. From 1999 to December 2002, Mr. Johnson was Vice President, Human Resources of Joico International, a division of Shisheido of Japan. Mr. Johnson holds a Bachelors of Arts degree in psychology from California State University at Los Angeles.  Roy Darjoined EMAK in 1998 and is currently our Senior Vice President, Controller and Principal Accounting Officer. Mr. Dar was promoted to his current position in March 2007. Mr. Dar joined EMAK in June 1998 and has served as our Controller since March 1999. He  7  was promoted to Vice President, Controller in April 2004. Prior to joining EMAK, Mr. Dar was serving as audit specialist with Arthur Andersen LLP. Mr. Dar holds a Bachelor of Arts degree in business economics from the University of California at Los Angeles and is a registered Certified Public Accountant.  Peter Boutrosjoined EMAK in 2006 and is currently our Chief Executive Officer of EMAKs worldwide Logistix agencies. Mr. Boutros joined EMAK as Chief Executive, Logistix Worldwide in April 2006. Prior to joining EMAK, from February 2003 through July 2005, Mr. Boutros served as Chief Operating Officer of The Creata Company, a global marketing and manufacturing company, where he was responsible for the organizations businesses in North America, Latin America, Europe, Japan and Austral/Asia. Prior thereto, Mr. Boutros spent ten years at The Walt Disney Company in various global positions, including senior vice president of worldwide licensing, managing director, Brazil, and vice president, international marketing and global brand development for Disney Consumer Products. Mr. Boutros holds a diploma in business management from The Australian Institute of Technology.  Brian D. Kristofekjoined EMAK in 2002 and is currently Chief Executive Officer of EMAKs wholly-owned subsidiary Upshot, Inc. Mr. Kristofek was promoted to his current position in March 2007. Mr. Kristofek joined EMAK in connection with the acquisition of Upshot in July 2002, where he had served since 1996. Prior to joining Upshot, Mr. Kristofek was a brand manager at Anheuser Busch, focusing on Budweiser, Michelob and Specialty Beers. Mr. Kristofek holds a Bachelor of Arts degree in marketing and advertising from Marquette University.  Available Information  Our website address iswww.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.  8  ITEM 1A.RISK FACTORS.  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 operation, 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 Restaurant Services, Inc. (RSI) and various distribution companies), which accounted for approximately 51%, 52% and 48% of our revenues for the years ended December 31, 2004, 2005 and 2006, 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 that 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 2008 (shipping through approximately September 2009). 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, the revenues generated by our business with Burger King decreased from $120,606 in 2004 to $117,257 in 2005 and $87,865 in 2006. 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 the Burger King system, which includes Supply Chain Services, LLC (SCS), which is a subsidiary of RSI. We began selling product to SCS in October 2003. Sales to SCS represented 65.1% of our sales to the Burger King System in 2006. Failure by SCS to honor their payment obligations to us could have a material adverse effect on our operations. Because of SCSs established credit history with us, we do not believe that the concentration of receivables has a negative impact to our overall credit risk. We occasionally provide SCS with extended payment terms of up to 60 days. 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 (loss). 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.  9   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 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 2006, 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 (SARS) 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.  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 (U.K.) enters into contracts denominated primarily in U.S. 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.  10   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 1B.
UNRESOLVED STAFF COMMENTS.
  Inapplicable.   ITEM 2.
PROPERTIES.
  Our corporate headquarters consists of approximately 42,000 square feet of space in Los Angeles, California under a lease which expires December 31, 2009. We also lease an approximately 36,000 square foot warehouse in Indianapolis, Indiana under a lease which expires July 31, 2010. In Hong Kong, we occupy approximately 10,000 square feet of space in Kowloon, under a lease which expires August 31, 2008. 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.   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, 2006.            11   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 Global Market under the symbol EMAK. On March 26, 2007 there were approximately 700 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 Stock2005

2006High

Low

High

LowFirst Quarter
10.44

8.76

8.95

6.50Second Quarter
11.09

9.20

8.53

4.56Third Quarter
10.90

7.50

7.88

3.37Fourth Quarter
7.60

5.91

7.30

5.50
  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. No shares were repurchased during the years ended December 31, 2005 and 2006. On March 27, 2006, our Board of Directors adopted a resolution terminating the repurchase program, as we are not planning on making any further stock repurchases.  12  Performance Graph  The following Performance Graph shall not be deemed to be soliciting material or to be filed with the Commission or subject to Regulations 14A or 14C of the Commission or the liabilities of Section 18 of the Exchange Act. Such Report and Performance Graph shall not be deemed incorporated by reference into any filing under the Securities Act or the Exchange Act, notwithstanding any general incorporation by reference of this Proxy Statement into any other document.  Set forth below is a line graph comparing the percentage change in the cumulative total stockholder return on the Companys Common Stock against the cumulative total return of the Standard & Poors 500 Index (S&P 500), and the Russell 2000 Index (Russell 2000) for the five previous fiscal years ended December 31, 2006.    Comparison of cumulative return among the Company, the S&P 500 and the Russell 2000 Index:  12/31/2001
12/31/2002
12/31/2003
12/31/2004
12/31/2005
12/31/2006EMAK Worldwide
$ 100.00
$ 102.77
$ 108.38
$ 76.86
$ 52.11
$ 45.35S&P 500
$ 100.00
$ 76.63
$ 96.85
$ 105.56
$ 108.73
$ 123.54Russell 2000
$ 100.00
$ 78.42
$ 114.00
$ 133.38
$ 137.81
$ 161.24
   13  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,
2002
2003
2004
2005
2006Consolidated Statements of Operations and Per Share Data:(in thousands, except share and per share data)Revenues
$
206,832
$
219,113
$
236,661
$
223,397
$
181,397Cost of sales

151,307

158,117

180,487

164,926

137,458Forgiveness of note receivable

1,685

-

-

-

-Minimum royalty guarantee shortfalls (gain)

-

-

7,722

(2,837)

(88)Gross profit

53,840

60,996

48,452

61,308

44,027Operating expenses:Salaries, wages and benefits

20,662

24,523

31,310

35,090

26,283Selling, general and administrative

22,423

24,576

25,606

23,587

18,657Impairment of assets

--

--

6,312

30,970

--Integration costs

453

--

174

81

--Restructuring loss

178

234

56

2,952

1,213Loss on lease

--

--

311

237

--Dispute resolution charge

--

--

237

--

--ERP reimplementation costs

--

--

59

147

92Total operating expenses

43,716

49,333

64,065

93,064

46,245Income (loss) from operations

10,124

11,663

(15,613)

(31,756)

(2,218)Other income (expense), net

383

389

(787)

37

(354)Income (loss) before provision (benefit) forincome taxes and cumulative effect of changein accounting principles

10,507

12,052

(16,400)

(31,719)

(2,572)Provision (benefit) for income taxes

3,786

4,103

(6,716)

8,153

(307)Income (loss) before cumulative effectof change in accounting principles

of change in accounting principles

6,721

7,949

(9,684)

(39,872)

(2,265)Cumulative effect of change in accountingprinciples, net of tax

(2,496)

--

--

--

--Net income (loss)

4,225

7,949

(9,684)

(39,872)

(2,265)Preferred stock dividends

1,500

1,500

1,500

1,500

375Excess of preferred stock warrants redemptioncost over carrying value

--

--

5,042

--

--Undistributed earnings allocated to participatingpreferred stock

623

1,474

--

--

--Net income (loss) available to commonstockholders
$
2,102
$
4,975
$
(16,226)
$
(41,372)
$
(2,640)Basic income (loss) per share:Income (loss) per share before cumulativeeffect of change in accounting principles
$
0.81
$
0.87
$
(2.82)
$
(7.15)
$
(0.45)Cumulative effect of change in accountingprinciples, net of tax

(0.44)

--

--

--

--Income (loss) per share
$
0.37
$
0.87
$
(2.82)
$
(7.15)
$
(0.45)Basic weighted average shares outstanding

5,721,790

5,718,548

5,753,978

5,782,925

5,834,990Diluted income (loss) per share:Income (loss) per share before cumulativeeffect of change in accounting principles
$
0.78
$
0.83
$
(2.82)
$
(7.15)
$
(0.45)Cumulative effect of change in accountingprinciples, net of tax

(0.42)

--

--

--

--Income (loss) per share
$
0.36
$
0.83
$
(2.82)
$
(7.15)
$
(0.45)Diluted weighted average shares outstanding

5,895,103

6,017,718

5,753,978

5,782,925

5,834,990
   14   As of December 31,

2002

2003

2004

2005

2006Consolidated Balance Sheet Data: (in thousands)Working capital
$
29,157
$
29,447
$
17,934
$
12,520
$
9,963Total assets
$
133,254
$
128,330
$
133,313
$
69,796
$
62,370Mandatorily redeemable preferred stock
$
23,049
$
23,049
$
19,914
$
19,914
$
19,041Stockholders equity
$
45,946
$
53,666
$
48,897
$
6,414
$
6,557
    ITEM 7.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.
 Overview  Revenues for the twelve months ended December 31, 2006 decreased $42,000 (18.8%) to $181,397 as compared to $223,397 recorded in the prior year as a result of a 20.0% decrease in revenues in our Promotional Products segment and by a 61.2% decrease in Consumer Products revenues, partially offset by a 45.1% increase in Agency Services revenues.  The decrease in Promotional Products revenues is primarily attributable to lower unit volumes purchased by our largest client. This decrease was anticipated, as the clients promotional calendar for 2005 was boosted by programs tied to a blockbuster film series (Lucasfilms Star Wars® movies). Loss of revenues from Johnson Grossfield due to the loss of that agencys primary client also contributed to the decrease in that segment. The decrease in Consumer Products revenues is due to the wind-down of our non-core business. The increase in Agency services revenues is the result of work performed for Upshots new clients in 2006.  We recorded a net loss of $2,265 for twelve months ended December 31, 2006 compared to a net loss of $39,872 in the prior year. The higher net loss during 2005 was attributable to the following factors:  
Non-cash impairment charges totaling $30,970 in 2005 for the write-off of goodwill and other intangibles attributable to Johnson Grossfield, Logistix (U.K.) and SCI Promotion. We incurred no impairment charges in 2006
  
Restructuring charges totaling $2,952 in 2005 related to the wind down of our Consumer Products business, the reorganization of our SCI Promotion agency, staff reductions at Logistix (U.K.), the closure of the Johnson Grossfield office in Minneapolis and the elimination of several executive management positions. In 2006, restructuring charges totaled $1,213 which represented the remaining costs incurred in connection with the reorganization of the SCI Promotion agency and the elimination of several executive management positions.
  
We incurred costs totaling $1,350 in 2005 related to the severance of our former CEO.
  
As a result of recent tax losses, we established a valuation allowance of $8,658 in 2005 against previously recorded deferred tax assets related to our U.S. operations. We had a net tax provision of $8,153 despite losses before taxes in 2005. In 2006, we recorded a tax benefit of $307.
  Our efforts to streamline the organizations cost structure had a visible impact in 2006. Salaries, wages and benefits are down $8,807 from 2005 levels. Selling, general and administrative expenses are down $4,930 from 2005 levels. The operating expense savings better aligns our cost model with current client needs. We have streamlined the organization and established a more efficient operating structure that can be leveraged to support profitable growth.  As we put the turnaround efforts largely behind us, the organizations focus turns to growth. Our agencies prospects for growth are very robust and will stem directly from current clients as well as new.  Looking forward to 2007, we continue to anticipate modest to moderate revenue growth. With our now more streamlined and efficient cost structure, we expect to deliver significantly improved net income in 2007.  15  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,
2004

