EMAK Worldwide (EMAK) 10-Q 2005 Q3 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2005

or

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 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, CA (Address of principal executive offices)	90048 (Zip Code)

(323) 932-4300
(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yesþ                    Noo

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yeso                    Noþ

Indicate by check mark whether the registrant is a Shell Company (as defined in Rule 12b-2 of the Exchange Act).

Yeso                    Noþ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date:

Common Stock, $.001 par value, 5,792,442 shares as of November 10, 2005.

EMAK WORLDWIDE, INC.

Index To Quarterly Report on Form 10-Q
Filed with the Securities and Exchange Commission
September 30, 2005

			Page
Part I.	Financial Information
	Item 1.	Financial Statements		3
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		21
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk		34
	Item 4.	Controls and Procedures		34
Part II.	Other Information
	Item 6.	Exhibits		35
Exhibit 10.1
Exhibit 10.2
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

Cautionary Statement

Certain expectations and projections regarding our future performance discussed in this quarterly report are forward-looking and are made under the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. These expectations and projections are based on currently available competitive, financial and economic data along with our operating plans and are subject to future events and uncertainties. Readers should not place undue reliance on any such forward-looking statements, which speak only as of the date made. Actual results could vary materially from those anticipated for a variety of reasons. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Readers are advised to review “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Cautionary Statements and Risk Factors.”

2

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

EMAK WORLDWIDE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)

ASSETS

	December 31,		September 30,
	2004		2005
CURRENT ASSETS:
Cash and cash equivalents	$	4,406	$	4,909
Accounts receivable (net of allowances of $1,733 and $1,545 as of December 31, 2004 and September 30, 2005, respectively)		47,180		31,402
Inventories, net (Note 2)		18,763		16,529
Prepaid expenses and other current assets		5,466		5,484
Total current assets		75,815		58,324
Fixed assets, net		5,029		3,624
Goodwill (Notes 2 and 6)		41,723		40,031
Other intangibles, net (Notes 2 and 6)		3,686		1,305
Other assets		7,060		5,667
Total assets	$	133,313	$	108,951

The accompanying notes are an integral part of these
unaudited condensed consolidated financial statements.

3

EMAK WORLDWIDE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)

LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY

	December 31,			September 30,
	2004			2005
CURRENT LIABILITIES:
Short-term debt	$	6,025		$	2,000
Accounts payable		30,996			23,991
Accrued liabilities		20,860			13,619
Total current liabilities		57,881			39,610
LONG-TERM LIABILITIES		6,621			3,939
Total liabilities		64,502			43,549
COMMITMENTS AND CONTINGENCIES (Note 8)
Mandatorily redeemable preferred stock, Series AA senior cumulative convertible, $.001 par value per share, 25,000 issued and outstanding, stated at liquidation preference of $1,000 per share ($25,000), net of issuance costs		22,518			22,518
STOCKHOLDERS’ EQUITY:
Preferred stock, $.001 par value per share, 1,000,000 shares authorized, 25,000 Series AA issued and outstanding		—			—
Common stock, $.001 par value per share, 25,000,000 shares authorized, 5,759,263 and 5,789,192 shares outstanding as of December 31, 2004 and September 30, 2005, respectively		—			—
Additional paid-in capital		27,516			28,080
Retained earnings		33,954			31,596
Accumulated other comprehensive income		4,972			2,927
		66,442			62,603
Less—
Treasury stock, 3,167,258 shares, at cost, as of December 31, 2004 and September 30, 2005		(17,669	)		(17,669	)
Unearned compensation		(2,480	)		(2,050	)
Total stockholders’ equity		46,293			42,884
Total liabilities, mandatorily redeemable preferred stock and stockholders’ equity	$	133,313		$	108,951

The accompanying notes are an integral part of these
unaudited condensed consolidated financial statements.

4

EMAK WORLDWIDE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2004			2005			2004			2005
REVENUES	$	58,055		$	49,810		$	161,645		$	165,154
COST OF SALES		45,645			35,261			122,232			121,596
Minimum royalty guarantee shortfall gain		—			(399	)		—			(2,724	)
Gross profit		12,410			14,948			39,413			46,282
OPERATING EXPENSES:
Salaries, wages and benefits		7,986			8,147			23,163			26,134
Selling, general and administrative		6,087			5,564			18,143			17,192
Integration costs		—			8			136			76
Loss on Chicago lease		—			—			311			—
Restructuring charge (gain)		(25	)		416			80			1,318
Impairment of assets		—			3,431			—			3,431
ERP reimplementation costs		—			22			—			124
Total operating expenses		14,048			17,588			41,833			48,275
Loss from operations		(1,638	)		(2,640	)		(2,420	)		(1,993	)
OTHER INCOME (EXPENSE), net		179			234			(181	)		131
Loss before benefit for income taxes		(1,459	)		(2,406	)		(2,601	)		(1,862	)
BENEFIT FOR INCOME TAXES		(566	)		(866	)		(1,012	)		(629	)
NET LOSS		(893	)		(1,540	)		(1,589	)		(1,233	)
PREFERRED STOCK DIVIDENDS		375			375			1,125			1,125
						��
NET LOSS AVAILABLE TO COMMON STOCKHOLDERS	$	(1,268	)	$	(1,915	)	$	(2,714	)	$	(2,358	)
BASIC LOSS PER SHARE	$	(0.22	)	$	(0.33	)	$	(0.47	)	$	(0.41	)
BASIC WEIGHTED AVERAGE SHARES OUTSTANDING		5,758,888			5,788,042			5,752,287			5,779,727
DILUTED LOSS PER SHARE	$	(0.22	)	$	(0.33	)	$	(0.47	)	$	(0.41	)
DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING		5,758,888			5,788,042			5,752,287			5,779,727

The accompanying notes are an integral part of these
unaudited condensed consolidated financial statements.

