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, 2007
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 Number 0-23346
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 |
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 | No X |
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 | No X |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No __
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, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] | Accelerated filer [ ] |
Non-accelerated filer [ ] | Smaller reporting company [ X ] |
(Do not check if a smaller reporting company) | |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). | Yes o | No x |
As of June 30, 2007, the aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was $9,507,231.
Number of shares outstanding of registrant’s common stock, $.001 par value, as of March 28, 2007: 6,883,677 shares
Documents Incorporated by Reference: Portions of the registrant’s definitive Proxy Statement relating to registrant’s 2008 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, 2007
ITEMS IN FORM 10-K
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PART I
($000’s omitted, except share and per share amounts)
Except as expressly indicated or unless the context otherwise requires, as used herein, “EMAK,” the “Company,” “we,” “our,” or “us,” means EMAK Worldwide, Inc., a Delaware corporation and its subsidiaries. Unless otherwise specifically indicated, all dollar amounts herein are expressed in thousands.
Overview
EMAK is the parent company of a family of marketing services agencies including Equity Marketing, Logistix, Mega and Upshot. Our agencies are experts in “consumer activation,” offering strategy-based marketing programs that directly impact consumer behavior. Our agencies provide strategic planning and research, consumer insight development, entertainment marketing, design and manufacturing of custom promotional products, kids and family marketing, event marketing, shopper marketing and environmental branding. Our blue-chip clients include Burger King Corporation, Frito-Lay, Kellogg, Kohl’s, Kraft, Macy’s, Miller Brewing Company and Procter & Gamble, among others. EMAK is headquartered in Los Angeles with offices in Chicago, Amsterdam, Frankfurt, London, Paris and Hong Kong.
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 several years, EMAK sought to diversify and grow its Marketing Services skills, geographic reach and client base through the pursuit of strategic acquisitions. 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, 2005 and 2007 which total $40,276, 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.
In 2007, while our Agency Services business grew and our domestic Promotional Products business stabilized, our European-based Promotional Products business fell substantially due to the continued shift away from kids marketing in the region. Management was again challenged to adjust the size and structure of the organization to better align costs with revenue. These adjustments, which will become visible in the first quarter of 2008, are expected to result in significant additional declines in EMAK’s overhead. 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 2008 and beyond is new business development and 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.
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Business Segments
During the three year period ended December 31, 2007, EMAK’s business was classified into three reportable business segments, namely Agency Services, Promotional Products and Consumer Products. These business segments were defined in a manner consistent with EMAK’s current organizational structure, internal reporting, allocation of resources and operational decision-making. Effective January 1, 2008, as a result of recent changes in management and agency structure and to be consistent with the way management now views business units internally, we consolidated our Consumer Products segment with our Promotional Products segment. In the future the Company will report its marketing services business as two separate reportable segments: Agency Services and Promotional Products.
Our Agency Services revenues for the years ended December 31, 2005, 2006 and 2007 were $20,766, $30,133 and $31,769, or 9%, 16%
and 19% of total revenues, respectively. Our Promotional Products revenues for the years ended December 31, 2005, 2006 and 2007 were $176,416, $141,083 and $126,612, or 79%, 78% and 77% of total revenues, respectively. Our Consumer Products revenues for the years ended December 31, 2005, 2006 and 2007 were $26,215, $10,181 and $5,793, or 12%, 6% and 4% of total revenues, respectively.
A single client, Burger King, accounted for approximately 52%, 48% and 47% of our total revenues for the years ended December 31,
2005, 2006 and 2007, respectively.
Agency Services
Our Agency Services businesses have 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, soft drinks, spirits, candy, consumer packaged goods, financial services, greeting cards, home electronics, hospitality, government services, pharmaceuticals, 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,” |
| • | 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 that 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.
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We perform a wide range of creative, design, development, production and fulfillment services for our clients, including:
| • | assisting clients in understanding the consumer through creative research and planning; |
| • | assisting clients with promotional strategy, calendar planning and concept development; |
| • | evaluating intellectual properties for which licenses are available; |
| • | advising clients as to which licenses are consistent with their marketing objectives; |
| • | assisting clients in procuring licenses; |
| • | proposing specific product and non-product based promotions often utilizing the properties secured by our clients; |
| • | developing promotional concepts and designs based on the property; |
| • | providing the development and engineering necessary to translate the property, which often consists of two-dimensional artwork, into finished products; |
| • | obtaining or coordinating licensor approval of product designs, prototypes and finished products; |
| • | contracting for and supervising the manufacture of products; |
| • | arranging for safety testing to customer and regulatory specifications by independent testing laboratories; and |
| • | arranging insurance, customs clearance and, in most instances, the shipping of finished products to the client. |
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 significant number of our clients are now running promotions globally—a trend we believe will continue to 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.
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 that have resulted in significant losses in previous years.
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. Binney & Smith is the world’s leading producer of children’s art products.
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.
Effective January 1, 2008, as a result of recent changes in management and agency structure and to be consistent with the way management now views business units internally, we consolidated our Consumer Products segment with our Promotional Products segment. In the future the Company will report its marketing services business as two separate reportable segments: Agency Services and Promotional Products.
Backlog
Order backlog at March 29, 2007 and March 28, 2008 was approximately $110,000 and $94,000, respectively. The Company expects the 2008 order backlog to be filled by December 31, 2008.
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Manufacturing
Our products are manufactured according to EMAK and customer specifications by unaffiliated contract manufacturers, primarily in China. Our Hong Kong staff manages the production of our products by our contract manufacturers and performs or procures product sourcing, product engineering, quality control inspections, independent safety testing and export/import documentation. We believe that the presence of a dedicated staff in Hong Kong results in lower net costs, increased ability to respond rapidly to customer orders and maintenance of more effective quality control standards. EMAK products are also manufactured by third parties in the United States and Europe.
We generally retain, either for 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 2007, approximately 96% of our products were manufactured in China. China currently enjoys permanent normal trade relations (“NTR”) status under US tariff laws, which provides a favorable category of US import duties. China’s NTR status became permanent on January 1, 2002, following enactment of a bill authorizing such status upon China’s accession to the World Trade Organization (“WTO”), which occurred in December 2001. Membership in the WTO substantially reduces the possibility of China losing its NTR status, which would result in increased manufacturing costs for us and those of our competitors sourcing products in China.
Virtually all of the raw materials used in our products are available from numerous suppliers. Our contract manufacturers generally do not have long-term supply contracts in place with their raw materials suppliers. Accordingly, we are subject to variations in the prices we pay to manufacturers for products, depending on what they pay for raw materials. An increase in the cost of raw materials, such as petroleum, could result in price increases that 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, Rivet, and Momentum), Arc Worldwide (a subsidiary of Publicis Groupe), Ogilvy Action (a subsidiary WPP), subsidiaries of Omnicom (Tracy Locke and Integer), and many independent agencies. 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 that 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
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has the authority to exclude from the market articles that are found to be hazardous and can require a manufacturer to repair or repurchase such toys under certain circumstances. Any such determination by the Consumer Product Safety Commission is subject to court review. Violations of the Acts may also result in civil and criminal penalties. Similar laws exist in some states and cities in the United States and in many jurisdictions throughout the world.
We perform quality control procedures (including the inspection of goods at factories and the retention of independent testing laboratories) to ensure compliance with applicable product safety requirements, both domestically and internationally. Notwithstanding the foregoing, there can be no assurance that all of our products are or will be hazard-free. A product recall could have a material adverse effect on our results of operations and financial condition and could also negatively affect EMAK’s reputation and the sales of our other products.
Employees
As of December 31, 2007, EMAK employed a total of 309 individuals, including 233 individuals located in the United States, 37 individuals located in Europe and 39 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 | | Position |
James L. Holbrook, Jr. | 48 | | Chief Executive Officer |
Teresa L. Tormey | 43 | | Chief Administrative Officer and General Counsel |
Michael W. Sanders | 38 | | Sr. Vice President and Chief Financial Officer |
Duane V. Johnson | 58 | | Sr. Vice President, Human Resources |
Roy Dar | 36 | | Sr. Vice President, Controller, and Principal Accounting Officer |
Peter Boutros | 44 | | Chief Executive Officer, Equity Marketing and Logistix |
Brian D. Kristofek | 40 | | 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. Tormey joined 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, Davis and a Juris Doctor from Pepperdine University School of Law.
Michael W. Sanders joined 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.
Duane V. Johnson joined 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, Los Angeles.
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Roy Dar joined 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 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, Los Angeles and is a registered Certified Public Accountant.
Peter Boutros joined EMAK in 2006 and is currently Chief Executive Officer of our Equity Marketing and 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 organization’s 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. Kristofek joined EMAK in 2002 and is currently Chief Executive Officer of our Upshot agency. Mr. Kristofek was promoted to his current position in March 2007. Mr. Kristofek joined EMAK as President, Upshot, 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 is www.emak.com. EMAK makes available, free of charge, on or through this website our periodic and current reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Act of 1934 as soon as reasonably practicable after such material is filed with or furnished to the SEC. Information contained on our website is not part of this report.
Cautionary Statements and Risk Factors
(Cautionary Statement Under the Private Securities Litigation Reform Act of 1995)
Certain written and oral statements made or incorporated by reference from time to time by EMAK or its representatives in this Annual Report on Form 10-K, other filings or reports filed with the SEC, press releases, conferences, or otherwise, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 and may include, but are not limited to, statements about: sales and inventory levels; competition; initiatives to promote revenue growth; globalization initiatives; restructuring and financial realignment plans; special charges and other non-recurring charges; initiatives aimed at anticipated cost savings; initiatives to enhance innovation, improve the execution of the core business, leverage scale and enter new categories, develop people, improve productivity, simplify processes and maintain client service levels; quality control and safety testing; potential impact of product recalls; supply chain operations; import and export licenses; integration of acquired companies and assets; operating efficiencies; capital framework; tax provisions; cost pressures and increases; profitability and the impact of recent organizational changes. EMAK is including this Cautionary Statement to make applicable and take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 for any such forward-looking statements. Forward-looking statements include any statement that may predict, forecast, indicate, or imply future results, performance, or achievements. Forward-looking statements can be identified by the use of terminology such as “believe,” “anticipate,” “expect,” “estimate,” “may,” “will,” “should,” “project,” “continue,” “plans,” “aims,” “intends,” “likely,” or other similar words or phrases. Except for historical matters, the matters discussed in this Annual Report on Form 10-K and other statements or filings made by EMAK from time-to-time may be forward-looking statements. Management cautions you that forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from the forward-looking statements. In addition to the important factors detailed herein and from time-to-time in other reports filed by EMAK with the SEC, including Forms 8-K, 10-Q and 10-K, the following important factors could cause actual results to differ materially from past results or those suggested by any forward-looking statements.
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 52%, 48% and 47% of our revenues for the years ended December 31, 2005, 2006 and 2007, respectively. The termination or a significant reduction by Burger King of its business with us would adversely affect our business. The Burger King business is subject to significant year-to-year variability, and over recent periods has materially declined. The revenues generated by our business with Burger King decreased from $117,257 in 2005 to $87,865 in 2006 and $76,528 in 2007. Due to this volatility, the profitability of our business with Burger King is dependent on our ability to control related costs, many of which are fixed and cannot be reduced in response to decreases in the level of business. The success of our business with Burger King is also partially dependent on the overall success of the Burger
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King restaurant system, whose sales could be negatively impacted by such factors as increased competition and product recalls. A continued reduction in our revenues from Burger King, if material, would adversely affect our business.
We Depend onKey Employees
We depend on the continued service of our senior management and other key employees. The loss of a key employee could hurt our business, particularly in the case of key employees who hold strategic relationships with our clients. Our future success depends on our ability to identify, attract, train, motivate and retain other highly skilled personnel. Failure to do so may adversely affect our results. We do not maintain “key person” life insurance policies on any of our employees.
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. Sales to SCS represented 81.5% of our product sales to the Burger King System in 2007. 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.
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 and 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,
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collection and destruction of product, and free goods. We currently maintain product recall coverage in amounts that we believe are adequate to defray 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 2007, approximately 96% 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 that 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.
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 that might be authorized by the Board of Directors in the future.
The Market Price of Our Common Stock is Likely to Be Volatile
Our stock price has fluctuated widely, ranging from $0.71 to $6.37 per share during 2007. Our stock price will likely continue to fluctuate in response to factors such as quarterly variations in operating results, operating results that vary from the expectations of securities analysts and investors, changes in financial estimates, changes in market valuations of competitors, announcements by us or our competitors of a material nature, additions or departures of key personnel, future sales of Common Stock and stock volume fluctuations.
We Are Exposed to Potential Risks and We Will Incur Costs as a Result of the Internal Control Assessment and Attestation Process Mandated by Section 404 of the Sarbanes-Oxley Act of 2002.
We have evaluated, tested and implemented internal controls over financial reporting to enable management to report on such internal controls as required by Section 404 of the Sarbanes-Oxley Act of 2002. In connection with the filing of our annual report for 2008, we are currently required to provide an auditor attestation on internal controls. The additional testing and the auditor attestation could cause us to incur significant costs, including increased accounting fees and staffing levels. While we believe that we are compliant with the
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management evaluation requirements of Section 404, if our independent registered public accounting firm cannot attest in a timely manner to our evaluation, we could be subject to regulatory scrutiny and a loss of public confidence in our internal controls. In addition, any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. We intend to devote substantial time and incur substantial costs, as necessary, to ensure ongoing compliance.
We May Have Limited Ability to Fully Use Our Recorded Tax Loss Carryforwards
We have accumulated approximately $10,499 of tax loss carryforwards to be used in future periods if we become profitable. If we were to experience a significant change in ownership, Internal Revenue Code Section 382 may restrict the future utilization of these tax loss carryforwards even if we become profitable.