2005

2006Revenues
100.0
%

100.0
%

100.0
%Cost of sales
76.3
%

73.8
%

75.8
%Minimum royalty guarantee shortfalls (gain)
3.2
%

(1.2)
%

--
%Gross profit
20.5
%

27.4
%

24.2
%Operating expenses:Salaries, wages and benefits
13.2
%

15.7
%

14.5
%Selling, general and administrative
10.8
%

10.5
%

10.2
%Impairment of assets
2.7
%

13.9
%

--
%Integration costs
0.1
%

0.0
%

--
%Restructuring loss
0.0
%

1.3
%

0.7
%Loss on lease
0.1
%

0.1
%

--
%Dispute resolution charge
0.1
%

--
%

--
%ERP reimplementation costs
0.1
%

0.1
%

0.1
%Total operating expenses
27.1
%

41.6
%

25.5
%Loss from operations
(6.6)
%

(14.2)
%

(1.3)
%Other income (expense), net
(0.3)
%

0.0
%

(0.1)
%Loss before provision (benefit)for income taxes
(6.9)
%

(14.2)
%

(1.4)
%Provision (benefit) for income taxes
(2.8)
%

3.6
%

(0.2)
%Net loss
(4.1)
%

(17.8)
%

(1.2)
%
  Year ended December 31, 2006 compared to year ended December 31, 2005  Revenues  Our consolidated revenues in 2006 decreased $42,000, or 18.8%, to $181,397 from $223,397 in 2005. Promotional Products revenues decreased $35,334, or 20.0%, to $141,082 primarily attributable to lower revenues at our Equity Marketing agency as a result of a reduction in unit volumes for promotional programs from its largest client and the loss of revenues from Johnson Grossfield due to the loss of that agencys primary client. Net foreign currency translation had a favorable impact to revenues of approximately $391 for Logistix (U.K.) versus the prior year period average exchange rates.  Our Agency Services segment revenues increased $9,367, or 45.1%, to $30,133 from $20,766 in 2005. The increase is primarily attributable to increased Upshot revenues for promotional work performed for a large client in the U.S. In March 2005, Upshot was one of two agencies selected for the promotional business of this large client and promotional work began in April 2005. The increase in Agency Services revenues is also attributable to higher levels of retainer revenues for other existing clients.  Our Consumer Products segment revenues decreased $16,033, or 61.2%, to $10,182 from $26,215 in 2005. The decrease is primarily attributable to the wind-down of the non-core business. The majority of the Consumer Products license agreements expired in December 2005. Our 2006 Consumer Product revenues were primarily comprised of Crayola®, JoJos Circus and Mighty Helmet Racers product.  Cost of sales and gross profit  Cost of sales decreased $27,468 to $137,458 (75.8% of revenues) from $164,926 (73.8% of revenues) in 2005 primarily due to lower sales volume in 2006.  Our gross margin percentage decreased to 24.3% from 27.4% in 2005. This decrease is the result of a gain of $2,837 recorded in 2005 as compared with $88 recorded in 2006 on the partial reversal of a previously recorded minimum royalty guarantee shortfall charge recorded in the fourth quarter of 2004. Excluding the impact of this gain, the gross profit percentage decreased to 26.2% from 27.4% in 2005.  The gross profit percentage for our Promotional Products segment decreased to 23.4% compared to 25.6% in 2005. This decrease is attributable to a few high volume but low margin Logistix (U.K.) promotional programs in 2006.  16   The gross profit percentage for our Agency Services segment decreased to 30.4% compared to 36.3% in 2005. This decrease is attributable to a higher level of direct outside costs in 2006, partially offset by higher retainer revenues which carry higher overall margins. Agency Services gross profit includes direct outside costs which fluctuate, making period-over-period comparables of the gross profit percentages difficult. Typically billings for direct outside costs, which are included in revenues, have very low gross margins. In periods in which segment revenues contain significant direct outside costs, the overall gross profit percentage will be lower.  The gross profit percentage for our Consumer Products segment decreased to 17.6% compared to 33.1% in 2005. This decrease in the margin is attributable to the gain of $2,837 discussed above. Excluding the impact of this gain, the gross profit percentage decreased to 16.8% from 22.3% in 2005. This decrease is the result of a write-off of $716 for barter credits obtained in 2004 and 2005. The decrease is also attributable to higher level of close-out sales of discontinued products and by a write-off of a pre-paid royalty related to discontinued products.  Salaries, wages and benefits  Salaries, wages and benefits decreased $8,807, or 25.1%, to $26,283 (14.5% of revenues) from $35,090 (15.7% of revenues) in 2005. This decrease was primarily attributable to a reduction in personnel of approximately 30 employees as a result of our restructuring initiatives designed to streamline operations. In 2005, costs of $1,350 were recorded relating to the departure of the Companys former CEO and $1,200 recorded for the accrual of contractual bonuses.  Selling, general and administrative expenses  Selling, general and administrative expenses decreased $4,930, or 20.9%, to $18,657 (10.2% of revenues) from $23,587 (10.5% of revenues) in 2005. The decrease is attributable to a reduction in marketing expense, commissions, freight out, third party warehousing and other selling expenses as a result of lower revenues and inventory levels for Consumer Products. The decrease was also attributable to lower occupancy costs resulting from the termination of an office and warehouse lease in Ontario, California and an office lease in Minneapolis as well as the sublease of a portion of our Los Angeles office. The decrease was also attributable to lower insurance costs and depreciation and amortization expense. This was partially offset by an increase in legal fees and other outside services costs incurred in connection with a now resolved proxy contest and an increase in bank charges for our credit facility with Bank of America.  Impairment of assets  We recorded a charge for impairment of assets of $30,970 (13.9% of revenues) in 2005. The charge is the result of a reduction in the fair value of certain reporting units due to a significant downturn in the forecasted cash flows used in the annual impairment test required by SFAS No. 142. A charge of $16,701 relates to Logistix (U.K.) agency whose largest client reduced the number and size of its promotional programs. A charge of $10,838 relates to SCI Promotion, which includes the business of USI (acquired in 1998). SCI Promotions retail department store clients are coping with industry consolidation and poor performance in 2005, resulting in tighter marketing budgets and smaller, less frequent promotional programs. A charge of $3,431 relates to the impairment of goodwill and other intangible assets of Johnson Grossfield as a result of the loss of that agencys primary client in August 2005. See Critical
Accounting Policies  Goodwill and Other Intangibles below.  Integration costs  We recorded integration costs of $81 (0.0% of revenues) in 2005. These are primarily travel, training and consulting costs directly related to the integration of Megaprint Group.  Restructuring  We recorded a restructuring charge of $1,213 (0.7% of revenues) compared to $2,952 (1.3% of revenues) in 2005. This charge represents severance expenses and other termination costs related to the reorganization of the SCI Promotion agency, the elimination of three centralized senior management positions, the elimination of two senior management positions as a result of the consolidation of SCI Promotion, Pop Rocket and Megaprint Group into the new Logistix agency and staff reductions in our Hong Kong office. The restructuring charge in 2005 consists primarily of severance expense and other termination costs resulting from our decision to wind down substantially all of our Consumer Products business, Pop Rocket, from staff reductions at Logistix (U.K.), the closure of the Johnson Grossfield office in Minneapolis, the reorganization of the SCI Promotion agency and the elimination of executive management positions. See
Restructuring below.  17  Loss on lease  We recorded a charge of $237 (0.1% of revenues) in 2005 on the Logistix (U.K.) office lease due to softness in the commercial real estate market for one of the Companys currently sublet offices in the U.K. Our subtenant has an option to terminate the lease and current market conditions indicated that we may incur a loss on the new sublease. This space had been sublet by Logistix in the U.K. prior to our acquisition. As a result of the anticipated loss we adjusted our liabilities and incurred this charge.  In 2005, we recorded a loss on our Los Angeles office lease of $184 for the estimated loss on the sublease of a portion of the premises over the term of the sublease ending December 31, 2009 (concurrent with the expiration of the master lease term).  ERP reimplementation costs  We recorded enterprise resource planning (ERP) reimplementation costs of $92 (0.1% of revenues) compared to $147 (0.1% of revenues) in 2005. This represents preliminary evaluation 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 $391 to $(354) from $37 in 2005. The decrease is primarily due to foreign currency losses as a result of the strengthening of the British pound relative to the U.S. dollar. This decrease was partially offset by a decrease in interest expense relating to short-term borrowings compared to the same period in 2005. The foreign currency transaction gains in 2005 were primarily a result of gains on forward contracts due to the strengthening of the U.S. dollar relative to the British pound. The Companys Logistix (U.K.) subsidiary purchases the bulk of its inventories from the Far East in U.S. dollars.  Provision (benefit) for Income Taxes  The effective tax rate changed in 2006 to 11.9% from (25.7)% in 2005. We recorded a net benefit for income taxes of $307 as the result of more favorable state income tax apportionment factors than originally anticipated in our previous tax provision estimates. In 2005, we established a valuation allowance of $8,658 against previously recorded deferred tax assets related to our U.S. operations. As a result, in 2005 we had a tax provision despite losses before taxes.  Net loss  Net loss decreased $37,607, to $(2,265) in 2006 ((1.2)% of revenues) from $(39,872) in 2005 ((17.8)% of revenues) primarily due to charges recorded in 2005 for the impairment of assets, the restructuring charge and the loss on lease. The decrease is also attributable to a reduction in salaries, wages and benefits and selling, general and administrative expenses.  Year ended December 31, 2005 compared to year ended December 31, 2004  Revenues  Our consolidated revenues in 2005 decreased $13,264, or 5.6%, to $223,397 from $236,661 in 2004. Promotional Products revenues decreased $15,858, or 8.2%, to $176,416 primarily the result of a decline in international revenues at Logistix (U.K.) and a decline in revenues for Johnson Grossfield due to the loss of that agencys primary client in August 2005. The decrease was partially offset by an increase in revenues from SCI Promotion attributable to new client wins. The results for 2005 include Johnson Grossfield (acquired February 2, 2004) and Megaprint Group (acquired November 10, 2004). Revenues for the Equity Marketing business decreased as a result of our decision not to pursue certain low margin logistical services. This was partially offset by an increase in sales attributable to increased unit volumes for programs relative to 2004. Our largest clients revenues represented 52% of total revenues in
2005 as compared to 51% in 2004.  In 2005, revenues for our Logistix (U.K.) business decreased as a result of a reduction in the number and size of promotional programs for its largest client, despite the addition of revenues from the Megaprint Group acquisition. The agency experienced a lower win rate of promotional programs from its largest client as well as a scale back of previously awarded programs. In addition, net foreign currency translation impact contributed approximately $267 to the revenues for Logistix (U.K.) versus the prior year period average exchange rates.  Our Agency Services segment revenues increased $1,514, or 7.9%, to $20,766 from $19,252 in 2004. The increase is primarily attributable to increased Equity Marketing and Upshot agency revenues for promotional work. In March 2005, Upshot was one of two agencies selected for the promotional business of this large client and promotional work began in April 2005. The increase in Agency Services revenues is also attributable to higher levels of retainer revenues for other existing clients.  18   Our Consumer Products revenues increased $1,080 or 4.3%, to $26,215 from $25,135 in 2004. The increase is primarily attributable to the introduction of Disneys JoJos Circus in 2005 and continued revenue growth of Baby Einstein and Crayola® product lines, partially offset by a decline in sales of Scooby-Doo product. Revenues for 2005 were primarily comprised of Scooby-Doo, Crayola®, Baby Einstein and JoJos Circus brands. In 2005, we began distributing the first toy products based on JoJos Circus, the popular Disney series produced in stop-motion animation. The continued growth in our Crayola® line of bath toys was attributable to an expanded product line and expanded distribution channels.  Cost of sales and gross profit  Cost of sales decreased $15,561 to $164,926 (73.8% of revenues) from $180,487 (76.3% of revenues) in 2004 due to lower sales volume in 2005. The gross profit percentage increased to 27.4% from 20.5% in 2004. This increase is primarily the result of a gain of $2,837 on the partial reversal of a previously recorded minimum royalty guarantee shortfall charge in the fourth quarter of 2004. The reversal is due to an agreement reached with one of our major licensors to exit certain licenses early in exchange for a reduction in overall royalty guarantee requirements. In 2004, we recorded a charge for minimum royalty guarantee shortfalls of $7,722 on several Consumer Products licenses resulting from the decision to wind down our consumer products business.  The gross profit percentage for our Promotional Products segment increased to 25.6% compared to 22.8% in 2004. This increase is attributable to an improved sales mix, as we have been phasing out certain low-margin logistical services for our largest client, partially offset by a decrease in gross margins from our SCI Promotion agency resulting from competitive pressures and materials cost increases in Asia.  The gross profit percentage for our Agency Services segment increased to 36.3% compared to 35.1% in 2005. This increase is attributable to increasing higher-margin fee-based revenues from our Equity Marketing and Upshot agencies. Agency Services gross profit includes direct outside costs which fluctuate, making period-over-period comparables of the gross profit percentages difficult. Typically billings for direct outside costs, which are included in revenues, have very low gross margins. In periods in which segment revenues contain significant direct outside costs, the overall gross profit percentage will be lower.  The gross profit percentage for our Consumer Products segment decreased to 17.6% compared to 33.1% in 2005. This decrease in the margin is attributable to the gain of $2,724 discussed above. Excluding the impact of this gain, the gross profit percentage decreased to 16.8% from 22.3% in 2005. This decrease is the result of a write-off of $716 for barter credits obtained in 2004 and 2005. The decrease is also attributable to higher level of close-out sales of discontinued products and by a write-off of a pre-paid royalty related to discontinued products.  The minimum royalty guarantee shortfalls (gain) contributed a positive impact of 1.2% to the gross profit percent in 2005 and 3.2% negative impact to the gross profit in 2004. The gross profit percentage in the Consumer Products segment increased from (8.2)% in 2004 to 33.1% in 2005 as a result of the impact of the minimum royalty guarantee shortfalls (gain).  Salaries, wages and benefits  Salaries, wages and benefits increased $3,780 in 2005, or 12.1%, to $35,090 (15.7% of revenues) from $31,310 (13.2% of revenues). This increase was primarily attributable to costs related to the departure of the Companys former CEO ($1,350), accruals for contractual bonuses ($1,200), annual employee merit pay increases, additional compensation expense resulting from grants of restricted stock units, an increase in recruiting costs and the addition of approximately 25 employees from the Megaprint Group acquisition. Of the $1,200 in contractual bonuses, $900 (75%) was paid in cash and the remainder of $300 (25%) was paid in shares of our Common Stock. These increases were partially offset by staffing reductions at Logistix (U.K.), SCI Promotion and the elimination of several executive management positions.  Salaries, wages and benefits increased as a percentage of revenues from 13.2% to 15.7% as a result of decreasing revenues. The impact of staffing reductions was not visible until 2006.  Selling, general and administrative expenses  Selling, general and administrative expenses decreased $2,019 in 2005, or 7.9%, to $23,587 (10.5% of revenues) from $25,606 (10.8% of revenues) in 2004. The decrease is attributable to a reduction in freight, creative development and marketing costs, partially offset by additional operating expenses resulting from the inclusion of the Megaprint Group business in the current year and by increased commissions resulting from higher Consumer Products revenues.  Selling, general and administrative expenses decreased as a percentage of revenues from 10.8% to 10.5% as a result of lower selling expenses which decreased at a faster rate than revenues.  19   Impairment of assets  We recorded a charge for impairment of assets of $30,970 (13.9% of revenues) in 2005 compared to $6,312 (2.7% of revenues) in 2004. The charge is the result of a reduction in the fair value of certain reporting units due to a significant downturn in the forecasted cash flows used in the annual impairment test required by SFAS No. 142. A charge of $16,701 relates to Logistix (U.K.) agency whose largest client reduced the number and size of its promotional programs. A charge of $10,838 relates to SCI Promotion, which includes the business of USI (acquired in 1998). SCI Promotions retail department store clients are coping with industry consolidation and poor performance, resulting in tighter marketing budgets and smaller, less frequent promotional programs. A charge of $3,431 relates to the impairment of goodwill and other intangible assets of Johnson Grossfield as a result of the loss of that agencys primary
client in August 2005. The 2004 charge relates to a write-down of goodwill resulting from the 2002 acquisition of Upshot as a result of the loss of a significant client in the fourth quarter of 2004. See Critical Accounting Policies  Goodwill and Other Intangibles below.  Integration costs  We recorded integration costs of $81 (0.0% of revenues) in 2005 compared to $174 (0.1% of revenues) in 2004. These are primarily travel, training and consulting costs directly related to the integration of Megaprint Group. The costs in 2004 are primarily travel costs directly related to the integration of SCI Promotion and Johnson Grossfield.  Restructuring  We recorded a net restructuring charge of $2,952 (1.3% of revenues) compared to $56 (0.0% of revenues) in 2004. This charge consists primarily of severance expense and other termination costs resulting from our decision to wind down substantially all of our Consumer Products business, Pop Rocket, from staff reductions at Logistix (U.K.), the closure of the Johnson Grossfield office in Minneapolis, the reorganization of the SCI Promotion agency and the elimination of executive management positions. The costs in 2004 are 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 the severance for workforce reductions at Upshot.  Loss on lease  We recorded a charge of $237 (0.1% of revenues) on the Logistix (U.K.) office lease due to softness in the commercial real estate market for one of the Companys currently sublet offices in the U.K. Our subtenant has an option to terminate the lease and current market conditions indicated that we may incur a loss on the new sublease. This space had been sublet by Logistix in the U.K. prior to our acquisition. As a result of the anticipated loss we adjusted our liabilities and incurred this charge.  In 2004, we recorded a loss on our Chicago office lease of $311. This is due to lower than estimated sublease income for vacated office space in the Upshot business. The office space was sublet at rates modestly below our initial estimates, due to softness in the Chicago real estate market.  In 2005, we recorded a loss on our Los Angeles office lease of $184 for the estimated loss on the sublease of a portion of the premises over the term of the sublease ending December 31, 2009 (concurrent with the expiration of the master lease term).  ERP reimplementation costs  We recorded enterprise resource planning (ERP) reimplementation costs of $147 (0.1% of revenues) in 2005 compared to $59 (0.1% of revenues) in 2004. This represents preliminary evaluation 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) increased $824 in 2005, to $37 (0.0% of revenues) from $(787) ((0.3)% of revenues) in 2004. Other income is composed of a gain on foreign exchange of $342, a gain on asset disposal of $17, other income of $27 and net interest expense of $349. Net interest expense increased $198 to $349 in 2005 from $151 in 2004 due to reduced levels of cash and cash equivalents and increased short-term borrowings in 2004. The foreign currency transaction gains in 2005 were primarily a result of gains on forward contracts due to the strengthening of the U.S. dollar relative to the British pound. The Companys Logistix (U.K.) subsidiary purchases the bulk of its inventories from the Far East in U.S. dollars.  21  Provision (benefit) for Income Taxes  The effective tax rate changed in 2005 to (25.7)% from 41.0% in 2004. We established a valuation allowance of $8,658 against previously recorded deferred tax assets related to our U.S. operations. As a result, we have a tax provision despite losses before taxes.  Net loss  Net loss increased $30,188, to $(39,872) in 2005 ((17.8)% of revenues) from $(9,684) in 2004 ((4.1)% of revenues) primarily due to the impairment of assets, the restructuring charge and increased salaries, wages and benefits. This was partially offset by an increase in gross margins in 2005 as compared to 2004 and the gain on the reversal of a portion of the minimum royalty guarantee shortfalls.  Financial Condition and Liquidity  Overview  Despite losses in 2006, we believe that our balance sheet is healthy. We generated $5,629 in cash flows from operations as a result of a decreased investment in working capital as of the end of 2006. We ended 2006 with $8,677 of cash and cash equivalents, $1,319 of restricted cash and no debt.  We have largely completed the wind down of a majority of our Consumer Products business. Historically, this business required disproportionately large investments in working capital relative to the revenues it generated.  In 2007, we expect to use cash to fund operations to meet working capital needs in the Promotional Products and Agency Services segments. We believe that cash from operations, cash on hand at December 31, 2006 and our credit facility will be sufficient to fund working capital needs for the next twelve months and for the foreseeable future. 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.  2006 Compared to 2005  At December 31, 2006, cash and cash equivalents increased by $2,362 to $8,677 compared to $6,315 at December 31, 2005, primarily due to the cash generated from operations. At December 31, 2006, restricted cash was $1,319 compared to $0 as of December 31, 2005.  As of December 31, 2006, net accounts receivable decreased $5,048 to $24,327 from $29,375 in 2005. This decrease was primarily due to lower revenues at Equity Marketing and Logistix (U.K.) in the fourth quarter of 2006. The decrease is also attributable to the wind-down of our non-core Consumer Products business.  At December 31, 2006, inventories decreased $4,860 to $6,386 from $11,246 in 2005. This was primarily due to a decrease in Promotional Products inventories for product scheduled for delivery in the first quarter of 2007. This decrease is also attributable to reduced inventory levels in the Consumer Products segment as a result of the wind down. Promotional Products inventories represent 63% and 67% of total inventories as of December 31, 2005 and 2006, respectively. Promotional Products inventories generally have lower risk than Consumer Products inventories, as they usually represent product made to order.  At December 31, 2006, accounts payable increased $120 to $20,238 from $20,118 in 2005.  At December 31, 2006, deferred revenue decreased $1,858 to $1,236 from $3,094 in 2005. This decrease is primarily attributable to the timing of Agency Services programs.  Due to customer increased $1,863 to $4,658 from $2,795 in 2005. This increase in due to customer was primarily due to the timing of the payment of administrative fees collected from distribution companies on behalf of a significant Promotional Products client.  At December 31, 2006, accrued liabilities, including accrued payroll and payroll related costs, decreased $5,159 to $8,346 from $13,505 in 2005. This decrease is primarily attributable to royalty payments resulting from the remaining amount of minimum royalty guarantee shortfall obligations recorded in 2004, the payment of 2005 contractual bonuses, payments of severance and other costs related to the 2005 restructurings.  At December 31, 2006, working capital was $9,963 compared to $12,520 at December 31, 2005. Cash flows provided by operations for 2006 were $5,629 compared to $12,093 in the prior year. This change is primarily the result of the collections of accounts receivable in 2005 from large fourth quarter 2004 promotional programs. Cash flows used in investing activities for 2006 increased  22  $378 to $3,078 from $2,700 in the prior year. This increase is primarily the result of restricted cash used to fund a bank guarantee to a new vendor of our Logistix (U.K.) subsidiary. In addition, the former Megaprint shareholders were paid $313 upon release of a purchase price holdback. Cash flows used in financing activities for 2006 were $763 compared to $7,410 in the prior year. This is primarily the result of the repayment of short-term borrowings used to finance the purchase of the Megaprint Group and the repayment of bank advances at Logistix (U.K.) in 2005. The reduction in cash used in financing activities is also attributable to the elimination of preferred stock dividends effective April 1, 2006.  Commitments  Future minimum annual commitments for guaranteed minimum royalty payments under license agreements, non-cancelable operating leases and employment agreements as of December 31, 2006 are as follows:  2007

2008

2009

2010

2011

Thereafter

TotalOperating Leases
$
4,126
$
3,981
$
3,795
$
665
$
546
$
1,112
$
14,225Guaranteed Royalties

270

300

--

--

--

--

570Employment Agreements

2,987

--

--

--

--

--

2,987Total
$
7,383
$
4,281
$
3,795
$
665
$
546
$
1,112
$
17,782
  We had no material commitments for capital expenditures at December 31, 2006. Letters of credit outstanding as of December 31, 2005 and 2006 totaled $2,763 and $310, respectively.  Credit Facilities  On April 24, 2001, we signed a credit facility (the Prior Facility) with Bank of America. On April 26, 2004, the maturity date of the Prior Facility was extended through June 30, 2005. Effective March 30, 2005 the maturity date of the Facility was further extended through March 31, 2006. The credit facility was collateralized by substantially all of our assets and provided for a line of credit of up to $20,000 with borrowing availability determined by a formula based on qualified assets. Interest on outstanding borrowings was 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 were 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 was based on the achievement of certain financial ratios. As of December 31, 2005, the marginal interest rate on available borrowings under the Prior Facility was 7.5%. As of December 31, 2005, $0 was outstanding under the Prior Facility.  On March 29, 2006, we entered into a new credit facility (the Facility) with Bank of America. The maturity date of the Facility is March 29, 2009. The Facility is collateralized by substantially all of our assets and provides for a line of credit of up to $25,000 with borrowing availability determined by a formula based on qualified assets. Interest on outstanding borrowings will be based on either a fixed rate equivalent to LIBOR plus an applicable spread of between 2.50 and 3.00 percent or a variable rate equivalent to the banks reference rate plus an applicable spread of between 0.75 and 1.25 percent. We are also required to pay an unused line fee of between 0.375 and 0.50 percent per annum and certain letter of credit fees. The applicable spread is based on the levels of borrowings relative to qualified assets. The Facility also requires us to comply with certain restrictions and
covenants as amended from time to time. The Facility may be used for working capital and other corporate financing purposes. The Facility does not permit the payment of dividends on Series AA Preferred Stock in 2006. The restriction on dividends may be removed in 2007 subject to 2006 audited results and compliance with covenants. On May 10, 2006, certain covenants under the Facility were amended. On August 11, 2006, we amended the Facility to provide for a temporary bridge facility to increase our available borrowings by up to $7,000 to fund working capital for a specific client program. The finance charges for borrowings under the bridge facility were 300 basis points greater than the interest charges under the Facility. This bridge facility expired November 30, 2006. As of December 31, 2006, the marginal interest rate on available borrowings under the Facility was 9.0%. As of December31, 2006, we were in compliance with the restrictions and covenants. As of December 31, 2006, $0 was outstanding
under the Facility.  In addition to the Facility, in October, 2003 our Logistix (U.K.) agency established an import/letter of credit facility with Hong Kong Shanghai Bank Corp. (HSBC) to provide short-term financing of product purchases in Asia. The total availability under this facility is 0 GBP. The total availability under this facility was increased from 1,000 GBP to 1,500 GBP in 2005. Under this facility HSBC may pay the agencys vendors directly upon receipt of invoices and shipping documentation. Logistix (U.K.) in turn is obligated to repay HSBC within 120 days. As of December 31, 2005 and 2006, $0 was outstanding under this facility. This facility expired in the fourth quarter of 2006.  24  Acquisitions and Impairment of Assets  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. The carrying value of the Upshot goodwill was $8,245 as of December 31, 2006. 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. An earnout of $800 was paid for 2003 performance. No earnouts were payable based upon 2004 through 2006 performance.  In the fourth quarter of 2005, we incurred a goodwill impairment charge of $10,838 in connection with the annual impairment test required by SFAS No. 142 for SCI Promotion. This charge is based on our most recent projections, which were formulated in the fourth quarter of 2005. Our projections were negatively impacted by the continuing trend of department store consolidation, and its industry-specific challenges which have resulted in smaller marketing budgets, fewer programs and smaller program sizes. Competitive pressures and materials cost increases in Asia have also compressed margins. See Critical Accounting Policies  Goodwill and Other Intangibles below. Included in the impairment analysis for SCI Promotion is $8,318 of goodwill related to the business of U.S. Import & Promotion, Co. (USI), which is our seasonal toy and promotions business catering to the oil and gas retailers. USI was
acquired in 1998 and later consolidated with SCI because its client base and offerings were complementary. SCI Promotion goodwill and other intangibles was $2,580 as of December 31, 2006.  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 (based upon a contractually agreed value of $13.97 per share). On April 19, 2005, we reached agreement with the sellers of Johnson Grossfield on the amount of earnout attributable to 2004 performance. Such earnout consideration totaled $257, of which $148 was payable in cash and the remainder payable in shares of our Common Stock (10,616 shares with a market value of $109 as of April 19, 2005). This earnout consideration was recorded as
goodwill in the second quarter of 2005.  On August 9, 2005, we were notified by the Subway Franchisee Advertising Fund Trust (SFAFT) that following completion of fulfillment on Subway Restaurants kids meal programs by Johnson Grossfield in November 2005, the relationship between Johnson Grossfield and Subway Restaurants would be terminated. As a result, in 2005 we recorded a charge of $3,431 for the impairment of goodwill and other intangible assets of Johnson Grossfield. Johnson Grossfield goodwill and other intangibles was $0 as of December 31, 2006. See Critical Accounting Policies  Goodwill and Other Intangibles below.  24  On November 10, 2004, we acquired all of the outstanding capital stock of Megaprint Group Limited (Megaprint Group), a privately held creative promotions agency headquartered in the United Kingdom. We financed the Megaprint Group acquisition through short-term debt. We paid 1,824 GBP (approximately US $3,388) in cash (net of a hold back for working capital adjustments of 180 GBP), plus related transaction costs of 305 GBP (approximately US $566). Under the terms of the Share Purchase Agreement, we were 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 accrued a liability for the minimum payment of 850 GBP as purchase price as of the acquisition date. We 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. No earnout was payable based upon the 2005 performance.  During the second quarter of 2005, an additional 256 GBP (approximately $461) was paid to the sellers of Megaprint Group for a working capital adjustment. The additional consideration was recorded as goodwill in the accompanying consolidated balance sheet.  Included in net current liabilities for the Megaprint Group as of the acquisition date was a mortgage loan for a building in the Netherlands. The balance of the mortgage loan as of the acquisition date totaled approximately 900 Euros (approximately $1,200). The building was recorded under fixed assets and was recorded at the same value as the balance of the mortgage loan. The building and mortgage loan were held in trust by the Megaprint Group on behalf of its former shareholders (the Sellers). In June 2005, we repaid the mortgage loan. The amount repaid of 900 Euros (approximately $1,090) was applied against monies owed to the Sellers for the 2004 Earnout Payment. As a result, in June 2005, we paid the sellers 199 GBP (approximately $360) of the 850 GBP owed for the 2004 Earnout Payment. Subsequent to the repayment of the mortgage loan, the building was sold in June 2005 for 747 Euros
(approximately $939). The proceeds from the sale were paid to the Sellers in the third quarter of 2005.  On March 31, 2006, we released 180 GBP ($313) to the former shareholders of Megaprint Group Limited related to a purchase price holdback under the terms of the Stock Purchase Agreement between the Company and Megaprint Group Limited. The holdback was recorded as an accrued liability as of the acquisition date. As a result, the release of the holdback had no impact on goodwill for the year ended December 31, 2006.  Effective January 1, 2005, the Megaprint Group was consolidated with the Logistix (U.K.) reporting unit, because its client base and service offerings were complementary to Logistix. As a result, the balance of Megaprint Group goodwill and other intangibles is analyzed in connection with the annual impairment test for the Logistix (U.K.) reporting unit. Throughout 2004, Logistix (U.K.) won all of its largest clients pan-European programs. The agency had a long string of consecutive wins, and it did not repeat this win rate in 2005. Additionally, this client has reduced the number and size of its promotional programs. Therefore, we incurred a goodwill impairment charge of $16,701 in the fourth quarter of 2005 in connection with the annual impairment test required by SFAS No. 142. Logistix (U.K.) goodwill and other intangibles was $2,955 as of December 31, 2006. See Critical Accounting Policies  Goodwill and
Other Intangibles below.  Issuance of Preferred Stock  On June 30, 2006, we entered in an Exchange and Extension Agreement with Crown EMAK Partners, LLC (Crown) providing that: (a) the conversion price of the our Series AA Senior Cumulative Convertible Preferred Stock (Series AA Stock) would be reduced from $14.75 per share of Common Stock to $9.00 per share of Common Stock; (b) the 6% cumulative perpetual dividend on the $25,000 face value of the Series AA Stock ($1,500 per annum) would be permanently eliminated effective April 1, 2006; (c) the provisions pertaining to election of Series AA directors would be revised to permit the holders of the Series AA Stock to elect two directors except (i) if the number of Common Stock directors exceeds seven or (ii) in situations involving a potential Change of Control (as defined in the Certificate of Designation of Series AA Stock) at a time when the total number of
directors (inclusive of Common Stock directors and Series AA Stock directors) exceeds eight, in either of which instances the holders of the Series AA Stock would be permitted to elect three directors; and (d) the terms of the Common Stock warrants held by Crown which previously expired on March 29 and June 20, 2010 would be extended until March 29 and June 20, 2012 (collectively, the Crown Transaction).  At our Annual Meeting held on May 31, 2006, our stockholders approved an amendment to the Certificate of Designation of the Companys Series AA Stock (the Certificate of Designation) in order to permit the closing of the Crown Transaction. The Certificate of Amendment of Certificate of Designation provides for the changes in the rights and preferences of the Series AA Stock.  Also in connection with the closing of the Crown Transaction, effective as of May 31, 2006, we entered into an Amendment No. 1 to Rights Agreement with Continental Stock Transfer & Trust Company as rights agent (Amendment No. 1) with respect to our Preferred Share Purchase Rights Plan (the Plan). Amendment No. 1 provides that the shares of Common Stock issuable upon conversion of the Series AA Stock, as may be amended from time to time, or upon the exercise of any options or warrants Crown holds to acquire our capital stock (as the same may be amended from time to time), in each case held by Crown as of May 31, 2006 or issuable to Crown as a result of the transactions approved by our stockholders at our 2006 Annual Meeting of Stockholders, will not result in a triggering of rights under the Plan.  25  The Crown Transaction was closed on June 30, 2006. We accounted for the transaction as a modification of equity instruments. As a result, the decrease in the fair value of the Series AA Stock was recorded as a reduction to mandatorily redeemable preferred stock of $873 with an offset to net income available to common stockholders. The increased in the value of the common stock warrants was recorded as an increase to additional paid-in capital of $873 with an offset to net income available to common stockholders. The net impact to income available to common stockholders is zero. Direct outside costs related to this transaction totaled $157 and were recorded as a reduction to additional paid-in capital.  Restructuring and Minimum Royalty Guarantee Shortfalls  In 2004, we implemented a restructuring plan in connection with the realignment of centralized resources in our Promotional Products 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 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.  In 2004, we finalized a decision to pursue the wind-down of a substantial majority of our Consumer Products business. Our determination was to significantly scale back this business during 2005 while exiting a substantial majority of the business permanently as soon as is feasible. As a result of the wind-down, in the fourth quarter of 2004, we recorded a pre-tax charge of $7,722 relating to minimum royalty guarantee shortfalls on several Consumer Products licenses. This charge was determined based on contractual commitments as of December 31, 2004 and reflected our decision not to fully exploit these licenses. Approximately $3,000 of this pre-tax charge was non-cash for write-offs of long-term royalty advances. The charge was recorded as minimum royalty guarantee shortfalls in the consolidated statement of operations for the year ended December 31, 2004.  On May 18, 2005, we reached a settlement with one of our licensors affecting several licenses. Under the terms of the settlement, we agreed to forgo our rights to certain licensed properties for 2006 and 2007 in exchange for a reduction in the overall royalty guarantees. We retained product distribution rights under the licenses for 2005. As a result of this settlement, our overall commitment for royalty guarantees was reduced by approximately $4,000. We paid the licensor a total of $1,800 through March 31, 2006. As a result of this settlement and higher than expected Scooby-Doo revenues that exceeded our initial estimates, $2,837 of the 2004 charge for minimum royalty guarantee shortfalls was reversed in 2005. In 2006, we reached a settlement with a different licensor which resulted in a reversal of $88. These reversals were recorded as minimum royalty guarantee shortfall gains in the consolidated statements of
operations for the year ended December 31, 2005 and 2006.  In 2005, in connection with the Consumer Products wind-down, we incurred a charge for one-time employee termination benefits and other costs totaling approximately $746. In 2006, we recorded an additional charge of $38 for employee termination costs. Such costs are recorded as a restructuring charge in the condensed consolidated statement of operations. The entire amount is attributable to the Consumer Products segment.  In 2005, we eliminated several centralized corporate positions as a result of a realignment of centralized resources. As a result, we incurred a charge for one-time employee termination benefits and other costs totaling approximately $622 in 2005. In 2006, we incurred an additional $58 for employee termination benefits. Such costs are recorded as a restructuring charge in the consolidated statement of operations. The entire amount is attributable to the corporate segment.  In 2005, we eliminated several positions at Logistix (U.K.) as a result of a less than optimal staff utilization rate resulting from a decrease in revenues. In connection with this decision, we incurred charges for one-time employee termination benefits and other costs totaling $568. In 2006, we incurred an additional $17 for one-time employee termination benefits and other costs. Such costs are recorded as a restructuring charge in the consolidated statements of operations. The entire amount is attributable to the Promotional Products segment.  In 2005, we made the determination to close our Minneapolis office effective October 31, 2005. We recorded a charge of approximately $192 for one-time employee termination benefits related to the closure of the Minneapolis office. Such costs are recorded as a restructuring charge in the consolidated statement of operations for 2005. The entire amount is attributable to the Promotional Products segment.  In 2005, we made a decision to reorganize and consolidate SCI Promotions offices in Ontario, California with our Los Angeles office. We recorded a charge for one-time employee termination benefits and other costs totaling $640. In 2006, we incurred an additional $723 for employee termination benefits and other costs. The entire amount is attributable to the Promotional Products segment.  In 2005, we made the determination to sublease approximately 15,000 square feet of our Los Angeles office space. The space was sublet effective December 15, 2005 for a term ending December 31, 2009 (the expiration of the master lease term). We recorded a charge of $184 for the estimated loss on the sublease over the term. Such costs are recorded as a restructuring charge in the consolidated statement of operations for 2005. The entire amount is attributable to the corporate segment.  27  In 2006, in connection with our decision to consolidate the SCI Promotion, Pop Rocket and Megaprint Group agencies into Logistix, we made a decision to eliminate two senior management positions. We recorded a charge for one-time employee termination benefits and other costs totaling $283. The entire amount is attributable to the Promotional Products segment.  In 2006, we made a decision to reorganize our Hong Kong office to better align our operations with the current business needs. As a result, we recorded a charge of $94 for one-time termination benefits associated with staff reductions in our Hong Kong office.  The following table summarizes activity in our restructuring reserve.  Pop Rocket *
Centralized Corporate *
Logistix (U.K.) *
Johnson Grossfield *
SCI Promotion *
Los Angeles Office Sublease
Logistix Consolidation *
Upshot *
Hong Kong *
TotalReserve at December 31, 2003
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
366
$
-
$
366Restructuring charge

-

81

-

-

-

-

-

-

-

81Reversal of restructuring reserve

-

-

-

-

-

-

-

(25)

-

(25)Utilization in 2004

-

(81)

-

-

-

-

-

(341)

-

(422)Reserve at December 31, 2004

-

-

-

-

-

-

-

-

-

-Restructuring charge
$
746
$
622
$
568
$
192
$
640
$
184
$
-
$
-
$
-
$
2,952Utilization in 2005

(513)

(261)

(137)

(96)

(110)

-

-

-

-

(1,117)Reserve at December 31, 2005

233

361

431

96

530

184

-

-

-

1,835Restructuring charge

38

58

17

-

723

-

283

-

94

1,213Utilization

(271)

(419)

(427)

(96)

(1,244)

(117)

(261)

-

(94)

(2,929)Reserve at December 31, 2006
$
-
$
-
$
21
$
-
$
9
$
67
$
22
$
-
$
-
$
119
  * One-time employee termination benefits and other related costs.  Income Taxes We assess the realizability of our deferred tax assets and the need for a valuation allowance based on the requirements of SFAS No. 109, Accounting for Income Taxes. SFAS No. 109 requires us to analyze all positive and negative evidence to determine if, based on the weight of available evidence, we are more likely than not to realize the benefit of our net deferred tax assets. The recognition of a valuation allowance against net deferred tax assets and the related tax provision is based upon our conclusions regarding, among other considerations, our estimates of future earnings based on information currently available. Because of the operating losses we have incurred over the past couple of years and based on projections of 2006 taxable income, we established a non-cash valuation allowance against our deferred tax assets in 2005. We do not expect to record tax expense or benefits on U.S.-based operating
results until we are consistently profitable on a quarterly basis. At that time, the valuation allowance will be reassessed and could be eliminated, resulting in the recognition of the deferred tax assets. The valuation allowance provided against deferred tax assets is $14,613 and $15,243 at December 31, 2005 and 2006, respectively. We recorded a tax provision of $8,153 in 2005 as the result of establishing a valuation allowance against deferred tax assets during the fourth quarter of 2005 (see disclosure in Note 9 to the Consolidated Financial Statements in this Form 10-K). In 2006, we recorded a net benefit for income taxes of $307 as the result of more favorable state income tax apportionment factors than originally anticipated in our previous tax provision estimates.  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 Company made no additional purchases during the years ended December 31, 2005 and 2006. On March 27, 2006, the Companys Board of Directors adopted a resolution terminating the repurchase program, as the Company is not planning on making any further stock repurchases.  28  Inflation  The effect of inflation on our operations during 2006 was insignificant. We will continue our policy of controlling costs and adjusting prices to the extent permitted by competitive factors.  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 did not include success fee guidelines. The USCI agreements provided 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 did not extend the arrangement with USCI after 2004. Recent Accounting Pronouncements  In July 2006, the Financial Accounting Standards Board, or FASB, issued Interpretation No. 48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109, or (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in financial statements according to SFAS No. 109, Accounting for Income Taxes. FIN 48 provides for the recognition of only those uncertain tax positions that are more-likely-than-not to be sustained upon examination, measured at the largest amount which has a greater than 50% likelihood of being realized upon settlement. Additionally, FIN 48 gives guidance on derecognition, classification, interest, penalties, accounting in interim periods and disclosure related to uncertain tax positions. The adoption of FIN 48 on January 1, 2007, as required, could result in an adjustment to the amount of recorded tax assets and liabilities related to uncertain tax positions by recording a corresponding adjustment to retained earnings in the consolidated
balance sheets. We are currently assessing the effect, if any, of FIN 48 on our consolidated results of operations and financial position.  In September 2006, the FASB issued SFAS No.157, Fair Value Measurements, or SFAS No. 157. SFAS No. 157 defines fair value, sets out a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements of assets and liabilities. SFAS No. 157 applies under other accounting pronouncements previously issued by the Board that require or permit fair value measurements. The adoption of SFAS No. 157 on January 1, 2007, as required, could result in a transition adjustment that would be recognized as a cumulative-effect adjustment to the opening balance of retained earnings. We are currently assessing the effect SFAS No. 157 may have, if any, on our consolidated results of operations and financial position.  In February of 2007, the SFAS issued FASB No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115. SFAS no. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. SFAS No. 159 is effective for us on January 1, 2008. We are evaluating the impact that the adoption of SFAS No. 159 will have on our financial statements.  In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108), which provides guidance for quantifying financial statement misstatements. SAB 108 was effective for us beginning December 31, 2006. The adoption of SAB 108 did not have a material effect on our financial statements.  28  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, 2004, 2005 and 2006 totaled $24,692, $31,526 and $38,032, 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, 2005 and 2006 totaled $1,322 and $1,177, 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.  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 the Burger King system, which includes 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. Because of SCSs established credit history with us, we do not believe that the concentration of receivables has a negative impact to 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. RSI and, beginning in October 2003, SCS, accounted for 80.2%, 84.8% and 65.1% of the products purchased from us by the Burger King system for the years ended December 31, 2004, 2005 and 2006, respectively. SCS accounted for 30.3% and 10.2% of accounts receivable as of December 31,
2005 and 2006, 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.  29   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, 2006 are adequate.  Goodwill and Other Intangibles Under the provisions of SFAS No. 142, the carrying value of assets acquired, including goodwill, are reviewed annually. During such a review we 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 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 2005, we performed the annual impairment test required by SFAS No. 142 and determined that the goodwill resulting from the acquisitions of Logistix (U.K.) and SCI Promotion was impaired as of December 31, 2005. As a result, we recorded a non-cash charge in the amount
of $16,701 and $10,838 to write-down the carrying value of the Logistix (U.K.) and SCI Promotion goodwill, respectively. In addition, we recorded a non-cash charge of $3,431 relating to the impairment of goodwill and other intangible assets of Johnson Grossfield as a result of the loss of its most significant client. In 2004, 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 each 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.  On May 18, 2005, we reached a settlement with one of our licensors affecting several licenses. Under the terms of the settlement, we agreed to forgo its rights to certain licensed properties for 2006 and 2007 in exchange for a reduction in the overall royalty guarantees. We retained product distribution rights under the licenses for 2005. As a result of this settlement, our overall commitment for royalty guarantees was reduced by approximately $4,000. We were required to pay the licensor a total of $1,800 through March 31, 2006. As a result of this settlement and higher than expected Scooby-Doo revenues that exceeded our initial estimates, $2,837 of the 2004 charge for minimum royalty guarantee shortfalls was reversed in 2005. In 2006, the Company reached a settlement with a different licensor which resulted in a reversal of $88. The reversals were recorded as a minimum royalty  31  guarantee shortfall gain in the accompanying consolidated statements of operations for the years ended December 31, 2005 and 2006.  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.  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, 2006 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:  2004