ITEM 1B. | UNRESOLVED STAFF COMMENTS. |
Inapplicable.
Our corporate headquarters consists of approximately 42,000 square feet of space in Los Angeles, California under a lease that expires December 31, 2009. Our Equity Marketing and Logistix (U.S.) agency personnel, as well as our centralized corporate employees, occupy our Los Angeles facility. In Hong Kong, our Asia-based supply chain personnel occupy approximately 10,000 square feet of space in Kowloon, under a lease that expires August 31, 2008. We are currently in negotiations with our Hong Kong office landlord to extend our lease term. Logistix (U.K.) 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 that expires November 30, 2009. Upshot occupies approximately 30,000 square feet of leased space in Chicago, Illinois under a lease that expires March 31, 2009.
On November 9, 2007, Upshot entered into a new 13-year lease for approximately 41,486 square feet of office space in Chicago that will serve as Upshot’s new headquarters. This new Upshot lease provides full abatement of the base rent for the first fifteen months of the Lease term (an aggregate of $1,420) and an aggregate of approximately $44 in additional reductions in the base rent over the sixteenth through thirty-second months of the lease term. In accordance with FASB No. 13, during the abatement period, the Company will recognize lease expense on a straight-line basis. The Company will continue to recognize lease expense through March 31, 2009 for Upshot’s current occupied office space.
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, 2007.
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 Capital Market under the symbol EMAK. On March 27, 2008 there were approximately 750 beneficial holders of our Common Stock.
On February 25, 2008, we received a Nasdaq Staff Determination Letter indicating that the Company fails to comply with the stockholders’ equity requirement of Marketplace Rule 4310(c)(3), and that its securities are, therefore, subject to delisting from The Nasdaq Capital Market. The Company requested a hearing before a Nasdaq Listing Qualifications Panel to review the Staff Determination, which is scheduled for April 3, 2008. There can be no assurance that the Panel will grant the Company’s request for continued listing. The Company has been in negotiations with the holder of its preferred stock with respect to a restructuring that would result in book value being reclassified as permanent equity on the Company’s balance sheet in order to satisfy continued listing requirements; however, as of the date of this report we have not reached agreement on terms of the restructuring. In the event that the
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Company’s Common Stock is delisted from the Nasdaq Capital Market, the Company expects that its Common Stock will be eligible for quotation on the Nasdaq Over-the-Counter Bulletin Board without interruption or delay.
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 5 of the accompanying Notes to Consolidated Financial Statements.)
The high and low Common Stock prices per share were as follows:
| Price Range of Common Stock |
| 2006 | | 2007 |
| High | | Low | | High | | Low |
| | | | | | | |
First Quarter | 8.95 | | 6.50 | | 6.37 | | 4.06 |
Second Quarter | 8.53 | | 4.56 | | 5.15 | | 2.50 |
Third Quarter | 7.88 | | 3.37 | | 3.15 | | 1.23 |
Fourth Quarter | 7.30 | | 5.50 | | 2.60 | | 0.71 |
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, 2007.
Comparison of cumulative return among the Company, the S&P 500 and the Russell 2000 Index:
| 12/31/02 | 12/31/03 | 12/31/04 | 12/31/05 | 12/31/06 | 12/31/07 |
EMAK Worldwide | $ 100.00 | $ 105.46 | $ 74.79 | $ 50.71 | $ 44.13 | $ 7.11 |
S&P 500 | $ 100.00 | $ 126.38 | $ 137.75 | $ 141.88 | $ 161.20 | $ 166.89 |
Russell 2000 | $ 100.00 | $ 145.37 | $ 170.08 | $ 175.73 | $ 205.61 | $ 199.96 |
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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, | 2003 | 2004 | 2005 | 2006 | 2007 |
Consolidated Statements of Operations and Per Share Data: (in thousands, except share and per share data) |
Revenues | $ | 219,113 | $ | 236,661 | $ | 223,397 | $ | 181,397 | $ | 164,174 |
Cost of sales | | 158,117 | | 180,487 | | 164,926 | | 137,458 | | 122,850 |
Minimum royalty guarantee shortfalls (gain) | | -- | | 7,722 | | (2,837) | | (88) | | -- |
Gross profit | | 60,996 | | 48,452 | | 61,308 | | 44,027 | | 41,324 |
Operating expenses: | | | | | | | | | | |
| Salaries, wages and benefits | | 24,523 | | 31,310 | | 35,090 | | 26,283 | | 26,817 |
| Selling, general and administrative | | 24,576 | | 25,606 | | 23,587 | | 18,657 | | 18,379 |
| Impairment of assets | | -- | | 6,312 | | 30,970 | | -- | | 3,298 |
| Integration costs | | -- | | 174 | | 81 | | -- | | -- |
| Restructuring loss | | 234 | | 56 | | 2,952 | | 1,213 | | 584 |
| Loss on lease | | -- | | 311 | | 237 | | -- | | -- |
| Dispute resolution charge | | -- | | 237 | | -- | | -- | | -- |
| ERP reimplementation costs | | -- | | 59 | | 147 | | 92 | | -- |
| Total operating expenses | | 49,333 | | 64,065 | | 93,064 | | 46,245 | | 49,078 |
| Income (loss) from operations | | 11,663 | | (15,613) | | (31,756) | | (2,218) | | (7,754) |
Other income (expense), net | | 389 | | (787) | | 37 | | (354) | | 350 |
| Income (loss) before provision (benefit) | | | | | | | | | |
| for income taxes | | 12,052 | | (16,400) | | (31,719) | | (2,572) | | (7,404) |
Provision (benefit) for income taxes | | 4,103 | | (6,716) | | 8,153 | | (307) | | 212 |
| Net income (loss) | | 7,949 | | (9,684) | | (39,872) | | (2,265) | | (7,616) |
Preferred stock dividends | | 1,500 | | 1,500 | | 1,500 | | 375 | | -- |
Excess of preferred stock warrants redemption | | | | | | | | | | |
cost over carrying value | | -- | | 5,042 | | -- | | -- | | -- |
Undistributed earnings allocated to participating | | | | | | | | | | |
preferred stock | | 1,474 | | -- | | -- | | -- | | -- |
Net income (loss) available to common | | | | | | | | | | |
stockholders | $ | 4,975 | $ | (16,226) | $ | (41,372) | $ | (2,640) | $ | (7,616) |
Basic income (loss) per share: | | | | | | | | | | |
Income (loss) per share | $ | 0.87 | $ | (2.82) | $ | (7.15) | $ | (0.45) | $ | (1.30) |
Basic weighted average shares outstanding | | 5,718,548 | | 5,753,978 | | 5,782,925 | | 5,834,990 | | 5,877,924 |
Diluted income (loss) per share: | | | | | | | | | | |
Income (loss) per share | $ | 0.83 | $ | (2.82) | $ | (7.15) | $ | (0.45) | $ | (1.30) |
Diluted weighted average shares outstanding | | 6,017,718 | | 5,753,978 | | 5,782,925 | | 5,834,990 | | 5,877,924 |
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As of December 31, | | 2003 | | 2004 | | 2005 | | 2006 | | 2007 |
Consolidated Balance Sheet Data: (in thousands) | | | | | | | | | | |
Working capital | $ | 29,447 | $ | 17,934 | $ | 12,520 | $ | 9,963 | $ | 6,408 |
Total assets | $ | 128,330 | $ | 133,313 | $ | 69,796 | $ | 62,370 | $ | 51,443 |
Mandatorily redeemable preferred stock | $ | 23,049 | $ | 19,914 | $ | 19,914 | $ | 19,041 | $ | 19,041 |
Stockholders’ equity | $ | 53,666 | $ | 48,897 | $ | 6,414 | $ | 6,557 | $ | 435 |
ITEM 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION |
Overview
Revenues for the twelve months ended December 31, 2007 decreased $17,223 (9.5%) to $164,174 as compared to $181,397 recorded in the prior year. The overall decline resulted from a $14,471 (10.3%) decrease in revenues in our Promotional Products segment and a $4,388 (43.1%) decrease in Consumer Products revenues, partially offset by a $1,636 (5.4%) increase in Agency Services revenues.
Our Upshot agency, in the Agency Services segment, posted double-digit growth during 2007, relative to 2006, as a result of increases in retainer and project revenues from both new and existing clients. The decrease in Promotional Products revenues is primarily attributable to two large, low-margin promotional programs that did not repeat this year and lower Consumer Products revenues as we continue to wind-down our Consumer Products business.
We recorded a net loss of $7,616 for twelve months ended December 31, 2007 compared to a net loss of $2,265 in the prior year. We recorded an international loss from operations of $9,262 and domestic income from operations of $1,508 for 2007. The higher net loss during 2007 was attributable to the following factors:
| • | Non-cash impairment charges totaling $3,298 in 2007 for the write-off of goodwill and other intangibles attributable to Logistix (U.K.). We incurred no impairment charges in 2006. |
| • | Our Promotional Products business in Europe continued to face a deteriorating marketing environment as a result of regulatory concerns over marketing to children, which has resulted in year-over-year declines in revenues and profitability. The result was significant losses in our European operations. |
On September 5, 2007, we announced that Equity Marketing’s contracted role as the primary promotional products and premiums manufacturing agency of record for our largest client, representing approximately 90 percent of revenues from this client and approximately 45 percent of our total revenues, has been extended through 2009 and provides visibility to associated revenues through 2010. However, Equity Marketing transitioned out of certain other retained agency services at the end of 2007. We expect to offset the lost margins resulting from the transition of these services through a reduction in associated overhead, other internal efficiencies and cost reductions.
Despite our recent history of operating losses, we are focused on a return to meaningful profitability in 2008 and we performed a comprehensive review of our business to assure not only that our operating expenses are aligned with revenues, but also that our client-by-client and program-by-program revenue models meet minimum profitability standards. In connection with the review, we integrated the operations of our Equity Marketing and Logistix agencies and we initiated a “Lean” enterprise process improvement program designed to streamline our operations. The restructurings plans that we implemented will reduce our annual operating expenses by approximately $2,600, primarily through reductions in U.S. and European-based headcount as we adjust the size of our footprint around the world.
In addition, we have taken steps in Europe to reduce headcount and the transition of certain other agency services for our largest client at year-end (discussed above) have resulted in the departure of related personnel in the U.S. As a result of this, we expect a further reduction in annual operating expenses of approximately $3,400, in addition to the expected annual savings resulting from the restructuring plans.
The changes discussed above are expected to impact our 2008 revenue mix. We anticipate a moderate decline in Agency Services revenues from our largest client, such declines should be more than offset by expected growth in revenues at Upshot. We do not expect significant near-term growth in revenues in our Promotional Products segment now that we have transitioned out of certain retained agency services. We expect the segment will experience a near term decline in revenues and a reduction in gross profit. We do expect that cost reductions and process improvements will improve our overall profitability in 2008 and beyond.
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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, | 2005 | | | 2006 | | 2007 |
| | | | | | | | | |
Revenues | 100.0 | % | | 100.0 | % | | 100.0 | % |
Cost of sales | 73.8 | % | | 75.8 | % | | 74.8 | % |
Minimum royalty guarantee gain | (1.2) | % | | -- | % | | -- | % |
Gross profit | 27.4 | % | | 24.2 | % | | 25.2 | % |
Operating expenses: | | | | | | | | |
| Salaries, wages and benefits | 15.7 | % | | 14.5 | % | | 16.3 | % |
| Selling, general and administrative | 10.5 | % | | 10.2 | % | | 11.2 | % |
| Impairment of assets | 13.9 | % | | -- | % | | 2.0 | % |
| Integration costs | 0.0 | % | | -- | % | | -- | % |
| Restructuring loss | 1.3 | % | | 0.7 | % | | 0.4 | % |
| Loss on lease | 0.1 | % | | -- | % | | -- | % |
| ERP reimplementation costs | 0.1 | % | | 0.1 | % | | -- | % |
| Total operating expenses | 41.6 | % | | 25.5 | % | | 29.9 | % |
| Loss from operations | (14.2) | % | | (1.3) | % | | (4.7) | % |
Other income (expense), net | 0.0 | % | | (0.1) | % | | 0.2 | % |
| Loss before provision (benefit) | | | | | | | | |
| for income taxes | (14.2) | % | | (1.4) | % | | (4.5) | % |
Provision (benefit) for income taxes | 3.6 | % | | (0.2) | % | | 0.1 | % |
| Net loss | (17.8) | % | | (1.2) | % | | (4.6) | % |
Year ended December 31, 2007 compared to year ended December 31, 2006
Revenues
Our consolidated revenues in 2007 decreased $17,223, or 9.5%, to $164,174 from $181,397 in 2006. Promotional Products revenues decreased $14,471, or 10.3%, to $126,612 primarily attributable to two large, low-margin promotional programs that did not repeat this year and to lower revenues at our Logistix (U.K.) agency resulting from the challenging environment in Europe as a result of regulatory concerns over marketing to children. Net foreign currency translation had a favorable impact to revenues of approximately $1,982 for Logistix (U.K.) versus the prior year period average exchange rates.
Our Agency Services segment revenues increased $1,636, or 5.4%, to $31,769 from $30,133 in 2006. The increase is attributable to increase at our Upshot agency as a result of increases in retainer and project revenues from both new and existing clients.