2005

2006Allowance for obsolescence
$
740


$
891


$
639As a percentage of total inventories

3.8
%


7.3
%


9.1
%
  The decrease from 2005 to 2006 in the allowance for obsolescence was mainly due to the specific identification of excess inventory that was impaired as of year end 2005. Management believes that its allowance for obsolescence at year end 2006 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.  32  Income Taxes Our income tax provision and related income tax assets and liabilities are based on actual and expected future income, U.S. and foreign statutory income tax rates, and tax regulations and planning opportunities in the various jurisdictions in which we operate. We believe that the accounting estimate related to income taxes is a critical accounting estimate because significant judgment is required in interpreting tax regulations in the U.S. and in foreign jurisdictions, determining our worldwide tax positions, and assessing the likelihood of realizing certain tax benefits. Actual results could differ materially from those judgments, and changes in judgments could materially affect our consolidated financial statements.  Certain income and expense items are accounted for differently for financial reporting and income tax purposes. As a result, the effective tax rate reflected in our consolidated statements of operations is different than that reported in our tax returns filed with the taxing authorities. Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation and amortization expense. These timing differences create deferred income tax assets and liabilities. Deferred income tax assets generally represent items that can be used as a tax deduction or credit in our tax returns in future years for which we have already recorded a tax benefit in its consolidated statement of operations. We record a valuation allowance to reduce our deferred income tax assets if, based on the weight of available evidence, management believes expected future
taxable income is not likely to support the use of a deduction or credit in that jurisdiction. We evaluate the level of our valuation allowances at least annually, and more frequently if actual operating results differ significantly from forecasted results.  We assess the realizability of our deferred tax assets and the need for a valuation allowance based on the requirements of SFAS No. 109, Accounting for Income Taxes. SFAS No. 109 requires us to analyze all positive and negative evidence to determine if, based on the weight of available evidence, we are more likely than not to realize the benefit of our net deferred tax assets. The recognition of a valuation allowance against net deferred tax assets and the related tax provision is based upon our conclusions regarding, among other considerations, our estimates of future earnings based on information currently available. Because of the operating losses we incurred in 2004 and 2005, and based on projections of 2006 taxable income, we established a non-cash valuation allowance against our deferred tax assets in 2005. We do not expect to record tax expense or benefits on U.S.-based operating results until we are
consistently profitable on a quarterly basis. At that time, the valuation allowance will be reassessed and could be eliminated, resulting in the recognition of the deferred tax assets. The valuation allowance provided against deferred tax assets is $14,613 and $15,243 at December 31, 2005 and 2006, respectively. We recorded a tax provision of $8,153 in 2005 as the result of establishing a valuation allowance against deferred tax assets during the fourth quarter of 2005 (see disclosure in Note 9 to the Consolidated Financial Statements in this Form 10-K). In 2006, we recorded a net benefit for income taxes of $307 as the result of more favorable state income tax apportionment factors than originally anticipated in our previous tax provision estimates.   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, 2006, we had no amount outstanding under our facility. As of December 31, 2006, the marginal interest rate on available borrowings under our credit facility was 9.0%.  Impact of Foreign Currency Fluctuation  Approximately 10% 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, 2006, our Logistix (U.K.) subsidiary entered into foreign currency forward contracts aggregating 1,906 GBP to sell Euros in exchange for GBP and USD, and to sell GBP in exchange for U.S. dollars. The contracts will expire by April 2007. At December 31, 2006, these foreign currency forward contracts had an estimated fair value of (17) GBP ($34 U.S. dollars). These foreign currency forward contracts are designated as a cash flow hedge of inventory purchases from vendors and cash receipts from customers related to Promotional Products programs. The fair value of the foreign currency forward contracts is recorded in accrued liabilities in the consolidated balance sheet as of December 31, 2006. The unrealized loss on the contracts is reflected in accumulated other comprehensive income.  32  ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
  Report of Independent Registered Public Accounting Firm   To the Board of Directors and Stockholders of EMAK Worldwide, Inc. Los Angeles, California  We have audited the accompanying consolidated balance sheet of EMAK Worldwide, Inc. and subsidiaries (the Company) as of December 31, 2006, and the related consolidated statement of operations, stockholders equity and mandatorily redeemable preferred stock, comprehensive loss and cash flows for the year then ended. Our audit also included the financial statement schedule listed in the Index at Item 15. These financial statements and the financial statement schedule are the responsibility of the Companys management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audit.  We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit also 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, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.  In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of EMAK Worldwide, Inc. as of December 31, 2006, and the results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statement taken as a whole, presents fairly in all material respects the information set forth therein.  As discussed in Note 1 to the consolidated financial statements, in 2006, the Company changed its method of accounting for stock-based compensation to conform to Statement of Financial Accounting Standards No. 123(R),Share-Based Payment.  DELOITTE & TOUCHE LLP Los Angeles, California March 30, 2007  33    Report of Independent Registered Public Accounting Firm   To the Board of Directors and Stockholders of EMAK Worldwide, Inc.  In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, of stockholders 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, 2005, and the results of their operations and their cash flows for each of the two years in the period endedDecember 31, 2005 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 the standards of the
Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit 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.  /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP  Los Angeles, California March 30, 2006, except for the restatement discussed in Note 1 to the consolidated financial statements included in the Annual Report on Form 10-K/A for the year ended December 31, 2005 (not presented herein), as to which the date is August 31, 2006 and except with respect to our opinion on the consolidated financial statements insofar as it relates to the effects of the change in segments discussed in Note 11, as to which the date is March 26, 2007   34  EMAK WORLDWIDE, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except share and per share data)  December 31,2005


2006ASSETSCURRENT ASSETS:Cash and cash equivalents
$
6,315

$
8,677Restricted cash

--


1,319Accounts receivable (net of allowances of $1,738 and $1,382as of December 31, 2005 and 2006, respectively)

29,375


24,327Inventories

11,246


6,386Prepaid expenses and other current assets

5,096


3,732Total current assets

52,032


44,441Fixed assets, net

3,571


3,583Goodwill

12,855


13,136Other intangibles, net

712


651Other assets

626


559Total assets
$
69,796

$
62,370LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS EQUITYCURRENT LIABILITIES:Short-term debt
$
--

$
--Accounts payable

20,118


20,238Deferred revenue

3,094


1,236Due to customer

2,795


4,658Accrued payroll and payroll related costs

3,679


1,629Accrued liabilities

9,826


6,717Total current liabilities

39,512


34,478Long-term liabilities

3,956


2,294Total liabilities

43,468


36,772COMMITMENTS AND CONTINGENCIES (Note 10)Mandatorily redeemable preferred stock, Series AA senior cumulativeconvertible, $.001 par value, 25,000 issued and outstanding, stated atliquidation preference of $1,000 per share ($25,000), net of issuance costs

19,914


19,041STOCKHOLDERS 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, 25,000,000 shares authorized 5,799,442 and5,851,663 shares outstanding as of December 31, 2005 and 2006, respectively

--


--Additional paid-in capital

34,068


33,840Accumulated deficit

(10,960)


(13,225)Accumulated other comprehensive income

2,699


3,61125,807


24,226LessTreasury stock, 3,167,258 shares at cost as of December 31, 2005 and 2006

(17,669)


(17,669)Unearned compensation

(1,724)


--Total stockholders equity

6,414


6,557Total liabilities, mandatorily redeemable preferred stockand stockholders equity
$
69,796

$
62,370
  The accompanying notes are an integral part of these consolidated financial statements.  35   EMAK WORLDWIDE, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except share and per share data)  Years Ended December 31,2004

2005

2006REVENUE:Revenues from services
$
16,985
$
21,900
$
26,889Revenues from tangible products and other revenues

219,676

201,497

154,508TOTAL REVENUE

236,661

223,397

181,397Cost of sales:Cost of services

6,263

9,134

12,045Cost of tangible goods sold

174,224

155,792

125,413Total cost of sales

180,487

164,926

137,458Minimum royalty guarantee shortfalls (gain)

7,722

(2,837)

(88)Gross profit

48,452

61,308

44,027OPERATING EXPENSES:Salaries, wages and benefits

31,310

35,090

26,283Selling, general and administrative

25,606

23,587

18,657Integration costs

174

81

--Loss on lease

311

237

--Restructuring charge

56

2,952

1,213Impairment of assets

6,312

30,970

--Dispute resolution charge

237

--

--ERP reimplementation costs

59

147

92Total operating expenses

64,065

93,064

46,245Loss from operations

(15,613)

(31,756)

(2,218)OTHER (EXPENSE) INCOME:Interest expense

(253)

(443)

(329)Interest income

102

94

58Other income (expense)

(636)

386

(83)Loss before provision (benefit) for income taxes

(16,400)

(31,719)

(2,572)PROVISION (BENEFIT) FOR INCOME TAXES

(6,716)

8,153

(307)Net loss

(9,684)

(39,872)

(2,265)PREFERRED STOCK DIVIDENDS

1,500

1,500

375EXCESS OF PREFERRED STOCK WARRANTS REDEMPTIONCOST OVER CARRYING VALUE

5,042

--

--NET LOSS AVAILABLE TO COMMON STOCKHOLDERS
$
(16,226)
$
(41,372)
$
(2,640)BASIC LOSS PER SHARE:BASIC LOSS PER SHARE
$
(2.82)
$
(7.15)
$
(0.45)BASIC WEIGHTED AVERAGE SHARES OUTSTANDING

5,753,978

5,782,925

5,834,990DILUTED LOSS PER SHARE:DILUTED LOSS PER SHARE
$
(2.82)
$
(7.15)
$
(0.45)DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING

5,753,978

5,782,925

5,834,990
  The accompanying notes are an integral part of these consolidated financial statements.  37  EMAK WORLDWIDE, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY AND MANDATORILY REDEEMABLE PREFERRED STOCK (in thousands, except share data)  Additional

Paid-in

Capital
RetainedEarnings

(Accumulated

Deficit)
Accumulated Other

Comprehensive

IncomeCommon Stock
Preferred Stock
Treasury

Stock
Unearned

CompensationShares
Amount
Shares
Amount
TotalBalance, January 1, 2004
5,684,953
$
--
25,000
$
23,049
$
23,886
$
45,138
$
3,334
$
(17,458)
$
(1,234)
$
76,715Net loss
--

--
--

--

--

(9,684)

--

--

--

(9,684)Excess of preferred stock warrants redemptioncost over carrying value
--

--
--

(3,135)

8,177

(5,042)

--

--

--

--Warrant exchange transaction costs
--

--
--

--

(44)

--

--

--

--

(44)Issuance of common stock
35,785

--
--

--

530

--

--

--

--

530Issuance of restricted stock units
--

--
--

--

2,399

--

--

--

(2,399)

--Issuance of shares pursuant to vestingof 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

19,914

35,162

28,912

4,972

(17,669)

(2,480)

68,811Net loss
--

--
--

--

--

(39,872)

--

--

--

(39,872)Issuance of common stock
10,616

--
--

--

109

--

--

--

--

109Issuance of restricted stock units
--

--
--

--

1,134

--

--

--

(1,134)

--Amortization of restricted stock units
--

--
--

--

--

--

--

--

804

804Cancellation of restricted stock units
(3,000)

--
--

--

(952)

--

--

--

952

--Amortization of restricted stock grants
--

--
--

--

--

--

--

--

134

134Exercise of stock options
32,563

--
--

--

115

--

--

--

--

115Preferred stock dividends
--

--
--

--

(1,500)

--

--

--

--

(1,500)Foreign currency translation adjustments
--

--
--

--

--

--

(2,679)

--

--

(2,679)Unrealized gain on foreign currency forward contracts
--

--
--

--

--

--

406

--

--

406Balance, December 31, 2005
5,799,442

--
25,000

19,914

34,068

(10,960)

2,699

(17,669)

(1,724)

26,328Net loss
--

--
--

--

--

(2,265)

--

--

--

(2,265)Crown Preferred Stock and Warrant revaluation
--

--
--

(873)

873

--

--

--

--

--Transaction costs in connection withmodification of preferred stock and warrants
--

--
--

--

(157)

--

--

--

--

(157)Issuance of Common Stock
36,142

--
--

--

306

--

--

--

--

306Amortization of restricted stock units
--

--
--

--

1,041

--

--

--

--

1,041Amortization of restricted stock grants
--

--
--

--

39

--

--

--

--

39Reclassify Deferred Compensation per SFAS No. 123 (R)
--

--
--

--

(1,724)

--

--

--

1,724

--Exercise of restricted stock units
16,079

--
--

--

--

--

--

--

--

--Preferred stock dividend
--

--
--

--

(375)

--

--

--

--

(375)Foreign currency translation adjustments
--

--
--

--

--

--

966

--

--

966Unrealized loss on foreign currency forward
--

--
--

--

--

--

(54)

--

--

(54)Repurchase of stock options
--

--
--

--

(231)

--

--

--

--

(231)Balance, December 31, 2006
5,851,663
$
--
25,000
$
19,041
$
33,840
$
(13,225)
$
3,611
$
(17,669)
$
0
$
25,598
  The accompanying notes are an integral part of these consolidated financial statements.  38  EMAK WORLDWIDE, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (in thousands)  Years Ended December 31,2004


2005


2006NET LOSS
$
(9,684)

$
(39,872)

$
(2,265)OTHER COMPREHENSIVE INCOME (LOSS):Foreign currency translation adjustments

1,805


(2,679)


966Unrealized gain (loss) on foreign currencyforward contracts

(167)


406


(54)COMPREHENSIVE LOSS
$
(8,046)

$
(42,145)

$
(1,353)
  The accompanying notes are an integral part of these consolidated financial statements.  39  EMAK WORLDWIDE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)  Years Ended December 31,2004

2005

2006CASH FLOWS FROM OPERATING ACTIVITIES:Net loss
$
(9,684)
$
(39,872)
$
(2,265)Adjustments to reconcile net loss to net cash provided by (used in) operating activities:Depreciation and amortization

2,067

2,165

1,685Provision for bad debts

48

180

13Gain on asset disposal

(13)

(17)

(2)Tax benefit from exercise of stock options

14

--

--Amortization of restricted stock

714

938

1,080Impairment of assets

6,312

30,970

--Minimum guarantee royalty shortfalls (gain)

7,722

(2,837)

(88)Deferred income taxes

(4,015)

8,976

--Changes in assets and liabilities, net of effects of acquisitions:Increase (decrease) in cash and cash equivalents:Accounts receivable

(3,222)

16,370

5,803Inventories

98

7,265

5,175Prepaid expenses and other current assets

(1,503)

(2,290)

1,450Other assets

(908)

(93)

100Accounts payable

82

(10,203)

(273)Accrued liabilities

(6,006)

1,494

(5,373)Long-term liabilities

(934)

(953)

(1,676)Net cash provided by (used in) operating activities

(9,228)

12,093

5,629CASH FLOWS FROM INVESTING ACTIVITIES:Restricted cash

--

--

(1,319)Payment for purchase of Johnson Grossfield

(4,614)

(148)

--Payment for purchase of Megaprint Group,net of cash acquired of $1,194

(2,591)

(1,908)

(313)Refund from purchase of Upshot

--

75

--Proceeds from sales of fixed assets

64

992

23Purchases of fixed assets

(1,602)

(1,711)

(1,469)Net cash used in investing activities

(8,743)

(2,700)

(3,078)CASH FLOWS FROM FINANCING ACTIVITIES:Preferred stock dividends paid

(1,500)

(1,500)

(375)Purchase of treasury stock

(211)

--

--Proceeds from exercise of stock options

640

115

--Transaction costs paid in connection with themodification of preferred stock and warrants

--

--

(157)Purchase of options via stock option buyback

--

--

(231)Repayment under line of credit

(14,325)

(76,550)

(64,387)Borrowings under line of credit

18,379

70,525

64,387Net cash provided by (used in) financing activities

2,983

(7,410)

(763)Net increase (decrease) in cash and cash equivalents

(14,988)

1,983

1,788Effects of exchange rate changes on cash and cash equivalents

103

(74)

574CASH AND CASH EQUIVALENTS , beginning of year

19,291

4,406

6,315CASH AND CASH EQUIVALENTS , end of year
$
4,406
$
6,315
$
8,677SUPPLEMENTAL CASH FLOW INFORMATION:Non-cash investing activitiesIssuance of shares for purchaseof Johnson Grossfield

530

--

--CASH PAYMENTS DURING YEAR FOR:Interest paid
$
236
$
449
$
331Income taxes paid (refunded), net
$
1,210
$
(1,824)
$
(119)
  The accompanying notes are an integral part of these consolidated financial statements.  40   EMAK WORLDWIDE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)   1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
  EMAK Worldwide, Inc., a Delaware corporation and subsidiaries (the Company or EMAK), is a leading global integrated marketing services company. The Company focuses on the design and execution of strategy-based marketing programs providing measurable results for our clients. EMAK has expertise in the areas of: strategic planning and research, entertainment marketing, design and manufacturing of custom promotional products, promotional marketing, event marketing, collaborative marketing, retail design and environmental branding. EMAK is headquartered in Los Angeles, with operations in Chicago, Frankfurt, London, Paris, the Netherlands, Hong Kong and Shanghai. The Company primarily sells to customers in the United States and Europe. The Companys functional currency is the U.S. dollar.  Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant accounts and transactions between the Company and its subsidiaries have been eliminated in consolidation.  Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.  Cash and Cash Equivalents The Company considers all highly liquid short-term investments with a maturity at the date of purchase of three months or less to be cash equivalents. Short-term investments included in cash and cash equivalents are valued at cost, which approximates fair value as of December 31, 2005 and 2006.  Marketable Securities In accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities, the Company determines the appropriate classification of marketable securities at the time of purchase and re-evaluates such designation at each balance sheet date. Marketable securities are classified as available-for-sale and are carried at fair value. The Company had no marketable securities as of December 31, 2005 and 2006.  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 For product related sales, the Company records revenues when title and risk of loss pass to the customer. When a right of return exists, the Companys 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. 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 tangible products and other revenues, and an equivalent amount of reimbursable expenses are included in cost of tangible goods sold. Service revenues, excluding reimbursements for
outside costs, for the years ended December 31, 2004, 2005 and 2006 totaled $16,985, $21,900 and $26,889, 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, 2005 and 2006 totaled $1,322 and $1,177, respectively. Unbilled revenues are recorded in accounts receivable in the accompanying consolidated balance sheets as of December 31, 2005 and 2006. Unbilled revenues are expected to be billed and collected within the next six months.  41  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 contractual arrangements with the Companys largest client, 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 the client.  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 Inventories consist of (a) production-in-process which primarily represents tooling costs which are deferred and expensed over the life of the related promotional programs (which is typically less than six months) and deferred costs on service contracts for which revenue has been deferred and (b) purchased finished goods held for sale to customers and purchased finished goods in transit to customers distribution centers. Inventories are stated at the lower of average cost or market. As of December 31, 2005 and 2006, inventories consisted of the following:  December 31,2005

2006Production-in-process
$
2,483

$
5,215Finished goods

8,763


1,171Total inventories
$
11,246

$
6,386
  Fixed Assets Fixed assets are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are provided on a straight-line basis over estimated useful lives as follows:  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.  Goodwill and Other Intangibles Under the provisions of SFAS No. 142, Goodwill and Other Intangible Assets 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. As of December 31, 2006, the Company had five reporting units: Equity Marketing, Logistix Marketing (formerly SCI Promotion), Logistix U.K., Logistix Retail (formerly Pop Rocket) and Upshot. The Company compares 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 2006, the
Company performed the impairment test required by SFAS No. 142 and determined that its remaining goodwill resulting from acquisitions was not impaired as of December 31, 2006. In the fourth quarter of 2005, the Company recorded a non-cash charge in the amount of $30,970 to write-down the carrying value of goodwill and other intangibles related to several acquisitions (see Note 3). In the fourth quarter of 2004, 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).  On March 31, 2006, the Company released 180 GBP ($313) to the former shareholders of Megaprint Group Limited related to a purchase price holdback under the terms of the Stock Purchase Agreement between the Company and Megaprint Group Limited. The holdback was recorded as an accrued liability as of the acquisition date. As a result, the release of the holdback had no impact on goodwill for the year ended December 31, 2006.  The change in the carrying amount of goodwill from $12,855 as of December 31, 2005 to $13,136 as of December 31, 2006 reflects an increase of $281 due to a foreign currency translation adjustment. Of the $13,136 as of December 31, 2006, $8,245 of the goodwill balance relates to the Agency Services segment and $4,891 relates to the Promotional Products segment.  42  The change in the carrying amount of identifiable intangibles from $712 as of December 31, 2005 to $651 as of December 31, 2006 reflects: a decrease of $144 for amortization expense and an increase due to a foreign currency translation adjustment of $83. The identifiable intangibles are subject to amortization and are reflected as other intangibles in the consolidated balance sheets.  Other intangibles are summarized as follows:  As of December 31,2005

2006Amortized Intangible AssetsEquity Marketing trademark
$
52
$
52Logistix trademark

629

716Licensing, royalty and standstill agreements

146

166Customer contracts and related customer relationships

940

957Non-competition agreement

94

94Sales order backlog

354

378Subtotal

1,586

2,363Less: Accumulated amortization

(1,503)

(1,712)Total Other Intangibles
$
712
$
651
  The Equity Marketing and Logistix trademarks are being amortized over an estimated useful life of 10 years.  In December 2005, as a result of the annual impairment test, the Company changed its estimate of useful life of the Logistix trademark, so it was amortized prospectively beginning January 1, 2006. 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.  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 were being amortized over an estimated useful life of 5 years. In December 2005, as a result of the annual impairment test which resulted in a write-down of the remaining balance of SCI Promotion customer contracts and related customer relationships (see Note 3), the Company changed its estimate of the remaining life of the SCI Promotion customer relationships to one year.  The customer relationship and non-competition agreements acquired in the purchase of Johnson Grossfield were being amortized over estimated useful lives of 2 years to 12 years. In 2005, the Company was notified the relationship between Johnson Grossfield and Subway Restaurants would be terminated. As a result, the entire remaining balance of Johnson Grossfield customer relationships was written off. (See Note 3).  The customer relationships acquired in the purchase of Megaprint Group were being amortized over an estimated useful life of 15 years. In December 2005, the Company performed the annual impairment test which resulted in a write-off of the remaining balance of Megaprint Group customer contracts and related customer relationships. Sales order backlog was also acquired in the purchase of Megaprint Group and was fully amortized as of December 31, 2005. (See Note 3).  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, 2004, 2005 and 2006, amortization expense related to other intangibles amounted to $363, $344 and $144, respectively.  44  The expected future amortization expense related to other intangibles is as follows:  Year2007
$
772008

732009

722010

722011

72Thereafter

285Total
$
651
  Due to Customer Pursuant to the terms of certain contracts between the Company and a promotions customer, the Company collects fees from the customers distribution companies on behalf of that customer. Once these fees are collected from the distribution companies, the Company remits the fees to the customer. As of December 31, 2005 and 2006, the amounts due to customer were $2,795 and $4,658, 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).  The Company assesses the realizability of its deferred tax assets and the need for a valuation allowance based on the requirements of SFAS No. 109. SFAS No. 109 requires the Company to analyze all positive and negative evidence to determine if, based on the weight of available evidence, we are more likely than not to realize the benefit of our net deferred tax assets. The recognition of a valuation allowance against net deferred tax assets and the related tax provision is based upon managements conclusions regarding, among other considerations, estimates of future earnings based on information currently available. Because of the operating losses the Company has incurred over the past two years and based on projections of 2006 taxable income, the Company established a non-cash valuation allowance against its deferred tax assets. The Company does not expect to record tax expense or benefits on U.S.-based operating
results until it is consistently profitable on a quarterly basis. At that time, the valuation allowance will be reassessed and could be eliminated, resulting in the recognition of the deferred tax assets.  Share-Based Compensation At December 31, 2006, the Company had three share-based compensation plans that are described in Note 8. Under the plans, the Company has the ability to grant stock options, restricted stock, restricted stock units (RSUs), stock bonuses, stock appreciation rights or performance units. Stock options expire no later than ten years from the date of grant and generally provide for vesting over a period of four years from the date of grant. Such stock options were granted with exercise prices at or above the fair market value of the Companys common stock on the date of grant.  Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123(R) using the modified-prospective transition method. Prior to January 1, 2006, the Company applied the recognition and measurement principles of APB Opinion No. 25, and related interpretations in accounting for its employee stock compensation plans. All employee stock options were granted at or above the grant date market price and, accordingly, no compensation expense was recognized in the statements of operations for these employee stock options. Instead, the amount of compensation expense that would have resulted if the Company had applied the fair value recognition provisions of SFAS No. 123 was included as a proforma disclosure in the financial statement footnotes.  In accordance with SFAS No. 123(R), the Company reclassified $1,724 from the unearned compensation line item within stockholders equity to additional paid-in capital. The Company recorded this reclassification upon adoption of SFAS No. 123(R) on January 1, 2006.  Prior to January 1, 2006, the Company presented all benefits of tax deductions resulting from the exercise of share-based compensation as operating cash flows in the statements of cash flows. SFAS No. 123(R) requires the benefits of tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) be classified as financing cash flows. Excess tax benefits reflected as a financing cash inflow totaled $0 in 2006. Excess tax benefits reflected as an operating cash inflow totaled $0 in 2005.  44  On December 15, 2005, the Board of Directors approved the accelerated vesting of unvested and out-of-the-money non-qualified stock options previously awarded to employees, officers and directors with option exercise prices equal to or greater than $7.18 effective as of December 15, 2005. Both the Companys non-employee directors and the Chief Executive Officer have entered into a Resale Restriction Agreement which imposes restrictions on the sale of any shares received through the exercise of accelerated options until the earlier of the original vesting dates set forth in the option or their termination of service. The accelerated options represented all of the outstanding Company options.  The Board of Directors decision to accelerate the vesting of these options was based upon the elimination of compensation expense to be recorded subsequent to the effective date of SFAS 123(R). In addition, the Board of Directors considered that because these options had exercise prices in excess of the current market value, they were not fully achieving their original objectives of incentive compensation and employee retention. The future compensation expense that was eliminated as a result of the acceleration of the vesting of these options is approximately $1,100. No options were granted in 2006.  The Company recognized no compensation expense for stock options in 2006 as a result of the Companys decision to accelerate the vesting of options mentioned above. As discussed above, prior to January 1, 2006, no compensation expense was recognized in the statements of operations for stock options. Had compensation expense for nonqualified stock options granted been determined based on their fair value at the grant date, consistent with the fair value method of accounting prescribed by SFAS No. 123, the Companys net income and net income per common share for the year ended December 31, 2004 and 2005 would have been adjusted as follows:  2004


2005Net loss available to common stockholders as reported
$
(16,226)

$
(41,372)Plus:Share-based compensation expense, net of tax, included in

422


562reported net income (loss) available to the common stockholderLess:Compensation expense (a)

1,065


1,198Net loss available to common stockholders - pro forma
$
(16,869)

$
(42,008)Loss per share:Basic loss per share, as reported
$
(2.82)

$
(7.15)Pro forma basic loss per share
$
(2.93)

$
(7.26)Diluted loss per share, as reported
$
(2.82)

$
(7.15)Pro forma diluted loss per share
$
(2.93)

$
(7.26)
  (a) Determined under fair value based method for all awards, net of tax.  Because the SFAS 123(R) 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 31,2004


2005Expected dividend yield
0.00
%

0.00
%Expected stock price volatility
45.00
%

41.33
%Risk free interest rate
2.76
%

4.46
%Expected life of options
5 years


4 years
  The weighted average fair value of options granted during 2004 and 2005 is $6.23 and $1.79, 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.  45   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 2,757,378, 2,650,636 and 1,959,236 shares of the Companys Common Stock, for the years ended December 31, 2004, 2005 and 2006, respectively, were excluded from the computation of diluted EPS as they would have been anti-dilutive. For the years ended December 31, 2004 and 2005, preferred stock convertible into 1,694,915 shares of Common Stock was excluded from the computation of diluted EPS. For the year ended December 31, 2006, preferred stock convertible into 2,777,778 shares
of Common Stock was excluded from the computation of diluted EPS.  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.  For the years ended December 31,2004

2005

2006Loss

Shares

Per Share
Loss

Shares

Per Share
Loss

Shares

Per Share(Numerator)

(Denominator)

Amount
(Numerator)

(Denominator)

Amount
(Numerator)

(Denominator)

AmountBasic EPS:Loss available tocommon stockholders
$
(16,226)

5,753,978

$
(2.82)
$
(41,372)

5,782,925

$
(7.15)
$
(2,640)

5,834,990

$
(0.45)Effect of dilutive securities:Options and warrants

--

--




--

--




--

--Restricted stock units

--

--




--

--




--

--Dilutive EPS:Loss available to commonstockholders
$
(16,226)

5,753,978

$
(2.82)
$
(41,372)

5,782,925

$
(7.15)
$
(2,640)