Our Consumer Products segment revenues decreased $4,388, or 43.1%, to $5,793 from $10,182 in 2006. The decrease is primarily attributable to the wind-down of this non-core business. In 2007, the only remaining license agreement after the wind-down was for Crayola® product. 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 $14,608 to $122,850 (74.8% of revenues) from $137,458 (75.8% of revenues) in 2006 primarily due to lower sales volume in 2007. Net foreign currency translation had an unfavorable impact to cost of sales of approximately $1,486 for Logistix (U.K.) versus the prior year period average exchange rates.
Our gross margin percentage increased to 25.2% from 24.3% in 2006.
The gross profit percentage for our Promotional Products segment decreased to 23.1% compared to 23.4% in 2006. This decrease is attributable to lower levels of high margin creative fees and lower margins on promotional programs. In 2006, there were a couple of high volume, but low margin promotional programs.
The gross profit percentage for our Agency Services segment increased to 31.4% compared to 30.4% in 2006. This increase is primarily attributable to a higher level of fee-based revenues from new and existing clients partially offset by lower fee-based revenues from our largest client as compared to the same period last year. The increase is also attributable to a decrease in direct
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outside costs associated with project work at our Upshot agency. Agency Services gross profit includes direct outside costs that 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 profit. 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 increased to 35.9% compared to 17.6% in 2006. This increase in the margin is attributable to a better sales mix of Crayola® product and fewer close-out sales of older product lines as compared to 2006. In 2006, the lower gross profit was also attributable to a one-time non-cash charge related to the write-off of barter credits obtained in 2004 and 2005.
Salaries, wages and benefits
Salaries, wages and benefits increased $534, or 2.0%, to $26,817 (16.3% of revenues) from $26,283 (14.5% of revenues) in 2006. This increase was primarily attributable to an increase in expense for restricted stock units, annual employee merit increases, and an increase in retention, signing and performance bonuses, partially offset by a lower average headcount in 2007 compared to the same period in 2006. Net foreign currency translation had an unfavorable impact to salaries, wages and benefits of approximately $553 for Logistix (U.K.) versus the average exchange rate for 2006.
Selling, general and administrative expenses
Selling, general and administrative expenses decreased $370, or 2.0%, to $18,379 (11.2% of revenues) from $18,749 (10.3% of revenues) in 2006. The decrease is attributable to a reduction in commissions, freight out and third party warehousing expenses as a result of lower revenues and inventory levels for Consumer Products. The decrease is also attributable to lower bank charges for our credit facility with Bank of America. These decreases were partially offset by higher costs for information technology consulting, consulting related to Sarbanes-Oxley compliance, higher legal fees and an increase in occupancy costs related to a new lease for our Chicago-based office. Net foreign currency translation had an unfavorable impact to selling, general and administrative expenses of approximately $507 for Logistix (U.K.) versus the average exchange rate for 2006.
Impairment of assets
We recorded a charge for the impairment of assets of $3,298 (2.0% of revenues) in 2007. This charge relates to impairment of goodwill, trademark and fixed assets of the Logistix (U.K.) reporting unit. The charge is the result of recent sustained declines in the quoted market price of our common stock, which represented an event or change in circumstance that would more likely than not reduce the fair value of certain of our assets. As a result, we determined that certain assets at our Logistix (U.K.) agency were impaired. See “Critical Accounting Policies — Goodwill and Other Intangibles” below.
Restructuring
We recorded a restructuring charge of $584 (0.4% of revenues) compared to $1,213 (0.7% of revenues) in 2006. This charge represents a loss on lease of $277 for the exit of a portion of office space in the U.K., severance expenses and other termination costs related to the integration of the Equity Marketing and Logistix agencies as well as severance expenses and other termination costs related to headcount reductions in Europe and Asia. In 2006, the 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. See “Restructuring” below.
ERP reimplementation costs
We recorded enterprise resource planning (“ERP”) reimplementation costs of $92 (0.1% of revenues) in 2006. 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 our 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 increased $704 to $350 from other expense of $354 in 2006. The increase is primarily due to foreign currency gains as a result of the strengthening of the Euro relative to the British pound and strengthening of the British pound relative to the U.S. dollar. The increase is also due to interest income in 2007 of $75 from net interest expense of $271 in 2006. Our Logistix (U.K.) subsidiary purchases the bulk of its inventories from the Far East in U.S. dollars.
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Provision (benefit) for income taxes
The effective tax rate changed in 2007 to (2.7)% from 11.9% in 2006. In 2006 and 2007, we recorded a tax provision for our Asia-based operations and recognized no tax provision (benefit) from our operations in the United States and the United Kingdom due to our valuation allowance. In 2007, the tax provision for our Asia based operations was partially offset by $198 for a reversal of a deferred income tax liability associated with the Logistix (U.K.) trademark which was written-off in 2007. See “Critical Accounting Policies — Goodwill and Other Intangibles” below.
Net loss
Net loss increased $5,351, to $7,616 in 2007 ((4.6)% of revenues) from $2,265 in 2006 ((1.2)% of revenues) primarily due to the impairment of assets for Logistix (U.K.) and a decrease in sales volume in 2007 This increase was partially offset by a higher restructuring charge recorded in 2006.
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.
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 that carry higher overall margins. Agency Services gross profit includes direct outside costs that 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.
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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 our 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 were 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.
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 that were not capitalized into fixed assets. The costs were incurred in connection with a significant upgrade and reimplementation of the Company’s ERP software that was designed to enhance management information, financial reporting, inventory management, cost evaluation and controls while assisting in compliance with the Sarbanes-Oxley Act of 2002.
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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.
Financial Condition and Liquidity
Overview
Despite losses in 2007, our balance sheet remains healthy. We used $5,028 in cash flows from operations as a result of the increased net loss. We ended 2007 with $2,988 of cash and cash equivalents, $390 of restricted cash and no debt.
In 2008, 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, 2007 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 5 of the accompanying Notes to Consolidated Financial Statements.
2007 Compared to 2006
At December 31, 2007, cash and cash equivalents decreased by $5,689 to $2,988 compared to $8,677 at December 31, 2006, primarily due to cash used in operating activities. At December 31, 2007, restricted cash was $390 compared to $1,319 as of December 31, 2006.
As of December 31, 2007, net accounts receivable increased $150 to $24,477 from $24,327 in 2006. This increase was primarily due to higher revenues at Upshot partially offset by lower revenues at Equity Marketing and Logistix (U.K.) in the fourth quarter of 2007.
At December 31, 2007, inventories increased $929 to $7,315 from $6,386 in 2006. This was primarily due to an increase in Promotional Products inventories for product scheduled for delivery in the first quarter of 2008.
At December 31, 2007, accounts payable decreased $4,853 to $15,385 from $20,238 in 2006 as a result of a payment to a vendor related to a large fourth quarter 2006 promotional program.
At December 31, 2007, deferred revenue increased $2,474 to $3,710 from $1,236 in 2006. This increase is primarily attributable to the timing of Agency Services programs.
Due to customer decreased $636 to $4,022 from $4,658 in 2006. This decrease 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, 2007, accrued liabilities, including accrued payroll and payroll related costs decreased $928 to $7,418 from $8,346 in 2006. This decrease is primarily attributable to the reduction of the accrual for selling expenses as a result of lower sales.
At December 31, 2007, working capital was $6,408 compared to $9,963 at December 31, 2006. Cash flows used in operating activities for 2007 were $5,028 compared to cash provided by operating activities of $5,629 in the prior year. This change is primarily the result of the timing of a payment to a vendor related to a large fourth quarter 2006 promotional program. Cash flows used in investing activities for 2007 decreased $2,574 to $504 from $3,078 in the prior year. This decrease is primarily the result of
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restricted cash used to fund a bank guarantee to a new vendor of our Logistix (U.K.) subsidiary in 2006—the restriction on most of the cash was lifted in 2007. Furthermore in 2006, the former Megaprint Group shareholders were paid $313 upon release of a purchase price holdback. Cash flows used in financing activities for 2007 were zero compared to $763 in the prior year. This is primarily the result of the payment of preferred stock dividends in 2006. The preferred stock dividend was eliminated 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, 2007 are as follows:
| | 2008 | | 2009 | | 2010 | | 2011 | | 2012 | | Thereafter | | Total |
Operating Leases | $ | 4,024 | $ | 4,228 | $ | 1,748 | $ | 1,781 | $ | 1,752 | $ | 12,479 | $ | 26,012 |
Guaranteed Royalties | | 280 | | -- | | -- | | -- | | -- | | -- | | 280 |
Employment Agreements | | 2,195 | | -- | | -- | | -- | | -- | | -- | | 2,195 |
Total | $ | 6,499 | $ | 4,228 | $ | 1,748 | $ | 1,781 | $ | 1,752 | $ | 12,479 | $ | 28,487 |
We had no material commitments for capital expenditures at December 31, 2007. Letters of credit outstanding as of December 31, 2006 and 2007 totaled $310 and $439, respectively.
Credit Facilities
On March 29, 2006, we entered into a credit facility with Bank of America (“the Facility”). 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. On May 10, 2006, certain covenants under the Facility were amended. For 2007, borrowing availability has ranged from $4,311 to $11,749. As of December 31, 2007, the marginal interest rate on available borrowings under the Facility was 8.5%. As of December31, 2007, we were in compliance with the restrictions and covenants. As of December 31, 2007, zero was outstanding under the Facility. The Facility was used to issue letters of credit.
Impairment of Assets
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 was based on 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 and 2007.
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.
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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.). See “Critical Accounting Policies — Goodwill and Other Intangibles” below.
In the third quarter of 2007, management determined that sustained declines in quoted market price of our common stock represent an event or change in circumstance that would more likely than not reduce the fair value of certain of our assets. Furthermore, management considered the current period operating loss combined with a history of operating losses and determined that a “triggering event” had occurred and an impairment review was necessary ahead of the annual impairment review which would normally occur in the fourth quarter. As a result of this review, we determined that certain assets at our Logistix (U.K.) agency were impaired and recorded charges of $3,298 in 2007. These charges were composed of goodwill impairment of $2,385, trademark impairment of $609, and fixed asset impairment of $304. These charges are for write-downs of assets in the Promotional Products segment.
The impairment of the Logistix (U.K.) trademark was assessed in accordance with the provisions of Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS 144”). The impairment test required us to estimate the fair value of our trademark. We tested these trademarks at the reporting unit level. We estimated fair value based on projections of the future cash flows of the reporting unit. We then compared the carrying value of the trademark to our fair value. Since the fair value of the trademark was less than its carrying value, the difference of $609 was the impairment charge recorded in 2007. During this period we also recorded $198 of a benefit for income taxes for a reversal of the deferred income tax liability associated with this trademark.
The impairment for fixed assets was assessed in accordance with the provisions of SFAS 144. In performing the test, we determined the total of the expected future undiscounted cash flows directly related to the existing potential of Logistix (U.K.) was less than the carrying value of that reporting unit; therefore, the analysis indicated an impairment charge. The impairment charge of $304 represented the difference between the fair value of the assets and their carrying value. As of December 31, 2007, the remaining carrying value for the fixed assets associated with the Logistix (U.K.) reporting unit was $227.
The impairment of goodwill was assessed in accordance with the provisions of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (“SFAS 142”). SFAS 142 indicates that if other types of assets (in addition to goodwill) of a reporting unit are being tested for impairment at the same time as goodwill, then those assets are to be tested for impairment prior to performing the goodwill impairment testing. Accordingly, in accordance with SFAS 142 the impairment charges noted above reduced the carrying value of the reporting unit when performing the impairment test for goodwill. The goodwill impairment test required us to estimate the fair value of our overall business enterprise at the reporting unit level. We estimated fair value using a discounted cash flow model. Under this model, we utilized estimated revenue and cash flow forecasts, as well as assumptions of terminal value, together with an applicable discount rate, to determine fair value. We then compared the carrying value of each of our reporting units to their fair value. Since the fair value of the Logistix (U.K.) reporting unit was less than the carrying amount of its net tangible and intangible assets, an impairment charge of $2,385, associated with the remaining balance of Logistix (U.K.) goodwill, was recorded in 2007.
As of December 31, 2007, there was no remaining carrying value for goodwill and trademark associated with the Logistix (U.K.) reporting unit.
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.
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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 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 was 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 recorded in the accompanying consolidated balance sheets at its Liquidation Preference net of issuance costs and excess of Preferred Stock warrant redemption. The issuance costs total approximately $1,951.
Restructuring and Minimum Royalty Guarantee Shortfalls
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. In 2007, we incurred $277 for the loss on lease for the exit of a portion of our office space in the U.K. and an additional $100 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.
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 2007, we recorded a gain of $22 for the reversal of previously recorded accruals for employee termination costs as a result of lower costs than initially estimated.
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. In 2007, we incurred an additional $64 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.
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In 2007, we made a decision to integrate the operations of our Equity Marketing and Logistix agencies. In connection with this integration and the planned exit of certain other agency services at the end of 2007, we recorded a charge of $165 for one-time employee termination benefit and other costs. The entire amount is attributable to the Promotional Products segment.
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* | Equity Marketing and Logistix Integration * | Hong Kong* | Total |
| | | | | | | | | | | | | | | | | | | | |
Reserve at December 31, 2004 | | - | | - | | - | | - | | - | | - | | - | | - | | - | | - |
Restructuring charge | $ | 746 | $ | 622 | $ | 568 | $ | 192 | $ | 640 | $ | 184 | $ | - | $ | - | $ | - | $ | 2,952 |
Utilization in 2005 | | (513) | | (261) | | (137) | | (96) | | (110) | | - | | - | | - | | - | | (1,117) |
| | | | | | | | | | | | | | | | | | | | |
Reserve at December 31, 2005 | | 233 | | 361 | | 431 | | 96 | | 530 | | 184 | | - | | - | | - | | 1,835 |
Restructuring charge | | 38 | | 58 | | 17 | | - | | 723 | | - | | 283 | | - | | 94 | | 1,213 |
Utilization | | (271) | | (419) | | (427) | | (96) | | (1,244) | | (117) | | (261) | | - | | (94) | | (2,929) |
| | | | | | | | | | | | | | | | | | | | |
Reserve at December 31, 2006 | $ | - | $ | - | $ | 21 | $ | - | $ | 9 | $ | 67 | $ | 22 | $ | - | $ | - | $ | 119 |
Restructuring charge | | - | | - | | 377 | | - | | - | | - | | (22) | | 165 | | 64 | | 584 |
Utilization | | - | | - | | (121) | | - | | (9) | | (22) | | - | | (131) | | (64) | | (348) |
| | | | | | | | | | | | | | | | | | | | |
Reserve at December 31, 2007 | $ | - | $ | - | $ | 277 | $ | - | $ | - | $ | 45 | $ | - | $ | 34 | $ | - | $ | 355 |
* 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 $15,243 and $14,926 at December 31, 2006 and 2007, 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 8 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. In 2007 we recorded a tax provision for our Asia-based operations and recognized no tax provision (benefit) from our operations in the United States and the United Kingdom due to our valuation allowance. In 2007, the tax provision for our Asia based operations was partially than offset by $198 for a reversal of a deferred income tax liability associated with the Logistix (U.K.) trademark which was written-off in 2007.
Inflation
The effect of inflation on our operations during 2007 was insignificant. We will continue our policy of controlling costs and adjusting prices to the extent permitted by competitive factors.
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Subsequent Event
On March 3, 2008, we issued 925,000 restricted shares of EMAK Common Stock to seven senior executives in lieu of 2008 salary increases and cash bonuses. The restricted share grants are being amortized to compensation expense over a three year vesting period. The closing price for EMAK Common Stock as of March 3, 2008, was $1.00 per share. As part of the issuance of the restricted stock grants, we repurchased stock options from our CEO in order to increase the number of shares available for grant under the Company’s Equity Compensation Plans. We paid $16 to repurchase 375,000 fully vested stock options with an average exercise price of $9.89. The Black-Scholes option pricing model was used in determining the valuation of the purchase price of the options repurchased. In accordance with the provisions of SFAS No. 123(R), the cash settlement of $16 was recorded as a repurchase of outstanding equity instruments and was charged to additional paid-in capital.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board, or FASB issued SFAS No. 157, “Fair Value Measurements,” which provides guidance for using fair value to measure assets and liabilities. The standard also responds to investors’ requests expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS No. 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value in any new circumstances. Under SFAS No. 157, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. SFAS No. 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data, for example, the reporting entity’s own data. Fair value measurements would be separately disclosed by level within the fair value hierarchy. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We do not expect the adoption of SFAS No. 157 to have a material impact on our results of operations and financial position.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” which provides companies with an option to report selected financial assets and liabilities at fair value. The objective of SFAS No. 159 is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective for the Company as of January 1, 2008. We do not expect the adoption of SFAS No. 159 to have a material impact on our results of operations or financial position.
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations,” which replaces SFAS No. 141, Business Combinations. SFAS 141(R) (i) requires the acquiring entity in a business combination to record all assets acquired and liabilities assumed at their acquisition-date fair values, (ii) changes the recognition of assets acquired and liabilities assumed arising from contingencies, (iii) requires contingent consideration to be recognized at its fair value on the acquisition date and, for certain arrangements, requires changes in fair value to be recognized in earnings until settled, (iv) requires companies to revise any previously issued post-acquisition financial information to reflect any adjustments as if they had been recorded on the acquisition date, (v) requires the reversals of valuation allowances related to acquired deferred tax assets and changes to acquired income tax uncertainties to be recognized in earnings, and (vi) requires the expensing of acquisition-related costs as incurred. SFAS 141(R) also requires additional disclosure of information surrounding a business combination to enhance financial statement users’ understanding of the nature and financial impact of the business combination. SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, with the exception of accounting for changes in a valuation allowance for acquired deferred tax assets and the resolution of uncertain tax positions accounted for under FIN 48, which is effective on January 1, 2009 for all acquisitions. We have not completed our evaluation of SFAS No. 141(R), but do not expect the adoption of SFAS No. 141(R) to have a material effect on our results of operations or financial position.
In March 2008, the FASB issued SFAS No. 161, “Disclosure about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133”. SFAS No. 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement No. 133 and its related interpretations and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. We are currently evaluating the impact SFAS No. 161 may have on our consolidated financial statements.
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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, excluding reimbursements for outside costs, for the years ended December 31, 2005, 2006 and 2007 totaled $21,900, $26,889 and $26,852, 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, 2006 and 2007 totaled $1,177 and $1,612, 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 84.8%, 65.1% and 81.5% of the products purchased from us by the Burger King system for the years ended December 31, 2005, 2006 and 2007, respectively. SCS accounted for 10.2% and 14.9% of accounts receivable as of December 31, 2006 and 2007, 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.
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Failure by one or more of these retailers to honor their payment obligations to us could have a material adverse effect on our operations.
We have procedures to mitigate the risk of exposure to losses from bad debts. Revenue is recognized provided that: there are no uncertainties regarding customer acceptance; persuasive evidence of an agreement exists documenting the specific terms of the transaction; the sales price is fixed or determinable; and collectibility is reasonably assured. Our credit limits and payment terms are established based on the underlying criteria that collectibility must be reasonably assured at the levels set for each customer. Extensive evaluations are performed on an on-going basis throughout the fiscal year of the financial performance, cash generation, financing availability and liquidity status of each customer. Each customer is reviewed at least annually, with more frequent reviews being performed if necessary based on the customer’s financial condition and the level of credit being extended. For customers who are experiencing financial difficulties, management performs additional financial analyses prior to shipping to those customers on credit. Customer terms and credit limits are reviewed and adjusted, if necessary, to reflect the results of the review. We use a variety of financial transactions to ensure collectibility of accounts receivable of customers deemed to be a credit risk, including requiring letters of credit and requiring cash on delivery.
We record allowances for doubtful accounts receivable and sales returns at the time revenue is recognized based on management’s assessment of the business environment, customers’ financial condition, historical collection experience, accounts receivable aging, retail sell through and customer disputes. When a significant event occurs, such as a bankruptcy filing of a customer, the allowance is reviewed for adequacy and adjusted to reflect the change in estimated receivable impairment. We believe that our allowances for doubtful accounts receivable and sales returns at December 31, 2007 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 the third quarter of 2007, we performed an impairment test in accordance with SFAS No. 142 and SFAS No. 144 and determined that certain assets at our Logistix (U.K.) agency were impaired and recorded charges of $3,298 in 2007. These charges were composed of goodwill impairment of $2,385, trademark impairment of $609, and fixed asset impairment of $304. As a result of the write-down, the carrying value of the Logistix (U.K.) is zero.
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.
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 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
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a settlement with a different licensor which resulted in a reversal of $88. The reversals were recorded as a minimum royalty 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, 2007 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:
| 2005 | | 2006 | | 2007 |
Allowance for obsolescence | $ | 891 | | | $ | 639 | | | $ | 360 | |
As a percentage of total inventories | | 7.3 | % | | | 9.1 | % | | | 4.7 | % |
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. The decrease from 2006 to 2007 in the allowance for obsolescence was primarily due to a reduction of 2006 Consumer Products inventory as a result of the wind-down. The majority of the inventory as of December 31, 2007, was Promotional product inventory used in Promotional Products which generally has lower risk than Consumer Product inventory, as it usually represents product made to order. Management believes that its allowance for obsolescence at year end 2007 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.
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
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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 $15,243 and $14,926 at December 31, 2006 and 2007, 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 8 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. In 2007, we recorded a tax provision for our Asia-based operations and recognized no tax provision (benefit) from our operations in the United States and the United Kingdom due to our valuation allowance. In 2007, the tax provision for our Asia based operations was partially than offset by $198 for a reversal of a deferred income tax liability associated with the Logistix (U.K.) trademark which was written-off in 2007.
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, 2007, we had no amount outstanding under our facility. As of December 31, 2007, the marginal interest rate on available borrowings under our credit facility was 8.5%.
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, 2007, we had no foreign currency forward contracts.
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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 sheets of EMAK Worldwide, Inc. and subsidiaries (the “Company”) as of December 31, 2007 and 2006, and the related consolidated statements of operations, changes in owner's equity, and cash flows for each of the two years in the period ended December 31, 2007. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and 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 schedules based on our audits.
We conducted our audits 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 audits 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 audits provide 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. and subsidiaries at December 31, 2007 and 2006, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.
As discussed in Note 2 of the Notes to the Consolidated Financial Statements, effective January 1, 2007, the Company adopted Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109.”
DELOITTE & TOUCHE LLP
Los Angeles, California
March 31, 2008
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Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
EMAK Worldwide, Inc.
In our opinion, the accompanying consolidated statements of operations, of stockholders’ equity, of comprehensive loss and of cash flows present fairly, in all material respects, the results of operations and cash flows of EMAK Worldwide, Inc. and its subsidiaries (the “Company”) for the year ended December 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 audit. We conducted our audit 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 audit provides 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 10, as to which the date is March 26, 2007
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EMAK WORLDWIDE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
| | December 31, |
| | 2006 | | | 2007 |
ASSETS (Note 5) | | | | | |
CURRENT ASSETS: | | | | | |
Cash and cash equivalents | $ | 8,677 | | $ | 2,988 |
Restricted cash | | 1,319 | | | 390 |
Accounts receivable (net of allowances of $1,382 and $853 | | | | | |
as of December 31, 2006 and 2007, respectively) | | 24,327 | | | 24,477 |
Inventories | | 6,386 | | | 7,315 |
Prepaid expenses and other current assets | | 3,732 | | | 1,773 |
Total current assets | | 44,441 | | | 36,943 |
| | | | | |
Fixed assets, net | | 3,583 | | | 3,377 |
Goodwill | | 13,136 | | | 10,825 |
Other intangibles, net | | 651 | | | 2 |
Other assets | | 559 | | | 296 |
Total assets | $ | 62,370 | | $ | 51,443 |
| | | | | |
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY | | | |
CURRENT LIABILITIES: | | | | | |
Short-term debt | $ | -- | | $ | -- |
Accounts payable | | 20,238 | | | 15,385 |
Deferred revenue | | 1,236 | | | 3,710 |
Due to customer | | 4,658 | | | 4,022 |
Accrued payroll and payroll related costs | | 1,629 | | | 1,347 |
Accrued liabilities | | 6,717 | | | 6,071 |
Total current liabilities | | 34,478 | | | 30,535 |
| | | | | |
Long-term liabilities | | 2,294 | | | 1,432 |
Total liabilities | | 36,772 | | | 31,967 |
| | | | | |
COMMITMENTS AND CONTINGENCIES (Note 10) | | | | | |
| | | | | |
Redeemable preferred stock, Series AA senior cumulative | | | | | |
convertible, $.001 par value, 25,000 issued and outstanding, stated at | | | | | |
liquidation preference of $1,000 per share ($25,000), net of issuance costs | | 19,041 | | | 19,041 |
| | | | | |
STOCKHOLDERS’ EQUITY: | | | | | |
Preferred stock, $.001 par value per share, 1,000,000 shares authorized, | | | | | |
25,000 Series AA senior cumulative convertible issued and outstanding | | -- | | | -- |
Common stock, par value $.001 per share, 25,000,000 shares authorized 5,851,663 and | | | |
5,943,278 shares outstanding as of December 31, 2006 and 2007, respectively | | -- | | | -- |
Additional paid-in capital | | 33,840 | | | 35,284 |
Accumulated deficit | | (13,225) | | | (20,841) |
Accumulated other comprehensive income | | 3,611 | | | 3,661 |
| | 24,226 | | | 18,104 |
Less | | | | | |
Treasury stock, 3,167,258 shares at cost as of December 31, 2006 and 2007 | | (17,669) | | | (17,669) |
Total stockholders’ equity | | 6,557 | | | 435 |
Total liabilities, redeemable preferred stock | | | | | |
and stockholders’ equity | $ | 62,370 | | $ | 51,443 |
The accompanying notes are an integral part of these consolidated financial statements.