5,834,990

$
(0.45)
  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 is 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).  Concentration of Risk Burger King accounted for approximately 51%, 52% and 48% of the Companys total revenues for the years ended December 31, 2004, 2005 and 2006, 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
80.2%, 84.8% and 65.1% of the products purchased from us by the Burger King system for the years ended December 31, 2004, 2005 and 2006, respectively. The largest such distribution company accounted for 30.3% and 10.2% of accounts receivable as of December 31, 2005 and 2006, respectively.  46  Restricted Cash During the first quarter of 2006, the Companys Logistix (U.K.) subsidiary entered into an agreement with Hong Kong Shanghai Bank Corp. (HSBC), under which HSBC issued a guarantee of up to 1,000 EURO (approx $1,319) to one of Logistixs vendors in exchange for the deposit of the same amount into an interest bearing restricted cash account with HSBC. Logistix (U.K.) does not have access to the cash until the guarantee expires in the first half of 2007. The guarantee from HSBC enabled Logistix (U.K.) to secure more favorable payment terms from a new vendor supplying significant quantities of goods.  Supplemental Cash Flow Information During 2006, the Company issued 36,142 shares with a market value of $306 as a partial payment of contractual bonuses for two executives. The contractual bonuses earned by the two executives for 2005 performance totaled $1,224 and were recorded as accrued liabilities in the Companys consolidated balance sheet as of December 31, 2005. Under the terms of the employment agreements, such bonuses are payable 25% in common stock and the remainder in cash. The cash portion of the bonuses was also paid in March 2006.  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.  Change in Accounting Principle Prior to January 1, 2006, the Company applied the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for its employee stock compensation plans. All employee stock options were granted at or above the grant date market price. Accordingly, no compensation expense was recognized in the statements of operations for these employee stock options.  Effective January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123(R), Share-Based Payment, using the modified-prospective transition method. Accordingly, results for prior periods have not been restated.  Beginning January 1, 2006 and in connection with the adoption of SFAS No. 123(R), the Company recognizes the cost of all new employee share-based payment awards on a straight-line attribution basis over their respective vesting periods, net of estimated forfeitures. In accounting for the income tax benefits associated with employee exercises of share-based payments, the Company has elected to adopt the alternative simplified method as permitted by FASB Staff Position (FSP) No. FAS 123(R)-3, Accounting for the Tax Effects of Share-Based Payment Awards. FSP No. FAS 123(R)-3 permits the adoption of either the transition guidance described in SFAS No. 123(R) or the alternative simplified method specified in the FSP to account for the income tax effects of share-based payment awards. In determining when additional tax benefits associated with share-based payment exercises are
recognized, the Company follows the ordering of deductions of the tax law, which allows deductions for share-based payment exercises to be utilized before previously existing net operating loss carryforwards. In computing dilutive shares under the treasury stock method, the Company does not reduce the tax benefit amount within the calculation for the amount of deferred tax assets that would have been recognized had the Company previously expensed all share-based payment awards.  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, 2004, 2005 and 2006 such costs totaled $1,799, $1,003, and $666, 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 U.S. 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, 2004, 2005 and 2006, the net transaction gain (loss) on foreign exchange of $(628), $342 and $(117), respectively, were recorded in other income (expense) in the accompanying consolidated statements of operations.  48  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, as amended which establishes accounting and reporting standards for derivative instruments and for hedging activities. SFAS No. 133 requires that an entity recognize derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation.  The Company designates its derivatives based upon criteria established by SFAS No. 133. For a derivative designated as a fair value hedge, the gain or loss is recognized in earnings in the period of change together with the offsetting loss or gain on the hedged item attributed to the risk being hedged. For a derivative designated as a cash flow hedge, the effective portion of the derivatives gain or loss is initially reported as a component of accumulated other comprehensive income and subsequently reclassified into earnings when the hedged exposure affects earnings. The ineffective portion of the gain or loss is reported in earnings immediately.  The Company 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.  As of December 31, 2006, our Logistix subsidiary entered into foreign currency forward contracts aggregating 1,906 GBP to sell Euros in exchange for GBP and to sell GBP in exchange for U.S. dollars. The contracts will expire by April 2007. At December 31, 2006, these foreign currency forward contracts had an estimated fair value of (17) GBP ($34 U.S. dollars). These foreign currency forward contracts are designated as a cash flow hedge of inventory purchases from vendors and cash receipts from customers related to Promotional Products programs. The fair value of the foreign currency forward contracts is recorded in accrued liabilities in the consolidated balance sheet as of December 31, 2006. The unrealized loss on the contracts was recorded in other income (expense) in the accompanying consolidated statements of operations.  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.  Reclassifications Certain reclassifications have been made to the 2005 Consolidated Financial Statements to conform them to the 2006 presentation. The current portion of accrued federal, state and foreign tax receivables, totaling $2,052, that were previously recorded as an offset to accrued liabilities as of December 31, 2005, have been reclassified to prepaids and other current assets in the Consolidated Balance Sheets and the Consolidated Statements of Cash Flows. In addition, accrued bonuses in current liabilities, totaling $1,556, which was previously recorded as Accrued liabilities as of December 31, 2005, have been reclassified to Accrued payroll and payroll related costs in the Consolidated Balance Sheets.  Recent Accounting Pronouncements  In July 2006, the Financial Accounting Standards Board, or FASB, issued Interpretation No. 48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109, or (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in financial statements according to SFAS No. 109, Accounting for Income Taxes. FIN 48 provides for the recognition of only those uncertain tax positions that are more-likely-than-not to be sustained upon examination, measured at the largest amount which has a greater than 50% likelihood of being realized upon settlement. Additionally, FIN 48 gives guidance on derecognition, classification, interest, penalties, accounting in interim periods and disclosure related to uncertain tax positions. The adoption of FIN 48 on January 1, 2007, as required, could result in an adjustment to the amount of recorded tax
assets and liabilities related to uncertain tax positions by recording a corresponding adjustment to retained earnings in the condensed consolidated balance sheets. The Company is currently assessing the effect, if any, of FIN 48 on the Companys consolidated results of operations and financial position.  In September 2006, the FASB issued SFAS No.157, Fair Value Measurements, or SFAS No. 157. SFAS No. 157 defines fair value, sets out a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value  48  measurements of assets and liabilities. SFAS No. 157 applies under other accounting pronouncements previously issued by the Board that require or permit fair value measurements. The adoption of SFAS No. 157 on January 1, 2007, as required, could result in a transition adjustment that would be recognized as a cumulative-effect adjustment to the opening balance of retained earnings. The Company is currently assessing the effect SFAS No. 157 may have, if any, on its consolidated results of operations and financial position.  In February of 2007, the SFAS issued FASB No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115. SFAS no. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. SFAS No. 159 is effective for our Company on January 1, 2008. The Company is evaluating the impact that the adoption of SFAS no. 159 will have on its financial statements.  In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108), which provides guidance for quantifying financial statement misstatements. SAB 108 was effective for the Company beginning December 31, 2006. The adoption of SAB 108 did not have a material effect on the Companys financial statements.  2.
RESTRUCTURING CHARGE AND MINIMUM ROYALTY GUARANTEE SHORTFALLS
  In 2004, the Company formulated and implemented a restructuring plan in connection with the realignment of centralized resources in its Promotional Products 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 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 represented a reversal of a portion of the 2003 restructuring charge related to the severance for workforce reductions at Upshot.  In 2004, the Company finalized a decision to pursue the wind-down of a substantial majority of its Consumer Products business. The Companys determination was to significantly scale back this business during 2005 while exiting a substantial majority of the business permanently as soon as is feasible. As a result of the wind-down, in the fourth quarter of 2004, the Company recorded a pre-tax charge of $7,722 relating to minimum royalty guarantee shortfalls on several Consumer Products licenses. This charge was determined based on contractual commitments as of December 31, 2004 and reflected our decision not to fully exploit these licenses. Approximately $3,000 of this pre-tax charge was non-cash for write-offs of long-term royalty advances. The charge was recorded as minimum royalty guarantee shortfalls in the consolidated statement of operations for the year ended December 31, 2004.  On May 18, 2005, the Company reached a settlement with one of its licensors affecting several licenses. Under the terms of the settlement, the Company agreed to forgo its rights to certain licensed properties for 2006 and 2007 in exchange for a reduction in the overall royalty guarantees. The Company retained product distribution rights under the licenses for 2005. As a result of this settlement, the Companys overall commitment for royalty guarantees was reduced by approximately $4,000. The Company paid the licensor a total of $1,800 through June 30, 2006. As a result of this settlement and higher than expected Scooby-Doo revenues that exceeded initial estimates, $2,837 of the 2004 charge for minimum royalty guarantee shortfalls was reversed in 2005. In 2006, the Company reached a settlement with a different licensor which resulted in a reversal of $88. These reversals were recorded as minimum royalty guarantee
shortfall gains in the consolidated statements of operations for 2005 and 2006.  In 2005, in connection with the Consumer Products wind-down, the Company incurred a charge for one-time employee termination benefits and other costs totaling approximately $746. In 2006, the Company incurred an additional $38 for employee termination costs. Such costs are recorded as a restructuring charge in the consolidated statement of operations. The entire amount is attributable to the Consumer Products segment.  In 2005, the Company eliminated several centralized corporate positions as a result of a realignment of centralized resources. As a result, we incurred a charge for one-time employee termination benefits and other costs totaling approximately $622 in 2005. In 2006, the Company incurred an additional $58 for employee termination benefits. Such costs are recorded as a restructuring charge in the consolidated statement of operations. The entire amount is attributable to the corporate segment.  In 2005, the Company eliminated several positions at Logistix (U.K.) as a result of a less than optimal staff utilization rate resulting from a decrease in revenues. In connection with this decision, the Company incurred charges for one-time employee termination benefits and other costs totaling $568. In 2006, the Company incurred an additional $17 for one-time employee termination benefits and other costs. Such costs are recorded as a restructuring charge in the consolidated statements of operations. The entire amount is attributable to the Promotional Products segment.  In 2005, the Company made the determination to close the Companys Minneapolis office effective October 31, 2005. The Company recorded a charge of approximately $192 for one-time employee termination benefits related to the closure of the Minneapolis office. Such  49  costs are recorded as a restructuring charge in the consolidated statement of operations for 2005. The entire amount is attributable to the Promotional Products segment.  In 2005, the Company made a decision to reorganize and consolidate SCI Promotions offices in Ontario, California with its Los Angeles office. The Company recorded a charge for one-time employee termination benefits and other costs totaling $640 in 2005. In 2006, the Company incurred an additional $723 for employee termination benefits and other costs. The entire amount is attributable to the Promotional Products segment.  In 2005, the Company made the determination to sublease approximately 15,000 square feet of its Los Angeles office space. The space was sublet effective December 15, 2005 for a term ending December 31, 2009 (the expiration of the master lease term). The Company recorded a charge of $184 in 2005 for the estimated loss on the sublease over the term. Such costs are recorded as a restructuring charge in the consolidated statement of operations for 2005. The entire amount is attributable to the corporate segment.  In 2006, in connection with the Companys decision to consolidate the SCI Promotion, Pop Rocket and Megaprint Group agencies into Logistix, the Company made a decision to eliminate two senior management positions. The Company recorded a charge for one-time employee termination benefits and other costs totaling $283. The entire amount is attributable to the Promotional Products segment.  In 2006, the Company made a decision to reorganize our Hong Kong office to better align the Companys operations with the current business needs. As a result, the Company recorded a charge of $94 for one-time termination benefits associated with staff reductions in the Companys Hong Kong office.  The following table summarizes activity in our restructuring reserve.  Pop Rocket *
Centralized Corporate *
Logistix (U.K.) *
Johnson Grossfield *
SCI Promotion *
Los Angeles Office Sublease
Logistix Consolidation *
Upshot *
Hong Kong *
TotalReserve at January1, 2004
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
366
$
-
$
366Restructuring charge

-

81

-

-

-

-

-

-

-

81Reversal of restructuring reserve

-

-

-

-

-

-

-

(25)

-

(25)Utilization in 2004

-

(81)

-

-

-

-

-

(341)

-

(422)Reserve at December 31, 2004

-

-

-

-

-

-

-

-

-

-Restructuring charge

746

622

568

192

640

184

-

-

-

2,952Utilization in 2005

(513)

(261)

(137)

(96)

(110)

-

-

-

-

(1,117)Reserve at December 31, 2005

233

361

431

96

530

184

-

-

-

1,835Restructuring charge

38

58

17

-

723

-

283

-

94

1,213Utilization

(271)

(419)

(427)

(96)

(1,244)

(117)

(261)

-

(94)

(2,929)Reserve at December 31, 2006
$
-
$
-
$
21
$
-
$
9
$
67
$
22
$
-
$
-
$
119
  * One-time employee termination benefits and other related costs.  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 a significant 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 was recorded as impairment of assets in the accompanying consolidated statement of operations for the year ended December 31, 2004 and was reflected in the Agency Services segment.  On August 9, 2005, the Company was notified by the Subway Franchisee Advertising Fund Trust (SFAFT) that following completion of fulfillment on Subway Restaurants kids meal programs by Johnson Grossfield in November 2005, the relationship between Johnson Grossfield and Subway Restaurants will be terminated. As a result, the Company recorded a charge of $3,431 for the impairment of goodwill and other intangible assets of Johnson Grossfield. Of the $3,431 impairment charge $1,449 was attributable to goodwill and  51  $1,982 was attributable to other intangible assets. The remaining carrying value of the goodwill and other intangible assets of Johnson Grossfield as of December 31, 2005 was $0. The impairment of assets charge was recorded in the consolidated statement of operations for the year ended December 31, 2005 and was reflected in the Promotional Products segment.  In the fourth quarter of 2005, we incurred a goodwill impairment charge of $10,838 for the SCI Promotion reporting unit in connection with the annual impairment test required by SFAS No. 142. This charge was calculated utilizing a discounted cash flow model based on the best available projections as of December 31, 2005 of SCI Promotions future cash flows. Such projections were formulated in the fourth quarter of 2005 and were negatively impacted by the continuing trend of department store consolidation, and its industry-specific challenges which have resulted in smaller marketing budgets, fewer programs and smaller program sizes. Competitive pressures and materials cost increases in Asia have also compressed margins. Included in the impairment analysis for the SCI Promotion reporting unit is $8,318 of goodwill related to the business of U.S. Import & Promotion, Co. (USI), which is the Companys
seasonal toy and promotions business catering to oil and gas retailers. USI was acquired in 1998 and later merged with SCI because its client base and offerings were complementary to SCIs. Of the $10,838 impairment charge, $10,578 was attributable to goodwill and $260 was attributable to other intangible assets of SCI Promotion. The remaining carrying value of goodwill and other intangible assets of SCI Promotion as of December 31, 2005 was $2,580 and $71, respectively. The impairment of assets charge was recorded in the consolidated statement of operations for the year ended December 31, 2005 and was reflected in the Promotional Products segment.  Effective January 1, 2005, the Megaprint Group was consolidated with the Logistix (U.K.) reporting unit, because its client base and service offerings were complementary to Logistix. As a result, the balance of Megaprint Group goodwill and other intangibles is analyzed in connection with the annual impairment test for the Logistix (U.K.) reporting unit. Throughout 2004, Logistix (U.K.) won all of its largest clients pan-European programs. The agency had a long string of consecutive wins, but it did not repeat this win rate in 2005. Additionally, this client has reduced the number and size of its promotional programs. Based on our projections, which were formulated in the fourth quarter of 2005, the Company believed this pattern will continue, and as a result, the Company incurred an impairment charge of $16,701 in the fourth quarter of 2005. This charge was calculated in accordance with the provisions of SFAS No. 142
utilizing a discounted cash flow model based on the best available projections as of December 31, 2005 of Logistix (U.K)s future cash flows. Of the $16,701 impairment charge, $16,418 was attributable to goodwill and $283 was attributable to other intangible assets of Logistix (U.K.) and Megaprint Group. The remaining carrying value of goodwill and other intangible assets of Logistix (U.K.), including Megaprint Group, as of December 31, 2005 was $2,659. The impairment of assets charge was recorded in the consolidated statement of operations for the year ended December 31, 2005 and was reflected in the Promotional Products segment. The entire remaining balance of $629 of other intangible assets for Logistix (U.K.) represents the Logistix trademark.  4.
ACQUISITIONS
  On February 2, 2004 (effective January 31, 2004), the Company acquired certain assets of Johnson Grossfield, Inc. (JGI-MN), a privately held promotional marketing services company based in Minneapolis, Minnesota. The Company financed the acquisition through its existing cash reserves. The acquisition was consummated pursuant to an Asset Purchase Agreement dated January 16, 2004 (the Johnson Grossfield Purchase Agreement). Under the terms of the Purchase Agreement, the Company purchased the assets of JGI-MNs promotional agency business for approximately $4,325 in cash (net of a holdback of $250) and 35,785 shares of the Companys Common Stock (which, based upon the January 30, 2004 closing market price of $14.80, had a value of $530), plus related transaction costs of $184 and a commitment to pay additional earnout consideration of up to $4,500 based upon future
performance of the acquired business. During 2004, additional consideration was paid in the amount of $105 as a working capital adjustment. The Company also assumed the operating liabilities of the promotional agency business in connection with the acquisition. The earnout consideration was based upon the acquired business achieving targeted levels of EBITDA over the period from 2004 through 2008. The earnout payments, if required, were payable 50% in cash and 50% in shares of the Companys Common Stock. The additional consideration, if any, would be recorded as goodwill. On April 19, 2005, the Company reached agreement with the sellers of Johnson Grossfield on the amount of earnout attributable to 2004 performance. Such earnout consideration totaled $257, of which $148 was paid in cash and the remainder payable in shares of the Companys Common Stock (10,616 shares valued at $109 as of April 19, 2005). This earnout consideration was recorded as goodwill in the second quarter of
2005. No earnout was payable based upon the 2005 and 2006 performance.  52  The Johnson Grossfield acquisition has been accounted for under the purchase method of accounting. The financial statements reflect the allocation of the purchase price to the acquired net assets based on their estimated fair values as of the acquisition date. The Companys allocation of purchase price for the Johnson Grossfield acquisition, based upon estimated fair values is as follows:  Net current assets
$
2,758Property, plant and equipment

8Other non-current assets

7Net current liabilities

(1,214)Estimated fair value, net assets acquired

1,559Goodwill

1,449Other intangible assets

2,393Total purchase price
$
5,401
  The intangible assets of $2,393 were comprised of customer relationships and a non-competition agreement, and were being amortized over estimated useful lives ranging from 2 years to 12 years.  In 2005, as a result of the loss of Johnson Grossfields primary client, the Company recorded an impairment charge to write-off the entire remaining balance Johnson Grossfield goodwill and other intangible assets (see Note 3).  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 $3,388) in cash (net of a hold back for working capital adjustments of 180 GBP), plus related transaction costs of 305 GBP (approximately $566). Under the terms of the Stock Purchase Agreement, the Company is committed to pay, subject to offset for any shortfall in the target level of net working capital at December 31, 2004, a minimum of 850 GBP and up to a maximum of 1,300 GBP in 2005 based on the performance of Megaprint Group for the year ended December 31, 2004 (2004 Earnout Payment). The Company has accrued a liability for the minimum payment of 850 GBP as
purchase price as of the acquisition date. The Company is also committed to pay additional consideration up to a maximum of 2,450 GBP based on future performance through 2009. The additional consideration is based upon the business achieving targeted levels of margin after direct overhead (MADO) over the period from 2005 through 2009. During 2005, the preliminary allocation of the purchase price was adjusted to revise the estimated value of accrued liabilities ($706 increase). During 2005, an additional 256 GBP (approximately $461) was paid to the sellers of Megaprint Group for a working capital adjustment. The additional consideration was recorded as goodwill in the accompanying consolidated balance sheet. The Companys 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

(7,995)Estimated fair value, net assets acquired

1,782Goodwill

3,887Other intangible assets

338Total purchase price
$
6,007
  Included in net current liabilities for the Megaprint Group was a mortgage loan for a building in the Netherlands. The balance of the mortgage loan as of the acquisition date totaled approximately 900 Euros (approximately $1,200). The building was recorded under fixed assets and was recorded at the same value as the balance of the mortgage loan. The building and mortgage loan were held in trust by the Megaprint Group on behalf of its former shareholders (the Sellers). In June 2005, the Company repaid the mortgage loan. The amount repaid of 900 Euros (approximately $1,090) was applied against monies owed to the Sellers for the 2004 Earnout Payment. As a result, in June 2005, the Company paid the sellers 199 GBP (approximately $360) of the 850 GBP owed for the 2004 Earnout Payment. Subsequent to the repayment of the mortgage loan, the building was sold in June 2005 for 747 Euros (approximately $939).
The proceeds from the sale were paid to the Sellers in the third quarter of 2005.  The intangible assets of $338 are comprised of sales order backlog and customer relationships, and were being amortized over estimated useful lives ranging from 7 months to 15 years.  53  Effective January 1, 2005, the Megaprint Group was consolidated with the Logistix (U.K.) reporting unit, because its client base and service offerings were complementary to Logistix. In the fourth quarter of 2005, in connection with the Companys annual impairment test of the Logistix reporting unit, the Company determined that the goodwill and other intangible assets resulting from the acquisitions of Logistix and Megaprint Group were impaired as of December 31, 2005 (See Note 3).  Pro Forma Financial Data The following selected unaudited pro forma consolidated results of operations are presented as if the Johnson Grossfield and Megaprint Group acquisitions had occurred as of the beginning of the period immediately preceding the period of acquisition after giving effect to certain adjustments for the amortization of intangibles, reduced interest income and related income tax effects.  The pro forma data is for informational purposes only and does not necessarily reflect the results of operations had the businesses operated as one during the period. No effect has been given for synergies, if any, that may have been realized through the acquisitions.  Year Ended December 31, 2004Pro forma revenues
$
249,920Pro forma net loss
$
(9,669)Pro forma basic loss per share
$
(2.82)Pro forma diluted loss per share
$
(2.82)Pro forma basic weighted averageshares outstanding

5,756,960Pro forma diluted weighted averageshares outstanding

5,756,960
  Refer to Note 1 for further discussion of the method of computation of earnings per share.  5.
FIXED ASSETS, NET
  Fixed assets, net is summarized as follows:  December 31,2005


2006Furniture, fixtures and equipment
$
3,366

$
3,485Computer software

5,580


5,913Computer hardware

5,646


6,302Leasehold improvements

2,125


2,571Fixed assets, at cost

16,717


18,271Accumulated depreciation and amortization

(13,146)