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EMAK WORLDWIDE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
| | | | | | |
| Years Ended December 31, |
| | 2005 | | 2006 | | 2007 |
| | | | | | |
REVENUE: | | | | | | |
Revenues from services | $ | 21,900 | $ | 26,889 | $ | 26,852 |
Revenues from tangible products and other revenues | | 201,497 | | 154,508 | | 137,322 |
TOTAL REVENUE | | 223,397 | | 181,397 | | 164,174 |
| | | | | | |
COST OF SALES | | | | | | |
Cost of services | | 9,134 | | 12,045 | | 12,384 |
Cost of tangible products sold | | 155,792 | | 125,413 | | 110,466 |
TOTAL COST OF SALES | | 164,926 | | 137,458 | | 122,850 |
Minimum royalty guarantee gain | | (2,837) | | (88) | | -- |
Gross profit | | 61,308 | | 44,027 | | 41,324 |
OPERATING EXPENSES: | | | | | | |
Salaries, wages and benefits | | 35,090 | | 26,283 | | 26,817 |
Selling, general and administrative | | 23,587 | | 18,657 | | 18,379 |
Integration costs | | 81 | | -- | | -- |
Loss on lease | | 237 | | -- | | -- |
Restructuring charge | | 2,952 | | 1,213 | | 584 |
Impairment of assets | | 30,970 | | -- | | 3,298 |
ERP reimplementation costs | | 147 | | 92 | | -- |
Total operating expenses | | 93,064 | | 46,245 | | 49,078 |
Loss from operations | | (31,756) | | (2,218) | | (7,754) |
OTHER (EXPENSE) INCOME: | | | | | | |
Interest expense | | (443) | | (329) | | (147) |
Interest income | | 94 | | 58 | | 222 |
Other income (expense) | | 386 | | (83) | | 275 |
Loss before provision (benefit) for income taxes | | (31,719) | | (2,572) | | (7,404) |
| | | | | | |
PROVISION (BENEFIT) FOR INCOME TAXES | | 8,153 | | (307) | | 212 |
Net loss | | (39,872) | | (2,265) | | (7,616) |
| | | | | | |
PREFERRED STOCK DIVIDENDS | | 1,500 | | 375 | | -- |
| | | | | | |
NET LOSS AVAILABLE TO COMMON STOCKHOLDERS | $ | (41,372) | $ | (2,640) | $ | (7,616) |
| | | | | | |
BASIC LOSS PER SHARE: | | | | | | |
BASIC LOSS PER SHARE | $ | (7.15) | $ | (0.45) | $ | (1.30) |
BASIC WEIGHTED AVERAGE SHARES OUTSTANDING | | 5,782,925 | | 5,834,990 | | 5,877,924 |
| | | | | | |
DILUTED LOSS PER SHARE: | | | | | | |
DILUTED LOSS PER SHARE | $ | (7.15) | $ | (0.45) | $ | (1.30) |
DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING | | 5,782,925 | | 5,834,990 | | 5,877,924 |
The accompanying notes are an integral part of these consolidated financial statements.
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EMAK WORLDWIDE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)
| | | | | Additional | Retained Earnings | Accumulated Other | | | | | | |
| | Common Stock | Paid-in | (Accumulated | Comprehensive | Treasury | Unearned | | |
| | Shares | Amount | Capital | Deficit) | Income | Stock | Compensation | Total |
Balance, December 31, 2004 | 5,759,263 | $ | -- | $ | 35,162 | $ | 28,912 | $ | 4,972 | $ | (17,669) | $ | (2,480) | $ | 48,897 |
| Net loss | -- | | -- | | -- | | (39,872) | | -- | | -- | | -- | | (39,872) |
| Issuance of common stock | 10,616 | | -- | | 109 | | -- | | -- | | -- | | -- | | 109 |
| Issuance of restricted stock units | -- | | -- | | 1,134 | | -- | | -- | | -- | | (1,134) | | -- |
| Amortization of restricted stock units | -- | | -- | | -- | | -- | | -- | | -- | | 804 | | 804 |
| Cancellation of restricted stock units | (3,000) | | -- | | (952) | | -- | | -- | | -- | | 952 | | -- |
| Amortization of restricted stock grants | -- | | -- | | -- | | -- | | -- | | -- | | 134 | | 134 |
| Exercise of stock options | 32,563 | | -- | | 115 | | -- | | -- | | -- | | -- | | 115 |
| Preferred stock dividends | -- | | -- | | (1,500) | | -- | | -- | | -- | | -- | | (1,500) |
| Foreign currency translation adjustments | -- | | -- | | -- | | -- | | (2,679) | | -- | | -- | | (2,679) |
| Unrealized gain on foreign currency forward contracts | -- | | -- | | -- | | -- | | 406 | | -- | | -- | | 406 |
Balance, December 31, 2005 | 5,799,442 | | -- | | 34,068 | | (10,960) | | 2,699 | | (17,669) | | (1,724) | | 6,414 |
| Net loss | -- | | -- | | -- | | (2,265) | | -- | | -- | | -- | | (2,265) |
| Crown Preferred Stock and Warrant revaluation | -- | | -- | | 873 | | -- | | -- | | -- | | -- | | 873 |
| Transaction costs in connection with | | | | | | | | | | | | | | | |
| modification of preferred stock and warrants | -- | | -- | | (157) | | -- | | -- | | -- | | -- | | (157) |
| Issuance of Common Stock | 36,142 | | -- | | 306 | | -- | | -- | | -- | | -- | | 306 |
| Amortization of restricted stock units | -- | | -- | | 1,041 | | -- | | -- | | -- | | -- | | 1,041 |
| Amortization of restricted stock grants | -- | | -- | | 39 | | -- | | -- | | -- | | -- | | 39 |
| Reclassify deferred compensation per SFAS No. 123 (R) | -- | | -- | | (1,724) | | -- | | -- | | -- | | 1,724 | | -- |
| Exercise of Restricted Stock | 16,079 | | -- | | -- | | -- | | -- | | -- | | -- | | -- |
| Preferred stock dividend | -- | | -- | | (375) | | -- | | -- | | -- | | -- | | (375) |
| Foreign currency translation adjustments | -- | | -- | | -- | | -- | | 966 | | -- | | -- | | 966 |
| Unrealized gain on foreign currency forward | -- | | -- | | -- | | -- | | (54) | | -- | | -- | | (54) |
| Repurchase of Options | -- | | -- | | (231) | | -- | | -- | | -- | | -- | | (231) |
Balance, December 31, 2006 | 5,851,663 | | -- | $ | 33,840 | | (13,225) | | 3,611 | | (17,669) | | 0 | | 6,557 |
| Net loss | -- | | -- | | -- | | (7,616) | | -- | | -- | | -- | | (7,616) |
| Issuance of Common Stock | 506 | | -- | | 3 | | -- | | -- | | -- | | -- | | 3 |
| Amortization of restricted stock units | -- | | -- | | 1,441 | | -- | | -- | | -- | | -- | | 1,441 |
| Exercise of Restricted Stock | 91,109 | | -- | | -- | | -- | | -- | | -- | | -- | | -- |
| Foreign currency translation adjustments | -- | | -- | | -- | | -- | | 50 | | -- | | -- | | 50 |
Balance, December 31, 2007 | 5,943,278 | $ | -- | $ | 35,284 | $ | (20,841) | $ | 3,661 | $ | (17,669) | $ | 0 | $ | 435 |
The accompanying notes are an integral part of these consolidated financial statements.
34
EMAK WORLDWIDE, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)
| | | | | | |
| | Years Ended December 31, |
| | | 2005 | | | 2006 | | | 2007 |
| | | | | | | | | |
NET LOSS | $ | (39,872) | | $ | (2,265) | | $ | (7,616) |
OTHER COMPREHENSIVE INCOME (LOSS): | | | | | | | | |
| Foreign currency translation adjustments | | (2,679) | | | 966 | | | 50 |
| Unrealized gain (loss) on foreign currency | | | | | | | | |
| forward contracts | | 406 | | | (54) | | | -- |
COMPREHENSIVE LOSS | $ | (42,145) | | $ | (1,353) | | $ | (7,566) |
The accompanying notes are an integral part of these consolidated financial statements.
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EMAK WORLDWIDE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
| Years Ended December 31, |
| | 2005 | | 2006 | | 2007 |
CASH FLOWS FROM OPERATING ACTIVITIES: | | | | | | |
Net loss | $ | (39,872) | $ | (2,265) | $ | (7,616) |
Adjustments to reconcile net loss to | | | | | | |
net cash provided by (used in) operating activities: | | | | | | |
Depreciation and amortization | | 2,165 | | 1,685 | | 1,596 |
Provision for bad debts | | 180 | | 13 | | (14) |
Gain on asset disposal | | (17) | | (2) | | (13) |
Amortization of restricted stock | | 938 | | 1,080 | | 1,441 |
Impairment of assets | | 30,970 | | -- | | 3,298 |
Minimum guarantee royalty gain | | (2,837) | | (88) | | -- |
Deferred income taxes | | 8,976 | | -- | | (198) |
Changes in assets and liabilities, net of effects of acquisitions: | | | | | | |
Increase (decrease) in cash and cash equivalents: | | | | | | |
Accounts receivable | | 16,370 | | 5,803 | | 9 |
Inventories | | 7,265 | | 5,175 | | (873) |
Prepaid expenses and other current assets | | (2,290) | | 1,450 | | 1,979 |
Other assets | | (93) | | 100 | | 217 |
Accounts payable | | (10,203) | | (273) | | (4,970) |
Accrued liabilities | | 1,494 | | (5,373) | | 786 |
Long-term liabilities | | (953) | | (1,676) | | (670) |
Net cash provided by (used in) operating activities | | 12,093 | | 5,629 | | (5,028) |
CASH FLOWS FROM INVESTING ACTIVITIES: | | | | | | |
Restricted cash | | -- | | (1,319) | | 1,036 |
Payment for purchase of Johnson Grossfield | | (148) | | -- | | -- |
Payment for purchase of Megaprint Group, | | | | | | |
net of cash acquired of $1,194 | | (1,908) | | (313) | | -- |
Refund from purchase of Upshot | | 75 | | -- | | -- |
Proceeds from sales of fixed assets | | 992 | | 23 | | 13 |
Purchases of fixed assets | | (1,711) | | (1,469) | | (1,553) |
Net cash used in investing activities | | (2,700) | | (3,078) | | (504) |
CASH FLOWS FROM FINANCING ACTIVITIES: | | | | | | |
Preferred stock dividends paid | | (1,500) | �� | (375) | | -- |
Proceeds from exercise of stock options | | 115 | | -- | | -- |
Transaction costs paid in connection with the | | | | | | |
modification of preferred stock and warrants | | -- | | (157) | | -- |
Purchase of options via stock option buyback | | -- | | (231) | | -- |
Repayment under line of credit | | (76,550) | | (64,387) | | (6,508) |
Borrowings under line of credit | | 70,525 | | 64,387 | | 6,508 |
Net cash used in financing activities | | (7,410) | | (763) | | -- |
Net increase (decrease) in cash and cash equivalents | | 1,983 | | 1,788 | | (5,532) |
Effects of exchange rate changes on cash and cash equivalents | | (74) | | 574 | | (157) |
CASH AND CASH EQUIVALENTS , beginning of year | | 4,406 | | 6,315 | | 8,677 |
CASH AND CASH EQUIVALENTS , end of year | $ | 6,315 | $ | 8,677 | $ | 2,988 |
SUPPLEMENTAL CASH FLOW INFORMATION: | | | | | | |
Non-cash investing activities—Issuance of shares for purchase | | | | | | |
of Johnson Grossfield | $ | 530 | $ | -- | $ | -- |
CASH PAYMENTS DURING YEAR FOR: | | | | | | |
Interest | $ | 449 | $ | 331 | $ | 136 |
Taxes refunded, net of payments | $ | (1,824) | $ | (119) | $ | (1,630) |
The accompanying notes are an integral part of these consolidated financial statements.
37
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 the parent company of a family of marketing services agencies including Equity Marketing, Logistix, Mega and Upshot. The Company’s agencies are experts in “consumer activation,” offering strategy-based marketing programs that directly impact consumer behavior. EMAK’s agencies provide strategic planning and research, consumer insight development, entertainment marketing, design and manufacturing of custom promotional products, kids and family marketing, event marketing, shopper marketing and environmental branding. EMAK is headquartered in Los Angeles with offices in Chicago, Amsterdam, Frankfurt, London, Paris and Hong Kong. The Company primarily sells to customers in the United States and Europe. The Company’s functional currency is the U.S. dollar.
The Company continues to experience losses and negative cash flow from operations. Net losses were $7,616 for 2007. Cash flows used in operations were $5,028 for 2007. Despite the Company’s recent history of operating losses, the Company is focused on a return to meaningful profitability in 2008 and performed a comprehensive review of its business to assure not only that its operating expenses are aligned with revenues, but also that its client-by-client and program-by-program revenue models meet minimum profitability standards. In connection with the review, the Company integrated the operations of its Equity Marketing and Logistix agencies and the Company initiated a “Lean” enterprise process improvement program designed to streamline its operations. The restructurings plans EMAK implemented will reduce its annual operating expenses primarily through reductions in U.S. and European-based headcount as the Company adjusts the size of our footprint around the world.
In addition, the Company has taken steps in Europe to reduce headcount and the transition of certain other agency services for its largest client at year-end have resulted in the departure of related personnel in the U.S. As a result of this, the Company expects a further reduction in annual operating expenses in addition to the expected annual savings resulting from the restructuring plans.
The Company has assessed its future cash needs based on projections of revenues, margins and operating expenses. Such projections reflect contractual commitments from existing clients, assumptions for program volumes and assumptions that the Company maintains its historical win-rate on promotional projects for the portion of its business which is not contractually committed. Based on these projections, the Company’s management believes that it will have adequate liquidity to fund operations for at least the next twelve months.
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, 2006 and 2007.
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, 2006 and 2007.
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.
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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, 2005, 2006 and 2007 totaled $21,900, $26,889 and $26,852, 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, 2006 and 2007 totaled $1,177 and $1,612, respectively. Unbilled revenues are recorded in accounts receivable in the accompanying consolidated balance sheets as of December 31, 2006 and 2007. Unbilled revenues are expected to be billed and collected within the next six months.
In May 2003, the Emerging Issues Task Force (“EITF”) issued Issue No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 provides guidance on how to determine when an arrangement that involves multiple revenue-generating activities or deliverables should be divided into separate units of accounting for revenue recognition purposes, and if this division is required, how the arrangement consideration should be allocated among the separate units of accounting. The guidance in this Issue is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. Under 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 project related 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, 2006 and 2007, inventories consisted of the following:
| December 31, |
| 2006 | | 2007 |
Finished goods | $ | 5,215 | | $ | 4,949 |
Production-in-process | | 1,171 | | | 2,366 |
Total inventories | $ | 6,386 | | $ | 7,315 |
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
39
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 third quarter of 2007, the Company performed an impairment test in accordance with SFAS No. 142 and SFAS No. 144 and determined that certain assets at our Logistix (U.K.) agency were impaired and recorded charges of $3,298 in 2007. These charges were composed of goodwill impairment of $2,385, trademark impairment of $609, and fixed asset impairment of $304 (see Note 3). As a result of the write-down, the carrying value of the Logistix (U.K.) is zero.