(14,688)Fixed assets, net
$
3,571

$
3,583
  For the years ended December 31, 2004, 2005 and 2006, depreciation expense related to fixed assets was $1,704, $1,821 and $1,541, respectively.  6.
SHORT-TERM DEBT
  On April 24, 2001, the Company signed a credit facility (the Prior Facility) with Bank of America. On April 26, 2004, the maturity date of the Prior Facility was extended through June 30, 2005. Effective March 30, 2005, the maturity date of the Prior Facility was further extended through March 31, 2006. The credit facility was collateralized by substantially all of the Companys assets and provided for a line of credit of up to $20,000 with borrowing availability determined by a formula based on qualified assets. Interest on outstanding borrowings was 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 was 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 was based on the achievement of certain financial ratios. As of December 31, 2005, the marginal interest rate on available borrowings under the Prior Facility was 7.5%. As of December 31, 2005, $0 was outstanding under the Prior Facility.  On March 29, 2006, the Company entered into a new credit facility (the Facility) with Bank of America. The maturity date of the Facility is March 29, 2009. The Facility is collateralized by substantially all of the Companys assets and provides for a line of credit of up to $25,000 with borrowing availability determined by a formula based on qualified assets. Interest on outstanding borrowings will be based on either a fixed rate equivalent to LIBOR plus an applicable spread of between 2.50 and 3.00 percent or a variable rate equivalent  53  to the banks reference rate plus an applicable spread of between 0.75 and 1.25 percent. The Company is also required to pay an unused line fee of between 0.375 and 0.50 percent per annum and certain letter of credit fees. The applicable spread is based on the levels of borrowings relative to qualified assets. The Facility also requires the Company to comply with certain restrictions and covenants as amended from time to time. The Facility may be used for working capital and other corporate financing purposes. The Facility does not permit the payment of dividends on Series AA Preferred Stock for 2006. The restriction on dividends may be removed in 2007 subject to 2006 audited results and compliance with covenants. On May 10, 2006 certain covenants under the facility were amended. On August 11, 2006, the Company amended the Facility to provide for a temporary bridge facility to increase the Companys
available borrowings by up to $7,000 to fund working capital for a specific client program. The finance charges for borrowings under the bridge facility were 300 basis points greater than the interest charges under the Facility. This bridge facility expired November 30, 2006. As of December 31, 2006, the marginal interest rate on available borrowings under the Facility was 9.0%. As of December 31, 2006, the Company was in compliance with the restrictions and covenants. As of December 31, 2006, $0 was outstanding under the Facility.  Letters of credit outstanding under the Companys prior credit facility and the Facility as of December 31, 2005 and 2006 totaled $2,763 and $310, respectively.  In addition to the Facility, in October, 2003 the Companys Logistix (U.K.) agency established an import/letter of credit facility with Hong Kong Shanghai Bank Corp. (HSBC) to provide short-term financing of product purchases in Asia. The total availability under this facility is 1,500 GBP. The total availability under this facility was increased from 1,000 GBP to 1,500 GBP in 2005. Under this facility HSBC may pay the agencys vendors directly upon receipt of invoices and shipping documentation. Logistix (U.K.) in turn is obligated to repay HSBC within 120 days. As of December 31, 2005 and 2006, $0 was outstanding under this facility. This facility expired in the fourth quarter of 2006.  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, 2004, 2005, and 2006 were $599, $730 and $377, 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). Under the plans, the Company has the ability to grant stock options, restricted stock, restricted stock units (RSUs), stock bonuses, stock appreciation rights or performance units. Stock options expire no later than ten years from the date of grant and generally provide for vesting over a period of four years from the date of grant. Such stock options were granted with exercise prices at or above the fair market value of the Companys common stock on the date of grant. A total of 2.4
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 720,969 shares were available for grant under the Equity Compensation Plans as of December 31, 2006. The 2000 Employee Plan expires in 2010. The Non-Employee Director Plan and the Stock Incentive Plan expire in 2014.  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.  In December 2006, the Company repurchased stock options from its employees in order to increase the number of shares available for grant under the Companys Equity Compensation Plans. The Company paid $231 to repurchase 345,500 fully vested stock options with an average exercise price of $14.44. The Black Scholes Model was used in determining the valuation of the purchase price of the shares repurchased. In the table below, the cancelled shares for 2006 include those options repurchased and cancelled by the Company. In accordance with the provisions of SFAS No. 123(R), the cash settlement of $231 was recorded as a repurchase of outstanding equity instruments and was charged to additional paid-in capital.  54  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 January 1, 2004
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
$
13.33Granted
500,000
118,648

9.03Exercised
(20,000)
(26,813)

2.46Canceled
(702,758)
(72,337)

14.17Outstanding at December 31, 2005
1,733,970
264,823

12.04

1,820,327
$
9.63Granted
-
515,349

-Exercised
-
(62,804)

-Canceled
(686,900)
(55,504)

12.30Outstanding at December 31, 2006
1,047,070
661,864
$
7.48

1,192,294
$
10.72
  The following table summarizes information about the Companys equity awards outstanding and exercisable as of December 31, 2006:  WEIGHTED

WEIGHTED


WEIGHTEAVERAGE

AVERAGE


AVERAGERANGE OF EXERCISE PRICES
NUMBER OUTSTANDING
REMAINING CONTRACTUAL LIFE

EXERCISE PRICE
NUMBER EXERCISABLE

EXERCISE PRICE$ 0.00 - $ 0.00
661,864
12.36
$
-
145,224
$
-$ 7.18 - $10.00
435,620
6.24
$
8.95
435,620
$
8.95$10.90 - $14.89
441,450
4.76
$
12.20
441,450
$
12.20$15.80 - $28.13
170,000
2.02
$
20.60
170,000
$
20.601,708,934
7.81
$
7.48
1,192,294
$
10.72
  The aggregate fair market value of the Companys restricted stock and RSU grants is being amortized to compensation expense over the vesting period (typically 4 years). Compensation expense recognized related to grants of restricted stock and RSUs to certain employees and non-employee Board members was $938 and $1,080 for the year ended December 31, 2005 and 2006, respectively. As of December 31, 2006, there was $3,621 of unrecognized compensation cost related to unvested restricted stock and RSUs. This cost is expected to be recognized over a weighted average of 2.4 years.  56  The following table summarizes the number and weighted average grant date fair value of the Companys unvested restricted stock and RSUs as of December 31, 2006:  Weighted AverageGrant DateShares


Fair ValueUnvested at January 1, 2006
177,110

$
12.00Granted
479,207


6.21Vested
(87,048)


10.46Forfeited
(52,629)


10.84Unvested at December 31, 2006
516,640

$
7.01
  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 On March 29, 2000, Crown EMAK Partners, LLC, a Delaware limited liability company (Crown), invested $11,900 in the Company in exchange for Preferred Stock and warrants to purchase additional Preferred Stock. Under the terms of the investment, Crown acquired 11,900 shares of Series A mandatorily redeemable senior cumulative participating convertible preferred stock, par value $.001 per share, (the Series A Stock) with a conversion price of $14.75 per common share. In connection with such purchase, the Company granted to Crown five year warrants (collectively, the Warrants) to purchase 5,712 shares of Series B senior cumulative participating convertible preferred stock, par value $.001 per share, (the Series B Stock) at an exercise price of $1,000 per share, and 1,428 shares of Series C senior cumulative participating convertible preferred stock, par
value $.001 per share, (the Series C Stock) at an exercise price of $1,000 per share. The Warrants were immediately exercisable. The conversion prices of the Series B Stock and the Series C Stock were $16.00 and $18.00 per common share, respectively. On June 20, 2000, Crown paid an additional $13,100 in exchange for an additional 13,100 shares of Series A Stock with a conversion price of $14.75 per common share. In connection with such purchase, the Company granted to Crown additional Warrants to purchase another 6,288 shares of Series B Stock and another 1,572 shares of Series C Stock. Each share of Series A Stock is convertible into 67.7966 shares of Common Stock, representing 1,694,915 shares of Common Stock in aggregate. Each share of Series B Stock and Series C Stock was convertible into 62.5 and 55.5556 shares of Common Stock, respectively, representing 916,666 shares of Common Stock in aggregate. Also in connection with such
purchase, the Company agreed to pay Crown a commitment fee in the aggregate amount of $1,250, paid in equal quarterly installments of $62.5 commencing on June 30, 2000 and ending on March 31, 2005.  The Series A Stock was subject to mandatory redemption at the option of the holder at 101% of the aggregate Liquidation Preference plus accrued and unpaid dividends if a change in control occurs.  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 redemption of the Warrants in exchange for the New Warrants in accordance with EITF Topic D-42, The Effect on the Calculation of Earnings per Share for the Redemption or Induced Conversion of Preferred Stock. Accordingly, the excess of the redemption cost over the net carrying amount of the redeemed shares was recorded as an increase to net loss available for common stockholders. The common stock warrants issued in this transaction were valued at $8,177 which results in a $5,042 ($8,177 less the $3,135 carrying value of the Warrants) increase to net loss available to common stockholders. The carrying value of the Warrants upon original issuance in 2000 was recorded as mandatorily redeemable preferred stock along with the Series A Stock. The exchange resulted in a reduction to mandatorily redeemable preferred stock of $3,135 to record the redemption of the Warrants and an
increase to additional paid-in capital of $8,177 to record the issuance of the New Warrants. The Company also recorded a reduction of $44 to additional paid-in capital for transaction costs associated with the issuance of the New Warrants.  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  57  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. Upon any voluntary or involuntary liquidation, dissolution or winding-up of the Companys affairs, Crown, as holder of the Series AA Stock, will be entitled to payment out of assets of the Company available for distribution of an amount equal to the greater of (a) the liquidation preference of $1,000 per share (the Liquidation Preference) plus all accrued and unpaid dividends or (b) the aggregate amount of payment that the outstanding preferred stock holder would have received assuming conversion to Common Stock immediately prior to the date of liquidation of capital stock, before any payment is made to other stockholders.  On June 30, 2006, the Company entered in an Exchange and Extension Agreement with Crown providing that: (a) the conversion price of the Companys Series AA Senior Cumulative Convertible Preferred Stock (Series AA Stock) would be reduced from $14.75 per share of Common Stock to $9.00 per share of Common Stock; (b) the 6% cumulative perpetual dividend on the $25,000 face value of the Series AA Stock ($1,500 per annum) would be permanently eliminated effective April 1, 2006; (c) the provisions pertaining to election of Series AA directors would be revised to permit the holders of the Series AA Stock to elect two directors except (i) if the number of Common Stock directors exceeds seven or (ii) in situations involving a potential Change of Control (as defined in the Certificate of Designation of Series AA Stock) at a time when the total number of directors (inclusive of
Common Stock directors and Series AA Stock directors) exceeds eight, in either of which instances the holders of the Series AA Stock would be permitted to elect three directors; and (d) the terms of the Common Stock warrants held by Crown which previously expired on March 29 and June 20, 2010 would be extended until March 29 and June 20, 2012 (collectively, the Crown Transaction).  At the Companys Annual Meeting held on May 31, 2006, the Companys stockholders approved an amendment to the Certificate of Designation of the Companys Series AA Stock (the Certificate of Designation) in order to permit the closing of the Crown Transaction. The Certificate of Amendment of Certificate of Designation provides for the changes in the rights and preferences of the Series AA Stock.  Also in connection with the closing of the Crown Transaction, effective as of May 31, 2006, the Company entered into an Amendment No. 1 to Rights Agreement with Continental Stock Transfer & Trust Company as rights agent (Amendment No. 1) with respect to the Companys Preferred Share Purchase Rights Plan (the Plan). Amendment No. 1 provides that the shares of Common Stock issuable upon conversion of the Series AA Stock, as may be amended from time to time, or upon the exercise of any options or warrants Crown holds to acquire capital stock of the Company (as the same may be amended from time to time), in each case held by Crown as of May 31, 2006 or issuable to Crown as a result of the transactions approved by the Companys stockholders at the Companys 2006 Annual Meeting of Stockholders, will not result in a triggering of rights under the Plan.  The Crown Transaction was closed on June 30, 2006. The Company accounted for the transaction as a modification of equity instruments. As a result, the decrease in the fair value of the Series AA Stock was recorded as a reduction to mandatorily redeemable preferred stock of $873 with an offset to net income available to common stockholders. The increase in the value of the common stock warrants was recorded as an increase to additional paid-in capital of $873 with an offset to net income available to common stockholders. The net impact to income available to common stockholders is zero. Direct outside costs related to this transaction totaled $157 and were recorded as a reduction to additional paid-in capital.  The Series AA Stock is subject to mandatory redemption at the option of the holder at 101% of the aggregate Liquidation Preference plus accrued and unpaid dividends if a change in control occurs.  Crown has voting rights equivalent to the number of shares of Common Stock into which their Series AA Stock is convertible on the relevant record date. Until March 31, 2006, Crown was 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, 2006 amounted to $375.  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 total approximately $1,951.  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 Company made no additional purchases during the years ended December 31, 2005 and 2006. On March 27, 2006, the Companys Board of Directors adopted a resolution terminating the repurchase program, as the Company is not planning on making any further stock
repurchases.  57  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 31,2004

2005

2006US operations
$
(20,013)
$
(16,764)
$
(1,375)Foreign operations

3,613

(14,955)

(1,197)$
(16,400)
$
(31,719)
$
(2,572)
  The provision (benefit) for income taxes consist of:  Years Ended December 31,2004

2005

2006CURRENT:Federal
$
(2,640)
$
(750)
$
(52)State and local

16

15

(336)Foreign

717

48

97(1,907)

(687)

(291)DEFERRED:Federal

(2,970)

6,554

--State and Local

(1,839)

2,387

--Foreign

--

(101)

(16)(4,809)

8,840

--$
(6,716)
$
8,153
$
(307)
  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 31,2004

2005

2006Tax at the Federal statutory rate
$
(5,641)
$
(10,911)
$
(885)State income taxes, net of the Federal tax benefit

(1,052)

(858)

(156)Effect of change in state rate on deferred tax assets

(300)

--

--Effect of permanent differences for non-deductible goodwill

--

5,010

--Valuation Allowance

223

14,390

630Other

54

522

104$
(6,716)
$
8,153
$
(307)
  Other reflects the effects of permanent differences such as tax free municipal interest income earned in 2004, 2005 and 2006, and the impact of foreign earnings/losses which are taxed at different rates. In 2005, the company recorded a tax provision despite recording pre-tax losses as a result of establishing a valuation allowance against previously recorded deferred tax assets (see below).  In 2006, the Company recorded a net tax benefit primarily as a result of more favorable state income tax apportionment factors than originally anticipated in our previous tax provision estimates.  59  The tax effects of the significant temporary differences giving rise to the Companys deferred tax assets (liabilities) for the years ended December 31, 2005 and 2006 are as follows:  2005

2006Allowance for doubtful accounts
$
644
$
599Inventory reserve

146

36Accrued expenses

1,199

716Net operating loss carryforwards

--

--Other

(488)

(223)Total current

1,501

1,128Goodwill and other intangibles

7,367

6,386Fixed assets

365

586Net operating loss and other carryforwards

3,152

5,568Long term liabilities

1,768

1,099Other

271

282Total non-current

12,923

13,535Deferred income tax asset valuation allowance

(14,613)

(15,243)Net deferred tax liabilities
$
(189)
$
(194)
  The Company assesses the realizability of its deferred tax assets and the need for a valuation allowance based on the requirements of SFAS No. 109. SFAS No. 109 requires the Company to analyze all positive and negative evidence to determine if, based on the weight of available evidence, we are more likely than not to realize the benefit of our net deferred tax assets. The recognition of a valuation allowance against net deferred tax assets and the related tax provision is based upon managements conclusions regarding, among other considerations, estimates of future earnings based on information currently available. Because of the operating losses the Company has incurred over the past two years and based on projections of 2006 taxable income, the Company established a non-cash valuation allowance against its deferred tax assets. The Company does not expect to record tax expense or benefits on U.S.-based operating
results until it is consistently profitable on a quarterly basis. At that time, the valuation allowance will be reassessed and could be eliminated, resulting in the recognition of the deferred tax assets. The valuation allowance provided against deferred tax assets is $14,613 and $15,243 at December 31, 2005 and 2006, respectively. We recorded a tax provision of $8,153 in 2005 as the result of establishing a valuation allowance against deferred tax assets during the fourth quarter of 2005.  Federal net operating loss (NOL) carryforwards totaled approximately $2,606 and $7,295 as of December 31, 2005 and 2006, respectively. The federal net operating losses related to 2004 were carried back and utilized in prior years. A portion of the 2005 loss was carried back and utilized in prior years. As of December 31, 2005, for the reasons discussed above, management established a full valuation allowance against the remaining balance of federal NOL carryforwards. Foreign NOL carryforwards totaled $1,287 as of December 31, 2006 and have a full valuation allowance against them.  State net operating loss carryforwards totaled approximately $13,102 and $17,606 as of December 31, 2005 and 2006, respectively. 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. 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. As of December 31, 2005, for the reasons discussed above, management established a full valuation allowance against the remaining balance of state NOL carryforwards.  A deferred U.S. tax liability has not been provided on the unremitted earnings of Logistix (U.K.) 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 $4,330 and $2,574 at December 31, 2005 and 2006, respectively.  On October 22, 2004, the American Jobs Creation Act (the Jobs Act) was signed into law. Among its various provisions, the Jobs Act creates a temporary incentive for U.S. 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. The Company repatriated $2,650 in foreign earnings during 2005 from a newly formed controlled foreign corporation (CFC) in Hong Kong. The repatriation related to the 2005 earnings of the CFC and had no impact on the Companys 2005 tax provision as a result
of the net losses and the establishment of the deferred tax asset valuation allowance. Managements domestic reinvestment plan for the reinvestment and repatriation of foreign earnings under the Jobs Act was completed and approved by Mr. Holbrook, the Companys  60  Chief Executive Officer, on December 14, 2005. The Companys Board of Directors approved this domestic reinvestment plan on December 15, 2005. The Company decided not to repatriate any earnings of Logistix (U.K.).  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:  Year2007
$
4,1262008