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 $13,136 as of December 31, 2006 to $10,825 as of December 31, 2007 reflects: the Logistix (U.K.) goodwill impairment charge of $2,385 and an increase of $74 due to a foreign currency translation adjustment. Of the $10,825 as of December 31, 2007, $8,245 of the goodwill balance relates to the Agency Services segment and $2,580 relates to the Promotional Products segment.
The change in the carrying amount of identifiable intangibles from $651 as of December 31, 2006 to $2 as of December 31, 2007 reflects: a decrease of $609 for the Logistix (U.K.) trademark impairment, a decrease of $60 for amortization expense and an increase due to a foreign currency translation adjustment of $20. 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, |
| | 2006 | | | 2007 |
| | | | | |
Amortized Intangible Assets | | | | | |
Equity Marketing trademark | $ | 52 | | $ | 52 |
Logistix trademark | | 716 | | | -- |
Licensing, royalty and standstill agreements | | 166 | | | 174 |
Customer contracts and related customer relationships | | 957 | | | 965 |
Non-competition agreement | | 94 | | | 94 |
Sales order backlog | | 378 | | | 390 |
Subtotal | | 2,363 | | | 1,675 |
Less: Accumulated amortization | | (1,712) | | | (1,673) |
Total Other Intangibles | $ | 651 | | $ | 2 |
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 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
41
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, 2005, 2006 and 2007, amortization expense related to other intangibles amounted to $344, $144 and $60, respectively.
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, 2006 and 2007, the amounts due to customer were $4,658 and $4,022, 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 8).
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 during 2004 and 2005 and based on projections of 2006 taxable income, the Company established a non-cash valuation allowance against its deferred tax assets in 2005. 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.
On January 1, 2007, the Company adopted the Financial Accounting Standards Board’s (“FASB”) Interpretation Number 48, “Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarified the accounting for uncertainty in an enterprise’s financial statements by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 requires management to evaluate its open tax positions that exist on the date of initial adoption in each jurisdiction. The Company did not have any unrecognized tax benefits and there was no effect on its financial condition or results of operations as a result of implementing FIN 48.
When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. As of the date of adoption of FIN 48, the Company did not have any accrued interest or penalties associated with any unrecognized tax benefits, nor was any interest expense recognized during the quarter. The Company’s effective tax rate differs from the federal statutory rate primarily due to losses sustained for which no tax benefit has been recognized.
As of December 31, 2006 and 2007, the Company had a valuation allowance equal to its total net deferred income tax assets due to the uncertainty of ultimately realizing income tax benefits of approximately $15,243 and $14,926. The Company files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The Company is no longer subject to U.S. federal tax examinations for years before 2003. State jurisdictions that remain subject to examination range from 2002 to 2005. The Company does not believe there will be any material changes in its unrecognized tax positions over the next 12 months.
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Share-Based Compensation
At December 31, 2007, 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 and 2007. Excess tax benefits reflected as an operating cash inflow totaled $0 in 2005.
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 2007.
The Company recognized no compensation expense for stock options in 2007 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, 2005 would have been adjusted as follows:
| | 2005 |
| | |
Net loss available to common stockholders as reported | $ | (41,372) |
Plus: | | |
Share-based compensation expense, net of tax, included in | | 562 |
reported net income (loss) available to the common stockholder | | |
Less: | | |
Compensation expense (a) | | 1,198 |
Net loss available to common stockholders - pro forma | $ | (42,008) |
| | |
Loss per share: | | |
Basic loss per share, as reported | $ | (7.15) |
Pro forma basic loss per share | $ | (7.26) |
| | |
Diluted loss per share, as reported | $ | (7.15) |
Pro forma diluted loss per share | $ | (7.26) |
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(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 for the year ended December 31, 2005:
| 2005 | |
| | |
Expected dividend yield | 0.00 | % |
Expected stock price volatility | 41.33 | % |
Risk free interest rate | 4.46 | % |
Expected life of options | 4 years | |
The weighted average fair value of options granted during 2005 is $1.79.
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.
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 2,650,636, 1,959,236 and 1,614,536 shares of the Company’s Common Stock, for the years ended December 31, 2005, 2006 and 2007, respectively, were excluded from the computation of diluted EPS as they would have been anti-dilutive. For the year ended December 31, 2005, preferred stock convertible into 1,694,915 shares of Common Stock was excluded from the computation of diluted EPS. For the years ended December 31, 2006 and 2007, 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, |
| | | 2005 | 2006 | 2007 |
| | Loss | Shares | Per Share | Loss | Shares | Per Share | Loss | | Shares | | Per Share |
| | (Numerator) | (Denominator) | Amount | (Numerator) | (Denominator) | Amount | (Numerator) | | (Denominator) | Amount |
Basic EPS: | | | | | | | | | | | | | | | | | | | | |
Loss available to | | | | | | | | | | | | | | | | | | | | |
common stockholders | $ | (41,372) | | 5,782,925 | | $ | (7.15) | $ | (2,640) | 5,834,990 | | $ | (0.45) | $ | (7,616) | | 5,877,924 | | $ | (1.30) |
Effect of dilutive securities: | | | | | | | | | | | | | | | | | | | |
| Options and warrants | | -- | | -- | | | | | -- | -- | | | | | -- | | -- | | | |
| Restricted stock units | | -- | | -- | | | | | -- | -- | | | | | -- | | -- | | | |
Dilutive EPS: | | | | | | | | | | | | | | | | | | | | |
Loss available to common | | | | | | | | | | | | | | | | | | | | |
| stockholders | $ | (41,372) | | 5,782,925 | | $ | (7.15) | $ | (2,640) | 5,834,990 | | $ | (0.45) | $ | (7,616) | | 5,877,924 | | $ | (1.30) |
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
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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 52%, 48% and 47% of the Company’s total revenues for the years ended December 31, 2005, 2006 and 2007, 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 84.8%, 65.1% and 81.5% of the products purchased from us by the Burger King system for the years ended December 31, 2005, 2006 and 2007, respectively. The largest such distribution company accounted for 10.2% and 14.9% of accounts receivable as of December 31, 2006 and 2007, respectively.
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 $1,207) to one of Logistix’s vendors in exchange for the deposit of the same amount into an interest bearing restricted cash account with HSBC. During 2007, HSBC released 747 EURO (approx $1,036) with the remaining balance to be released by the end of the first quarter of 2008. The guarantee from HSBC enabled Logistix (U.K.) to secure more favorable payment terms from a new vendor supplying significant quantities of goods for a promotional program. This guarantee ended when the associated program was completed in the second quarter of 2007.
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.
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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, 2005, 2006 and 2007 such costs totaled $1,003, $666, and $756 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, 2005, 2006 and 2007, the net transaction gain (loss) on foreign exchange of $342, $(117) and $251, respectively, were recorded in other income (expense) in the accompanying consolidated statements of operations.
In accordance with the SFAS No. 52, “Foreign Currency Translation,” the financial statements of Logistix and Megaprint Group are translated into U.S. dollars as follows: assets and liabilities at year-end exchange rates; income and expenses at average exchange rates; and shareholders’ equity at historical exchange rates. Since the functional currency of Logistix and Megaprint Group is the British Pound (“GBP”), the resulting translation adjustment is recorded as a component of accumulated other comprehensive income in the accompanying consolidated balance sheet. Translation adjustments are not tax-effected since they relate to investments which are permanent in nature.
Derivative Instruments
The Company adopted SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” 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, 2007, the Company had no foreign currency forward contracts.
Advertising
Production costs of commercials and programming are charged to expense in the period during which the production is first aired. The costs of other advertising, promotion and marketing programs are charged to expense in the period incurred.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board, or FASB issued SFAS No. 157, “Fair Value Measurements,” which provides guidance for using fair value to measure assets and liabilities. The standard also responds to investors’ requests expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS No. 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value in any new circumstances. Under SFAS No. 157, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. SFAS No. 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data, for example, the reporting entity’s own data. Fair value measurements would be separately disclosed by level within the fair value hierarchy. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company does not expect the adoption of SFAS No. 157 to have a material impact on its results of operations and financial position.
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In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” which provides companies with an option to report selected financial assets and liabilities at fair value. The objective of SFAS No. 159 is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective for the Company as of January 1, 2008. The Company does not expect the adoption of SFAS No. 159 to have a material impact on its results of operations or financial position.
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations,” which replaces SFAS No. 141, Business Combinations. SFAS 141(R) (i) requires the acquiring entity in a business combination to record all assets acquired and liabilities assumed at their acquisition-date fair values, (ii) changes the recognition of assets acquired and liabilities assumed arising from contingencies, (iii) requires contingent consideration to be recognized at its fair value on the acquisition date and, for certain arrangements, requires changes in fair value to be recognized in earnings until settled, (iv) requires companies to revise any previously issued post-acquisition financial information to reflect any adjustments as if they had been recorded on the acquisition date, (v) requires the reversals of valuation allowances related to acquired deferred tax assets and changes to acquired income tax uncertainties to be recognized in earnings, and (vi) requires the expensing of acquisition-related costs as incurred. SFAS 141(R) also requires additional disclosure of information surrounding a business combination to enhance financial statement users’ understanding of the nature and financial impact of the business combination. SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, with the exception of accounting for changes in a valuation allowance for acquired deferred tax assets and the resolution of uncertain tax positions accounted for under FIN 48, which is effective on January 1, 2009 for all acquisitions. The Company has not completed its evaluation of SFAS No. 141(R), but does not expect the adoption of SFAS No. 141(R) to have a material effect on the Company’s results of operations or financial position.
In March 2008, the FASB issued SFAS No. 161, “Disclosure about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133”. SFAS No. 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement No. 133 and its related interpretations and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company is currently evaluating the impact SFAS No. 161 may have on its consolidated financial statements.
2. | RESTRUCTURING CHARGE AND MINIMUM ROYALTY GUARANTEE SHORTFALLS |
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. In 2007, the Company incurred $277 for the loss on lease for the exit of a portion of our office space in the U.K. and an additional $100 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.
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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 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 2007, we recorded a gain of $22 for the reversal of previously recorded accruals for employee termination costs as a result of lower costs than initially estimated.
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. In 2007, we incurred an additional $64 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 2007, we made a decision to integrate the operations of our Equity Marketing and Logistix agencies. In connection with this integration and the planned exit of certain other agency services at the end of 2007, we recorded a charge of $165 for one-time employee termination benefit and other costs. The entire amount is attributable to the Promotional Products segment.
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* | Equity Marketing and Logistix Integration * | Hong Kong* | Total |
| | | | | | | | | | | | | | | | | | | | |
Reserve at December 31, 2004 | | - | | - | | - | | - | | - | | - | | - | | - | | - | | - |
Restructuring charge | $ | 746 | $ | 622 | $ | 568 | $ | 192 | $ | 640 | $ | 184 | $ | - | $ | - | $ | - | $ | 2,952 |
Utilization in 2005 | | (513) | | (261) | | (137) | | (96) | | (110) | | - | | - | | - | | - | | (1,117) |
| | | | | | | | | | | | | | | | | | | | |
Reserve at December 31, 2005 | | 233 | | 361 | | 431 | | 96 | | 530 | | 184 | | - | | - | | - | | 1,835 |
Restructuring charge | | 38 | | 58 | | 17 | | - | | 723 | | - | | 283 | | - | | 94 | | 1,213 |
Utilization | | (271) | | (419) | | (427) | | (96) | | (1,244) | | (117) | | (261) | | - | | (94) | | (2,929) |
| | | | | | | | | | | | | | | | | | | | |
Reserve at December 31, 2006 | $ | - | $ | - | $ | 21 | $ | - | $ | 9 | $ | 67 | $ | 22 | $ | - | $ | - | $ | 119 |
Restructuring charge | | - | | - | | 377 | | - | | - | | - | | (22) | | 165 | | 64 | | 584 |
Utilization | | - | | - | | (121) | | - | | (9) | | (22) | | - | | (131) | | (64) | | (348) |
| | | | | | | | | | | | | | | | | | | | |
Reserve at December 31, 2007 | $ | - | $ | - | $ | 277 | $ | - | $ | - | $ | 45 | $ | - | $ | 34 | $ | - | $ | 355 |
* One-time employee termination benefits and other related costs.
Refer to Note 1, “Summary of Significant Accounting Policies - Goodwill and Other Intangibles” for discussion of goodwill impairment.
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 would 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 $1,982 was attributable to other intangible assets. The remaining carrying value of the goodwill and other intangible assets of Johnson
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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 was 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 had 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 would 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.
In the third quarter of 2007, management determined that sustained declines in quoted market price of the Company’s common stock represent an event or change in circumstance that would more likely than not reduce the fair value of certain of its assets. Furthermore, management considered the current period operating loss combined with a history of operating losses and determined that a “triggering event” had occurred and an impairment review was necessary ahead of the annual impairment review which would normally occur in the fourth quarter. As a result of this review, the Company determined that certain assets at its Logistix (U.K.) agency were impaired and recorded charges of $3,298 in 2007. These charges were composed of goodwill impairment of $2,385, trademark impairment of $609, and fixed asset impairment of $304. These charges are for write-downs of assets in the Promotional Products segment.
The impairment of the Logistix (U.K.) trademark was assessed in accordance with the provisions of Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS 144”). The impairment test required the Company to estimate the fair value of our trademark. The Company tested these trademarks at the reporting unit level. The Company estimated fair value based on projections of the future cash flows of the reporting unit. The Company determined that the trademark’s fair value was $0 and accordingly wrote-off the carrying value of $609. During this period the Company also recorded $198 of a benefit for income taxes for a reversal of the deferred income tax liability associated with this trademark.
The impairment for fixed assets was assessed in accordance with the provisions of SFAS 144. In performing the test, the Company determined the total of the expected future undiscounted cash flows directly related to the existing potential of Logistix (U.K.) was less than the carrying value of that reporting unit; therefore, the analysis indicated an impairment charge. The impairment charge of $304 represented the difference between the fair value of the assets and their carrying value.
The impairment of goodwill was assessed in accordance with the provisions of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (“SFAS 142”). SFAS 142 indicates that if other types of assets (in addition to goodwill) of a reporting unit are being tested for impairment at the same time as goodwill, then those assets are to be tested for impairment prior to performing the goodwill impairment testing. Accordingly, in accordance with SFAS 142 the impairment charges noted above reduced the carrying value of the reporting unit when performing the impairment test for goodwill. The goodwill impairment test required the Company to estimate the fair value of its overall business enterprise at the reporting unit level. The Company estimated fair value using a discounted cash flow model. Under this model, the Company utilized estimated revenue and cash flow forecasts, as well as assumptions of terminal value, together with an applicable discount rate, to determine fair value. The Company then compared the carrying value of each of its reporting units to their fair value. Since the fair value of the Logistix (U.K.) reporting unit was less than the carrying amount of its net tangible and intangible assets, an impairment charge of $2,385, associated with the remaining balance of Logistix (U.K.) goodwill, was recorded in 2007.
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As of December 31, 2007, there was no remaining carrying value for goodwill and trademark associated with the Logistix (U.K.) reporting unit.
Fixed assets, net is summarized as follows:
| December 31, |
| | 2006 | | | 2007 |
Furniture, fixtures and equipment | $ | 3,485 | | $ | 3,660 |
Computer software | | 5,913 | | | 6,194 |
Computer hardware | | 6,302 | | | 7,351 |
Leasehold improvements | | 2,571 | | | 2,694 |
Fixed assets, at cost | | 18,271 | | | 19,899 |
| | | | | |
Accumulated depreciation and amortization | | (14,688) | | | (16,522) |
Fixed assets, net | $ | 3,583 | | $ | 3,377 |
For the years ended December 31, 2005, 2006 and 2007, depreciation expense related to fixed assets was $1,821, $1,541 and $1,536, respectively.
On March 29, 2006, the Company entered into a 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 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. On May 10, 2006 certain covenants under the facility were amended. For 2007, borrowing availability has ranged from $4,311 to $11,749. As of December 31, 2007, the marginal interest rate on available borrowings under the Facility was 8.5%. As of December 31, 2007, the Company was in compliance with the restrictions and covenants. As of December 31, 2007, $0 was outstanding under the Facility.
Letters of credit outstanding under the Company’s prior credit facility and the Facility as of December 31, 2006 and 2007 totaled $310 and $439, respectively.
6. | 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, 2005, 2006, and 2007 were $730, $377 and $492, respectively.
7. | 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 years from the date of grant. Outstanding 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 1.8 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 801,628 shares were available for grant under the Equity Compensation Plans as of December 31, 2007. The 2000 Employee Plan expires in 2010. The Non-Employee Director Plan and the Stock Incentive Plan expire in 2014.
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The Company previously had a 1996 Stock Option Plan, which expired in 2001, and a Non-Employee Director Stock Option Plan, which expired in 2003 (collectively, the “Expired Plans”). An aggregate of 288,120 shares are reserved for issuance pursuant to outstanding options granted under these Expired Plans.
The 2000 Employee Plan provides for option grants at exercise prices not less than the fair market value on the date of grant in the case of qualified incentive stock options, and not less than par value in the case of non-qualified options. Under the terms of the 2000 Employee Plan, the Company may issue awards of restricted stock and restricted stock units upon such terms and conditions as it may deem appropriate.
The Non-Employee Director Plan provides for the annual grant of incentive awards which may consist of stock options, restricted stock grants or restricted stock units. The Non-Employee Director Plan is administered by the Board of Directors or, if the Board so determines, by a committee of the Board.
The Stock Incentive Plan provides for the grant of incentive awards which may consist of stock options, restricted stock grants, restricted stock units, stock bonuses, stock appreciation rights or performance units. The Stock Incentive Plan is administered by the Board of Directors or, if the Board so determines, by a committee of the Board.
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 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.
Transactions involving the Stock Compensation Plans and the Expired Plans are summarized as follows:
| | | | | | Exercisable at End of Year |
| | | | Weighted Average Exercise Price Per Share | | | | Weighted Average Exercise Price Shares |
| | Restricted Stock Outstanding | | | | |
| Options | | | Number Exercisable | |
| Outstanding | | | |
Outstanding at December 31, 2004 | 1,956,728 | 245,325 | | 12.01 | | 1,315,383 | $ | 13.33 |
Granted | 500,000 | 118,648 | | 9.03 | | | | |
Exercised | (20,000) | (26,813) | | 2.46 | | | | |
Canceled | (702,758) | (72,337) | | 14.17 | | | | |
Outstanding at December 31, 2005 | 1,733,970 | 264,823 | | 12.04 | | 1,820,327 | $ | 9.63 |
Granted | - | 515,349 | | - | | | | |
Exercised | - | (62,804) | | - | | | | |
Canceled | (686,900) | (55,504) | | 12.30 | | | | |
Outstanding at December 31, 2006 | 1,047,070 | 661,864 | | 7.48 | | 1,191,394 | $ | 10.72 |
Granted | - | 96,806 | | - | | | | |
Exercised | - | (103,032) | | - | | | | |
Canceled | (352,200) | (60,765) | | 13.46 | | | | |
Outstanding at December 31, 2007 | 694,870 | 594,873 | $ | 5.54 | | 978,970 | $ | 7.39 |
The following table summarizes information about the Company’s equity awards outstanding and exercisable as of December 31, 2007:
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 3 years). Compensation expense recognized related to grants of restricted stock and RSU’s to certain employees and non-employee Board members was $1,080 and $1,441 for the year ended December 31, 2006 and 2007, respectively. As of December 31, 2007, there was $1,985 of unrecognized compensation cost related to unvested restricted stock and RSUs. This cost is expected to be recognized over a weighted average of 1.8 years.
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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, 2007:
| Shares | | | Weighted Average Grant Date Fair Value |
| | | | |
Unvested at January 1, 2007 | 516,640 | | $ | 7.01 |
Granted | 96,806 | | | 3.53 |
Vested | (241,908) | | | 6.27 |
Forfeited | (60,765) | | | 7.66 |
Unvested at December 31, 2007 | 310,773 | | $ | 6.39 |
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
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conversion price of $14.75 per common share, in exchange for 25,000 shares of Series A Stock. The Series AA Stock has substantially the same rights and preferences as the Series A Stock, but does not participate in cash dividends paid on Common Stock. The exchange was effected in response to the impact of EITF 03-6 on reported earnings. 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.
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.
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, |
| | 2005 | | 2006 | | 2007 |
US operations | $ | (16,764) | $ | (1,375) | $ | (1,285) |
Foreign operations | | (14,955) | | (1,197) | | (6,119) |
| $ | (31,719) | $ | (2,572) | $ | (7,404) |
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The provision (benefit) for income taxes consist of:
| Years Ended December 31, |
| | 2005 | | 2006 | | 2007 |
CURRENT: | | | | | | |
Federal | $ | (750) | $ | (52) | $ | -- |
State and local | | 15 | | (336) | | 8 |
Foreign | | 48 | | 97 | | 402 |
| | (687) | | (291) | | 410 |
DEFERRED: | | | | | | |
Federal | | 6,554 | | -- | | -- |
State and Local | | 2,387 | | -- | | -- |
Foreign | | (101) | | (16) | | (198) |
| | 8,840 | | 0 | | (198) |
| $ | 8,153 | $ | (307) | $ | 212 |
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, |
| | 2005 | | 2006 | | 2007 |
Tax at the Federal statutory rate | $ | (10,911) | $ | (885) | $ | (2,547) |
State income taxes, net of the Federal tax benefit | | (858) | | (156) | | (315) |
Effect of change in state rate on deferred tax assets | | -- | | -- | | 1,195 |
Effect of permanent differences for non-deductible goodwill | | 5,010 | | -- | | 792 |
Effect of deemed dividend from Asia subsidiary | | -- | | -- | | 593 |
Valuation Allowance | | 14,390 | | 630 | | (317) |
Other | | 522 | | 104 | | 811 |
| $ | 8,153 | $ | (307) | $ | 212 |
Other reflects the effects of permanent differences such as the non-deductible portion of meals and entertainment expenses, tax free municipal interest income earned in 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). The increase in “Other” in 2007 is primarily due to the losses in Europe which are subject to lower tax rates.
In 2007, the Company recorded a net tax provision primarily as a result of its Asia-based operations and recognized no tax provision (benefit) from the Company’s operations in the United States and the United Kingdom due to the valuation allowance (see below). The tax provision for our Asia based operations was partially offset by $198 for a reversal of a deferred income tax liability associated with the Logistix (U.K.) trademark which was written-off in 2007.
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The tax effects of the significant temporary differences giving rise to the Company’s deferred tax assets (liabilities) for the years ended December 31, 2006 and 2007 are as follows:
| | 2006 | | 2007 |
| | | | |
Allowance for doubtful accounts | $ | 599 | $ | 335 |
Inventory reserve | | 36 | | (80) |
Accrued expenses | | 716 | | 764 |
Net operating loss carryforwards | | -- | | -- |
Other | | (223) | | (416) |
Total current | | 1,128 | | 603 |
| | | | |
Goodwill and other intangibles | | 6,386 | | 5,219 |
Fixed assets | | 586 | | 496 |
Net operating loss and other carryforwards | | 5,568 | | 7,690 |
Long term liabilities | | 1,099 | | 665 |
Other | | 282 | | 253 |
Total non-current | | 13,921 | | 14,323 |
Deferred income tax asset valuation allowance | | (15,243) | | (14,926) |
Net deferred tax assets (liabilities) | $ | (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 previous two years and based on projections of 2006 taxable income, the Company established a non-cash valuation allowance against its deferred tax assets in 2005. 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 $15,243 and $14,926 at December 31, 2006 and 2007, 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 $7,295 and $10,499 as of December 31, 2006 and 2007, 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 and $6,092 as of December 31, 2006 and 2007 and have a full valuation allowance against them.
State net operating loss carryforwards totaled approximately $17,606 and $19,022 as of December 31, 2006 and 2007, 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. 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 (U.K.), which have been or are intended to be permanently invested in accordance with APB No. 23, “Accounting for Income Taxes – Special Areas,” aggregated $2,574 at December 31, 2006. As of December 31, 2007, as a result of continued operating losses, Logistix (U.K.) has an accumulated loss of $2,109.
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 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.).
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On January 1, 2007, the Company adopted the Financial Accounting Standards Board’s (“FASB”) Interpretation Number 48, “Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarified the accounting for uncertainty in an enterprise’s financial statements by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 requires management to evaluate its open tax positions that exist on the date of initial adoption in each jurisdiction. The Company did not have any unrecognized tax benefits and there was no effect on its financial condition or results of operations as a result of implementing FIN 48.
9. | COMMITMENTS AND CONTINGENCIES |
Operating Leases
The Company has operating leases for its properties and equipment, which expire at various dates through 2021.
Future minimum lease payments under non-cancelable operating leases are as follows:
| | |
Year | | |
| | |
2008 | $ | 4,024 |
2009 | | 4,228 |
2010 | | 1,748 |
2011 | | 1,781 |
2012 | | 1,752 |
Thereafter | | 12,479 |
Total* | $ | 26,012 |
* Minimum payments have not been reduced by minimum sublease rentals of $1,355 due to the Company in the future under noncancelable subleases.
Aggregate rental expenses for operating leases were $3,922, $3,249 and $3,456 for the years ended December 31, 2005, 2006 and 2007, respectively.
Guaranteed Royalties
For the years ended December 31, 2005, 2006, and 2007, the Company incurred $4,168, $1,899 and $506, 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, 2007, the Company has committed to pay total minimum guaranteed royalties as follows:
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.
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10. 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 52%, 48% and 47% of the Company’s consolidated revenues for the years ended December 31, 2005, 2006 and 2007, 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, 2008, 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.
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.