3,9812009

3,7952010

6652011

546Thereafter

1,112Total
$
14,225
  Aggregate rental expenses for operating leases were $3,873, $3,922 and $3,249 for the years ended December 31, 2004, 2005 and 2006, respectively.  Guaranteed Royalties  For the years ended December 31, 2004, 2005, and 2006, the Company incurred $3,996, $4,168 and $1,899, 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. In 2005, we reached a settlement with one of our licensors affecting several licenses. As a result of this settlement and Scooby-Doo revenues that exceeded our initial estimates, $2,837 of the 2004 charge for minimum royalty guarantee shortfalls was reversed in 2005. In 2006, we reached a settlement with a different licensor which resulted in a reversal of $88. License agreements for certain copyrights and trademarks require minimum guaranteed royalty payments over the respective terms of the licenses.  As of December 31, 2006, the Company has committed to pay total minimum guaranteed royalties as follows:  Year2007
$
2702008

300Total
$
570
  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 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).  60  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 51%, 52% and 48% of the Companys consolidated revenues for the years ended December 31, 2004, 2005 and 2006, respectively, were from one customer in the Promotional Products segment.  The Company has identified three reportable segments through which it conducts its operations: Agency Services, Promotional Products and Consumer Products. Effective January 1, 2006, as a result of recent changes in management and agency structure and to be consistent with the way management now views business units internally, the Company now reports its marketing services business as two separate reportable segments: Agency Services and Promotional Products. This reflects the changes in the structure and format of internal management reports provided to the chief operating decision maker. The factors for determining the reportable segments were based on the distinct nature of their operations. Each segment is responsible for executing a unique business strategy. The Agency Services segment provides various services such as strategic planning and research, entertainment marketing, promotion, event marketing, collaborative
marketing, retail design, and environmental branding. The Agency Services segment is a service-based business whose revenues are derived either from fees for hours worked or from fixed price retainer contracts. The Promotional Products segment designs and contracts for the manufacture of promotional products used as free premiums or sold in conjunction with the purchase of other items at a retailer or quick service restaurant. Promotional Products are used for marketing purposes by both the companies sponsoring the promotions and the licensors of the entertainment properties on which the promotional programs are often based. The Promotional Products segment manufactures product to order and derives its revenues primarily from the sale of such product to its clients. The Consumer Products segment designs and contracts for the manufacture of toys and other consumer products for sale to major mass market and specialty retailers, who in turn sell the products to consumers. Certain information presented in
the tables below have been restated to conform to the current management structure as of January 1, 2006.  Earnings of industry segments and geographic areas exclude interest income, interest expense, depreciation expense, integration costs, and other unallocated corporate expenses. Income taxes are allocated to segments on the basis of operating results. Identified assets are those assets used in the operations of the segments and include inventory, receivables, goodwill and other intangibles. Corporate assets consist of cash, certain corporate receivables, fixed assets, and certain trademarks.  The primary measure of segment profit or loss reviewed by the chief operating decision maker is segment income (loss) from operations.  61  Industry Segments   As of and For the Year Ended December 31, 2004Agency

Promotional

ConsumerServices

Products

Products

Corporate

TotalTotal revenues

$
19,252
$
192,274
$
25,135
$
--
$
236,661Segment income (loss)from operations

$
(3,211)
$
16,151
$
(9,333)
$
(19,220)
$
(15,613)Fixed asset additions
$
--
$
--
$
--
$
1,602
$
1,602Depreciation and amortization
$
--
$
358
$
--
$
1,709
$
2,067Total assets

$
12,852
$
86,913
$
11,570
$
21,978
$
133,313As of and For the Year Ended December 31, 2005Agency

Promotional

ConsumerServices

Products

Products

Corporate

TotalTotal revenues

$
20,766
$
176,416
$
26,215
$
--
$
223,397Segment income (loss) beforefrom operations

$
4,137
$
(15,807)
$
2,642
$
(22,728)
$
(31,756)Fixed asset additions
$
--
$
--
$
--
$
1,711
$
1,711Depreciation and amortization
$
--
$
344
$
--
$
1,821
$
2,165Total assets

$
15,213
$
33,002
$
5,963
$
15,618
$
69,796As of and For the Year Ended December 31, 2006Agency

Promotional

ConsumerServices

Products

Products

Corporate

TotalTotal revenues

$
30,133
$
141,083
$
10,181
$
--
$
181,397Segment income (loss) beforefrom operations

$
5,812
$
9,944
$
(260)
$
(17,714)
$
(2,218)Fixed asset additions
$
--
$
--
$
--
$
1,469
$
1,469Depreciation and amortization
$
--
$
139
$
--
$
1,546
$
1,685Total assets

$
13,027
$
28,482
$
2,985
$
17,876
$
62,370
   Information about the Companys operations by geographical area is as follows:  As of and For the Years Ended December 31,2004

2005

2006Revenues:United States
$
177,125

$
171,995

$
134,907International

59,536


51,402


46,490Total revenues

236,661

$
223,397

$
181,397Income (loss) from operations:United States
$
(14,893)

$
(12,076)

$
1,318International

(720)


(19,680)


(3,536)Total income from operations
$
(15,613)

$
(31,756)

$
(2,218)Fixed assets, net:United States
$
2,916

$
2,984

$
3,093International

2,113


587


490Total fixed assets
$
5,029

$
3,571

$
3,583
   62  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 did not include success fee guidelines. The USCI agreements provided 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 did not extend its arrangement with USCI beyond 2004.  13.
SUMMARIZED QUARTERLY FINANCIAL DATA (UNAUDITED)
  Three Months EndedMarch 31

June 30

September 30

December 312005Revenues
$
57,242

$
58,102

$
49,810

$
58,243Gross profit
$
14,449

$
16,885

$
14,948

$
15,026Income (loss) from operations
$
(600)

$
1,247

$
(2,640)

$
(29,763)
(1)Net income (loss) available to common stockholders
$
(792)

$
349

$
(1,915)

$
(39,014)Basic income (loss) per share:Income (loss) per share
$
(0.14)

$
0.06

$
(0.33)

$
(6.74)Weighted average shares outstanding
5,765,938


5,785,202


5,788,042


5,792,517Diluted income (loss) per share:Income (loss) per share
$
(0.14)

$
0.06

$
(0.33)

$
(6.74)Weighted average shares outstanding
5,765,938


6,005,326


5,788,042


5,792,517
   Three Months EndedMarch 31

June 30

September 30

December 312006Revenues
$
42,686

$
40,094

$
43,078

$
55,539Gross profit
$
10,333

$
11,310

$
11,547

$
10,837Income (loss) from operations
$
(2,105)

$
(530)

$
409

$
8Net income (loss) available to common stockholders
$
(2,463)

$
(644)

$
219

$
248Basic income (loss) per share:Income (loss) per share
$
(0.42)

$
(0.11)

$
0.04

$
0.04Weighted average shares outstanding

5,806,203


5,838,785


5,845,788


5,849,186Diluted income (loss) per share:Income (loss) per share
$
(0.42)

$
(0.11)

$
0.03

$
0.03Weighted average shares outstanding

5,806,203


5,838,785


8,675,447


8,930,472
  (1.) Changes primarily attributable to the impairment charges in the fourth quarter. (See Note 3).   63  ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
  Changes in Accountants  The Company filed a current report on Form 8-K on July 6, 2006, to report a change in the Companys independent registered public accounting firm from PricewaterhouseCoopers LLP (PwC) to Deloitte & Touche LLP (Deloitte). There were no disagreements with the accountants.  Disagreements with Accountants on Accounting and Financial Disclosure  Inapplicable   ITEM 9A(T).
CONTROLS AND PROCEDURES.
  Evaluation of Disclosure Controls and Procedures  The Company maintains disclosure controls and procedures, as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934 (the Exchange Act) , that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and forms and that such information is accumulated and communicated to the Companys management, including its Chief Executive Officer and Principal Accounting Officer, as appropriate to allow timely decisions regarding required disclosure. The Company carried out an evaluation, under the supervision and with the participation of the Companys management, including the Companys Chief Executive Officer and Principal Accounting Officer, of the effectiveness of
the design and operation of the Companys disclosure controls and procedures as of December 31, 2006. As a result of this evaluation, our Chief Executive Officer and Principal Accounting Officer concluded that our disclosure controls and procedures were effective as of December 31, 2006 and are designed to provide management with the appropriate information to allow timely decisions regarding required disclosure.   ITEM 9B.
OTHER INFORMATION.
  Inapplicable  PART III   ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
  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 2007 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 2007 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 2007 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 2007 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 2007 Annual Meeting of Stockholders, which is incorporated herein by reference.   64  ITEM 14.PRINCIPAL ACCOUNTANT FEES AND SERVICES  Information relating to this item appears under the caption RATIFICATION OF SELECTION OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM in our Proxy Statement relating to our 2007 Annual Meeting of Stockholders, which is incorporated herein by reference.  PART IV   ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
  (a)List of documents filed as part of this Report.  1. Financial Statements:
 Page
  Report of Independent Registered Public Accounting Firm
31
 Report of Independent Registered Public Accounting Firm
32
  CONSOLIDATED FINANCIAL STATEMENTS: Balance Sheets as of December 31, 2005 and 2006
33
 Statements of Operations for the Years Ended December 31, 2004, 2005 and 2006
34
 Statements of Stockholders Equity and Mandatorily Redeemable Preferred Stock for the Years Ended
 December 31, 2004, 2005 and 2006
35
 Statements of Comprehensive Loss for the Years Ended December 31, 2004, 2005 and 2006
36
 Statements of Cash Flows for the Years Ended December 31, 2004, 2005 and 2006
37
 Notes to Consolidated Financial Statements
38
  2. Financial Statement Schedules: Report of Independent Registered Public Accounting Firm on Financial Statement Schedule
66
 Schedule II Valuation and Qualifying Accounts
67
  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. (2)
 3.3
Certificate of Amendment of Certificate of Incorporation dated September 15, 2004. (2)
 3.4
Amended and Restated Bylaws. (3)
 3.5
Certificate of Designation of Series AA Senior Cumulative Convertible Preferred Stock of the Company, dated December 30, 2004. (4)
 3.6
Certificate of Amendment of Certificate of Designation of Series AA Senior Cumulative Convertible Preferred Stock of the Company dated September 2, 2005. (5)
 3.7
Certificate of Amendment of Certificate of Designation of Series AA Senior Cumulative Convertible Preferred Stock of the Company dated June 30, 2006. (6)
 10.1
Securities Purchase Agreement by and between Crown Acquisition Partners, LLC and Equity Marketing, Inc., dated March 29, 2000. (7)
 10.2
Registration Rights Agreement by and between Crown Acquisition Partners, LLC and Equity Marketing, Inc., dated March 29, 2000. (7)
 10.3
Exchange Agreement by and between Crown EMAK Partners, LLC and EMAK Worldwide dated as of December 30, 2004. (4)
 10.4
Agreement of Lease dated July 17, 1998 between Miracle Mile, L.L.C. and Equity Marketing, Inc. (8)
 10.5
Second Amendment to Office Lease by and between Lexington San Vicente Associates, LLC (successor to Miracle Mile, L.L.C.) and Equity Marketing, Inc. (9)
  66  10.6
Agreement of Lease (18th Floor) effective September 1, 2005 between Wide Harvest Investment Ltd. and Equity Marketing Hong Kong, Ltd. (9)
 10.7
Agreement of Lease (19th Floor) effective September 1, 2005 between Wide Harvest Investment Ltd. and Equity Marketing Hong Kong, Ltd. (9)
 10.8
Agreement of Lease dated June 30, 1998, as amended August 27, 1998, March 31, 2000 and May 22, 2002 between 303 Wacker Realty L.L.C. and EMAK Worldwide, Inc. (as successor to Promotional Marketing, L.L.C., d/b/a Upshot). (9)
 10.9
Loan and Security Agreement by and between Bank of America, N.A. and EMAK Worldwide, Inc. (and its domestic subsidiaries), dated March 29, 2006. (9)
 10.10
Form of Directors and Officers Indemnification Agreement. (10)
 10.11
Amended and Restated 1996 Stock Option Plan. (11)
 10.12
Non-Employee Director Stock Option Plan. (12)
 10.13
Amended and Restated 2000 Stock Option Plan. (13)
 10.14
2004 Non-Employee Director Stock Incentive Plan. (14)
 10.15
2004 Stock Incentive Plan. (14)
 10.16
Employment agreement dated as of October 3, 2005 between Equity Marketing, Inc. and Kim H. Thomsen. (15)
 10.17
Employment agreement dated as of October 3, 2005 between Equity Marketing, Inc. and Jonathan Banks. (15)
 10.18
Employment agreement dated as of November 9, 2005 between the Company and Jim Holbrook. (16)
 10.19
Form of Resale Restriction Agreement. (17)
 10.20
Exchange and Extension Agreement by and between Crown EMAK Partners, LLC and the Company dated June 30, 2006. (6)
 10.20
First Amendment to Loan and Security Agreement dated May 10, 2006. (18)
 10.21
Second Amendment to Loan and Security Agreement dated August 11, 2006. (18)
 10.22
Third Amendment to Loan and Security Agreement dated November 21, 2006.*
 10.23
Fourth Amendment to Loan and Security Agreement dated February 5, 2007.*
 21.
Subsidiaries of the Registrant.*
 23.1
Consent of PricewaterhouseCoopers LLP.*
 23.2
Consent of Deloitte & Touche LLP*
 31.1
Certification of Principal Executive Officer dated April 2, 2007 pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
 31.2
Certification of Principal Accounting Officer dated April 2, 2007 pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
 32.1
Certification of Principal Executive Officer dated April 2, 2007 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 Accounting Officer dated April 2, 2007 pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
 ------------------------  67  (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 Annual Report on Form 10-K for the year ended December 31, 2004, and incorporated herein by reference.
  (3)
Previously filed as an exhibit to the Registrants Current Report on Form 8-K dated March 17, 2005, and incorporated herein by reference.
  (4)
Previously filed as an exhibit to the Registrants Current Report on Form 8-K dated January 5, 2005, and incorporated herein by reference.
  (5)
Previously filed with the Registrants Proxy Statement for the 2005 Annual Meeting of Stockholders dated April 28, 2005 and incorporated herein by reference.
  (6)
Previously filed as an exhibit to the Registrants Current Report on Form 8-K dated June 30, 2006, and incorporated herein by reference.
  (7)
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.
  (8)
Previously filed as an exhibit to the Registrants Current Report on Form 8-K dated April 11, 2000, 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, 2005.
  (10)
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.
  (11)
Previously filed as an exhibit to the Registrants Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, and incorporated herein by reference.
  (12)
Previously filed as an exhibit to the Registrants Annual Report on Form 10-K for the year ended December 31, 1997, and incorporated herein by reference.
  (13)
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.
  (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.
  (15)
Previously filed as an exhibit to the Registrants Quarterly Report on Form 10-Q for the quarter ended September 30, 2005, and incorporated herein by reference.
  (16)
Previously filed as an exhibit to the Registrants Current Report on Form 8-K dated November 15, 2005, and incorporated herein by reference.
  (17)
Previously filed as an exhibit to the Registrants Current Report on Form 8-K dated December 21, 2005, and incorporated herein by reference.
  (18)
Previously filed as an exhibit to the Registrants Quarterly Report on Form 10-Q for the quarter ended June 30, 2006.
  (*) Filed herewith  (b) Exhibits Required by Item 601 of Regulation S-K
  See Item 3. above.
   68  (c) Financial Statement Schedule
  See Item 2. above.
   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 2nd day of April, 2007.  EMAK WORLDWIDE, INC.
   By:
/s/ James L. Holbrook, Jr.James L. Holbrook, Jr.

Chief Executive Officer
  POWER OF ATTORNEY  We, the undersigned directors and officers of EMAK Worldwide, Inc. do hereby severally constitute and appoint James L. Holbrook, Jr., Teresa L. Tormey and Roy Dar 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/ James L. Holbrook, Jr.

Chief Executive Officer, Director
April 2, 2007James L. Holbrook, Jr.

(Principal Executive Officer)/s/ Roy Dar

Senior Vice President, Controller
April 2, 2007Roy Dar

(Principal Accounting Officer)/s/ Stephen P. Robeck

Chairman, Director
April 2, 2007Stephen P. Robeck/s/ Howard D. Bland

Director
April 2, 2007Howard D. Bland/s/ Jeffrey S. Deutschman

Director
April 2, 2007Jeffrey S. Deutschman/s/ Daniel W. OConnor

Director
April 2, 2007Daniel W. OConnor/s/ Alfred E. Osborne, Jr.

Director
April 2, 2007Alfred E. Osborne, Jr./s/ Charles H. Rivkin

Director
April 2, 2007Charles H. Rivkin
   69   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 30, 2006, except for the restatement discussed in Note 1 to the consolidated financial statements included in the Annual Report on Form 10-K/A for the year ended December 31, 2005 (not presented herein), as to which the date is August 31, 2006 and except with respect to our opinion on the consolidated financial statements insofar as it relates to the effects of the change in segments discussed in Note 11, as to which the date is March 26, 2007, appearing in the 2006 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 30, 2006  70   EMAK WORLDWIDE, INC.  SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS  (in thousands)   Balance at Beginning of Year

Additions Charged to Expenses

Additions Charged to Revenues

Net Deductions


Balance at End of YearCLASSIFICATIONYear 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


-


-



223Year Ended December 31, 2005Allowances for doubtful accounts receivable and sales returns
$
1,733

$
180

$
1,247

$
(1,422)
(A)

$
1,738Inventory reserve

740


1,719


-


(1,568)



891Restructuring reserves

-


2,952


-


(1,117)



1,835Deferred tax asset valuation allowance

223


14,390


-


-



14,613Year Ended December 31, 2006Allowances for doubtful accounts receivable and sales returns
$
1,738

$
13

$
958

$
(1,327)
(A)

$
1,382Inventory reserve

891


437


-


(689)



639Restructuring reserves

1,835


1,213


-


(2,929)



119Deferred tax asset valuation allowance

14,613


630


-


-



15,243
  (A) Represents product returns, credits applied and accounts receivable written off, net of recoveries.   72