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Industry Segments
| | As of and For the Year Ended December 31, 2005 |
| | | | Agency | | Promotional | | Consumer | | | | |
| | | | Services | | Products | | Products | | Corporate | | Total |
| Total revenues | | $ | 20,766 | $ | 176,416 | $ | 26,215 | $ | -- | $ | 223,397 |
| Segment income (loss) | | | | | | | | | | |
| from operations | | $ | 4,137 | $ | (15,807) | $ | 2,642 | $ | (22,728) | $ | (31,756) |
| Fixed asset additions | $ | -- | $ | -- | $ | -- | $ | 1,711 | $ | 1,711 |
| Depreciation and amortization | $ | -- | $ | 344 | $ | -- | $ | 1,821 | $ | 2,165 |
| Total assets | | $ | 15,213 | $ | 33,002 | $ | 5,963 | $ | 15,618 | $ | 69,796 |
| | | | | | | | | | | | |
| | | As of and For the Year Ended December 31, 2006 |
| | | | Agency | | Promotional | | Consumer | | | | |
| | | | Services | | Products | | Products | | Corporate | | Total |
| Total revenues | | $ | 30,133 | $ | 141,083 | $ | 10,181 | $ | -- | $ | 181,397 |
| Segment income (loss) | | | | | | | | | | |
| from operations | | $ | 5,812 | $ | 9,944 | $ | (260) | $ | (17,714) | $ | (2,218) |
| Fixed asset additions | $ | -- | $ | -- | $ | -- | $ | 1,469 | $ | 1,469 |
| Depreciation and amortization | $ | -- | $ | 139 | $ | -- | $ | 1,546 | $ | 1,685 |
| Total assets | | $ | 13,027 | $ | 28,482 | $ | 2,985 | $ | 17,876 | $ | 62,370 |
| | | | | | | | | | | | |
| | | As of and For the Year Ended December 31, 2007 |
| | | | Agency | | Promotional | | Consumer | | | | |
| | | | Services | | Products | | Products | | Corporate | | Total |
| Total revenues | | $ | 31,769 | $ | 126,612 | $ | 5,793 | $ | -- | $ | 164,174 |
| Segment income (loss) | | | | | | | | | | |
| from operations | | $ | 3,951 | $ | 4,510 | $ | 1,337 | $ | (17,552) | $ | (7,754) |
| Fixed asset additions | $ | -- | $ | -- | $ | -- | $ | 1,553 | $ | 1,553 |
| Depreciation and amortization | $ | -- | $ | 54 | $ | -- | $ | 1,542 | $ | 1,596 |
| Total assets | | $ | 16,809 | $ | 23,521 | $ | 2,287 | $ | 8,826 | $ | 51,443 |
Information about the Company’s operations by geographical area is as follows:
| As of and For the Years Ended December 31, |
| 2005 | | 2006 | | 2007 |
Revenues: | | | | | | | | |
United States | $ | 171,995 | | $ | 134,907 | | $ | 126,819 |
International | | 51,402 | | | 46,490 | | | 37,355 |
Total revenues | | 223,397 | | $ | 181,397 | | $ | 164,174 |
Income (loss) from operations: | | | | | | | | |
United States | $ | (12,076) | | $ | 1,318 | | $ | 1,508 |
International | | (19,680) | | | (3,536) | | | (9,262) |
Total loss from operations | $ | (31,756) | | $ | (2,218) | | $ | (7,754) |
Fixed assets, net: | | | | | | | | |
United States | $ | 2,984 | | $ | 3,093 | | $ | 3,053 |
International | | 587 | | | 490 | | | 324 |
Total fixed assets | $ | 3,571 | | $ | 3,583 | | $ | 3,377 |
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11. | SUMMARIZED QUARTERLY FINANCIAL DATA (UNAUDITED) |
| Three Months Ended | |
| March 31 | | June 30 | | September 30 | | December 31 | |
| | | | | | | | | | | | |
2006 | | | | | | | | | | | | |
Revenues | $ | 42,686 | | $ | 40,094 | | $ | 43,078 | | $ | 55,539 | |
Gross profit | $ | 10,333 | | $ | 11,310 | | $ | 11,547 | | $ | 10,837 | |
Income (loss) from operations | $ | (2,105) | | $ | (530) | | $ | 409 | | $ | 8 | |
Net income (loss) available to common stockholders | $ | (2,463) | | $ | (644) | | $ | 219 | | $ | 248 | |
Basic income (loss) per share: | | | | | | | | | | | | |
Income (loss) per share | $ | (0.42) | | $ | (0.11) | | $ | 0.04 | | $ | 0.04 | |
Weighted average shares outstanding | | 5,806,203 | | | 5,838,785 | | | 5,845,788 | | | 5,849,186 | |
Diluted income (loss) per share: | | | | | | | | | | | | |
Income (loss) per share | $ | (0.42) | | $ | (0.11) | | $ | 0.03 | | $ | 0.03 | |
Weighted average shares outstanding | | 5,806,203 | | | 5,838,785 | | | 8,675,447 | | | 8,930,472 | |
| Three Months Ended | |
| March 31 | | June 30 | | September 30 | | December 31 | |
| | | | | | | | | | | | |
2007 | | | | | | | | | | | | |
Revenues | $ | 36,248 | | $ | 39,539 | | $ | 42,532 | | $ | 45,855 | |
Gross profit | $ | 7,963 | | $ | 10,221 | | $ | 10,544 | | $ | 12,596 | |
Income (loss) from operations | $ | (2,457) | | $ | (1,756) | | $ | (3,977) | | $ | 436 | |
Net income (loss) available to common stockholders | $ | (2,593) | | $ | (1,819) | | $ | (3,736) | | $ | 532 | |
Basic income (loss) per share: | | | | | | | | | | | | |
Income (loss) per share | $ | (0.44) | | $ | (0.31) | | $ | (0.63) | | $ | 0.09 | |
Weighted average shares outstanding | | 5,852,174 | | | 5,875,991 | | | 5,887,830 | | | 5,895,699 | |
Diluted income (loss) per share: | | | | | | | | | | | | |
Income (loss) per share | $ | (0.44) | | $ | (0.31) | | $ | (0.63) | | $ | 0.06 | |
Weighted average shares outstanding | | 5,852,174 | | | 5,875,991 | | | 5,887,830 | | | 8,784,821 | |
(1.) Changes primarily attributable to the impairment charges in the fourth quarter. (See Note 3).
On March 3, 2008, the Company issued 925,000 restricted shares of Common Stock to seven senior executives in lieu of 2008 salary increases and cash bonuses. The restricted share grants are being amortized to compensation expense over a three year vesting period. The closing price for EMAK Common Stock as of March 3, 2008, was $1.00 per share. As part of the issuance of the restricted stock grants, the Company repurchased stock options from its CEO in order to increase the number of shares available for grant under the Company’s Equity Compensation Plans. The Company paid $16 to repurchase 375,000 fully vested stock options with an average exercise price of $9.89. The Black-Scholes option pricing model was used in determining the valuation of the purchase price of the options repurchased. In accordance with the provisions of SFAS No. 123(R), the cash settlement of $16 was recorded as a repurchase of outstanding equity instruments and was charged to additional paid-in capital.
ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
None.
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| ITEM 9A. | CONTROLS AND PROCEDURES. |
Evaluation of Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) that are designed to ensure that information required to be disclosed in reports filed with the SEC are recorded, processed, summarized and reported within the time period specified by the SEC’s rules and forms and that such information is accumulated and communicated to our management, including to our Chief Executive Office and Principal Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure.
As required by Rule 13a-15 under the Exchange Act, the Company’s management, with the participation of the Company’s Chief Executive Officer and its Principal Accounting Officer, has evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2007. Based on this evaluation, our Chief Executive Officer and Principal Accounting Officer have concluded that the Company’s disclosure controls and procedures are effective for ensuring that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
Management's Report on Internal Control over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act). Under the supervision and with the participation of management, including our Chief Executive Office and Principal Accounting Officer, the Company conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the Company’s evaluation under the framework in Internal Control-Integrated Framework, the Company’s management concluded that our internal control over financial reporting was effective as of December 31, 2007.
This annual report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.
Remediation of Prior Material Weaknesses
As of December 31, 2007, management believes that the material weaknesses in our internal control over financial reporting that was included in Item 4 of our Form 10-Q for the quarter ended September 30, 2007 have been effectively remediated. Prior to the quarter ended December 31, 2007, the remediation measures as described below were implemented.
We have taken appropriate actions to remediate the material weakness related to our internal controls over the completeness and accuracy of our the timely identification of a “triggering event” for impairment testing in accordance with Statement of Financial Accounting Standards No.SFAS 142, “Goodwill and Other Intangible Assets”(“SFAS No. 142”). We have implemented a more formal process to document and review the impact of the Company’s decline in quoted market price as a potential indicator of impairment, to ensure that goodwill is tested for potential impairment in accordance with generally accepted accounting principles. This process will be completed on a quarterly basis to ensure any such transactions are accounted for appropriately.
Changes in Internal Control over Financial Reporting
Other then mentioned above, there were no changes in our internal control over financial reporting during the quarter ended December 31, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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| 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 2008 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 2008 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 2008 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 2008 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 2008 Annual Meeting of Stockholders, which is incorporated herein by reference.
ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES |
Information relating to this item appears under the caption “RATIFICATION OF SELECTION OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM” in our Proxy Statement relating to our 2008 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.
CONSOLIDATED FINANCIAL STATEMENTS:
2. Financial Statement Schedules:
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| Note: | All other supplementary schedules are omitted since they are not applicable or the required information can be obtained from the consolidated financial statements. |
| 3.1 | 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) |
| 3.8 | Amended and Restated Certificate of Designation of Series AA Senior Cumulative Convertible Preferred Stock of the Company dated June 1, 2007. (19) |
| 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) |
| 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) |
64
| 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. (20) |
| 10.23 | Fourth Amendment to Loan and Security Agreement dated February 5, 2007. (20) |
| 10.24 | Office Lease dated November 9, 2007 between 350 North Orleans L.L.C. and Upshot, Inc. (21) |
| 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 March 31, 2008 pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.* |
| 31.2 | Certification of Principal Accounting Officer dated March 31, 2008 pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.* |
| 32.1 | Certification of Principal Executive Officer dated March 31, 2008 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 March 31, 2008 pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.* |
------------------------
| (1) | Previously filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1995, and incorporated herein by reference. |
| (2) | Previously filed as an exhibit to the Registrant’s 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. |
65
| (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. |
| | |
| (19) | Previously filed with the Registrant’s Proxy Statement for the 2007 Annual Meeting of Stockholders dated May 4, 2007 and incorporated herein by reference. |
| | |
| (20) | Previously filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2006, and incorporated herein by reference. |
| | |
| (21) | Previously filed as an exhibit to the Registrant’s Current Report on Form 8-K dated November 15, 2007, and incorporated herein by reference. |
| | |
(*) Filed herewith
| (b) Exhibits Required by Item 601 of Regulation S-K |
| (c) Financial Statement Schedule |
66
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 31st day of March, 2008.
| | 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 | March 31, 2008 |
James L. Holbrook, Jr. | | (Principal Executive Officer) | |
| | | |
/s/ Roy Dar | | Senior Vice President, Controller | March 31, 2008 |
Roy Dar | | (Principal Accounting Officer) | |
| | | |
/s/ Stephen P. Robeck | | Chairman, Director | March 31, 2008 |
Stephen P. Robeck | | | |
| | | |
/s/ Howard D. Bland | | Director | March 31, 2008 |
Howard D. Bland | | | |
| | | |
/s/ Jeffrey S. Deutschman | | Director | March 31, 2008 |
Jeffrey S. Deutschman | | | |
| | | |
/s/ Daniel W. O’Connor | | Director | March 31, 2008 |
Daniel W. O’Connor | | | |
| | | |
/s/ Alfred E. Osborne, Jr. | | Director | March 31, 2008 |
Alfred E. Osborne, Jr. | | | |
67
Report of Independent Registered Public Accounting Firm on
Financial Statement Schedule
To the Board of Directors and Stockholders of
EMAK Worldwide, Inc.:
Our audit of the consolidated statements of operations, of stockholders' equity, of comprehensive loss and of cash flows 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 10, as to which the date is March 26, 2007, appearing in the 2007 Annual Report to Shareholders of EMAK Worldwide, Inc. also included an audit of the financial statement schedule for the year ended December 31, 2005 listed in Item 15(a)(2) of this Form 10-K. In our opinion, this financial statement schedule for the year ended December 31, 2005 presents fairly, in all material respects, the information set forth therein when read in conjunction with the consolidated statements referred to above.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Los Angeles, CA
March 30, 2006
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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 Year |
| | | | | |
CLASSIFICATION | | | | | |
| | | | | | | | | | | | | | | |
Year Ended December 31, 2005 | | | | | | | | | | | | | | | |
Allowances for doubtful accounts receivable | $ | 1,733 | | $ | 180 | | $ | 1,247 | | $ | (1,422) | (A) | | $ | 1,738 |
and sales returns | | | | | | | | | | | | | | | |
Inventory reserve | | 740 | | | 1,719 | | | - | | | (1,568) | | | | 891 |
Restructuring reserves | | - | | | 2,952 | | | - | | | (1,117) | | | | 1,835 |
Deferred tax asset valuation allowance | | 223 | | | 14,390 | | | - | | | - | | | | 14,613 |
Year Ended December 31, 2006 | | | | | | | | | | | | | | | |
Allowances for doubtful accounts receivable | $ | 1,738 | | $ | 13 | | $ | 958 | | $ | (1,327) | (A) | | $ | 1,382 |
and sales returns | | | | | | | | | | | | | | | |
Inventory reserve | | 891 | | | 437 | | | - | | | (689) | | | | 639 |
Restructuring reserves | | 1,835 | | | 1,213 | | | - | | | (2,929) | | | | 119 |
Deferred tax asset valuation allowance | | 14,613 | | | 630 | | | - | | | - | | | | 15,243 |
Year Ended December 31, 2007 | | | | | | | | | | | | | | | |
Allowances for doubtful accounts receivable | $ | 1,382 | | $ | (14) | | $ | 2,167 | | $ | (2,682) | (A) | | $ | 853 |
and sales returns | | | | | | | | | | | | | | | |
Inventory reserve | | 639 | | | (82) | | | - | | | (197) | | | | 360 |
Restructuring reserves | | 119 | | | 584 | | | - | | | (348) | | | | 355 |
Deferred tax asset valuation allowance | | 15,243 | | | (317) | | | - | | | - | | | | 14,926 |
(A) Represents product returns, credits applied and accounts receivable written off, net of recoveries.
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