5

EMAK WORLDWIDE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
(UNAUDITED)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2004			2005			2004			2005
NET LOSS	$	(893	)	$	(1,540	)	$	(1,589	)	$	(1,233	)
OTHER COMPREHENSIVE INCOME (LOSS):
Foreign currency translation adjustments (Note 2)		(93	)		(581	)		227			(2,411	)
Unrealized gain (loss) on foreign currency forward contracts (Note 2)		(267	)		330			(61	)		366
COMPREHENSIVE LOSS	$	(1,253	)	$	(1,791	)	$	(1,423	)	$	(3,278	)

The accompanying notes are an integral part of these
unaudited condensed consolidated financial statements.

6

EMAK WORLDWIDE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

	Nine Months Ended
	September 30,
	2004			2005
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(1,589	)	$	(1,233	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		1,529			1,684
Provision for doubtful accounts		147			(75	)
Gain on disposal of fixed assets		—			(17	)
Tax benefit from exercise of stock options		65			—
Amortization of restricted stock		621			769
Minimum royalty guarantee shortfall gain		—			(2,724	)
Impairment of assets		—			3,431
Other		(13	)		—
Changes in operating assets and liabilities, net of effect of acquisition:
Increase (decrease) in cash and cash equivalents:
Accounts receivable		1,948			14,880
Inventories		(3,408	)		2,107
Prepaid expenses and other current assets		(1,195	)		(141	)
Other assets		(556	)		1,045
Accounts payable		497			(6,550	)
Accrued liabilities		(2,926	)		(4,580	)
Long-term liabilities		(758	)		(682	)
Net cash provided by (used in) operating activities		(5,638	)		7,914
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of fixed assets		(1,080	)		(1,289	)
Proceeds from sale of fixed assets		20			992
Refund for purchase of Upshot		—			75
Payment for purchase of Megaprint Group		(4,614	)		(1,908	)
Payment for purchase of Johnson Grossfield		—			(148	)
Net cash used in investing activities		(5,674	)		(2,278	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under line of credit		863			—
Payment of preferred stock dividends		(1,125	)		(1,125	)
Purchase of treasury stock		(211	)		—
Repayment of short-term debt		—			(4,025	)
Proceeds from exercise of stock options		538			115
Net cash used in financing activities		65			(5,035	)
Net increase (decrease) in cash and cash equivalents		(11,247	)		601
Effects of exchange rate changes on cash and cash equivalents		13			(98	)
CASH AND CASH EQUIVALENTS, beginning of period		19,291			4,406
CASH AND CASH EQUIVALENTS, end of period	$	8,057		$	4,909
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
CASH PAID FOR:
Interest	$	148		$	324
Income taxes, net of refunds	$	77		$	(118	)

The accompanying notes are an integral part of these
unaudited condensed consolidated financial statements.

7

EMAK WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2005
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)

NOTE 1 — ORGANIZATION AND BUSINESS

EMAK Worldwide, Inc., a Delaware corporation and subsidiaries (“EMAK” or the “Company”), is a leading global integrated marketing services company. EMAK has expertise in the areas of: strategic planning and research, entertainment marketing, design and manufacturing of custom promotional products, promotion, event marketing, collaborative marketing, retail design and environmental branding. The Company’s clients include Burger King, Kellogg’s, Frito Lay, Kohl’s, Macy’s, Kraft, Procter & Gamble and Miller Brewing Company, among others. EMAK is headquartered in Los Angeles, with operations in Chicago, New York, Ontario (California), Dublin, Frankfurt, London, Paris, The Netherlands, Hong Kong and Shanghai. The Company primarily sells to customers in the United States and Europe. The Company’s functional currency is the US dollar.

NOTE 2 — BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

In the opinion of management and subject to year-end audit, the accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments considered necessary for fair statement have been included. The results of operations for the interim periods are not necessarily indicative of the results for a full year. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

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.

Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Diluted EPS includes in-the-money options using the treasury stock method. During a loss period, the assumed exercise of in-the-money stock options has an antidilutive effect. As a result, these shares are not included with the weighted average shares outstanding used in the calculation of diluted loss per share for the three and nine months ended September 30, 2004 and 2005. Options to purchase 2,108,666 and 1,327,612 shares of common stock, $.001 par value per share (the “Common Stock”), as of September 30, 2004 and 2005, respectively, were excluded from the computation of diluted EPS as they would have been anti-dilutive. For the three and nine months ended September 30, 2004 and 2005, preferred stock convertible into 1,694,915 shares of Common Stock was excluded in the computation of diluted EPS.

8

The following is a reconciliation of the numerators and denominators of the basic and diluted EPS computation for “income available to common shareholders” and other disclosures required by SFAS No. 128, “Earnings per Share” Emerging Issues Task Force Issue No. 03-6, “Participating Securities and the Two-Class Method under SFAS No. 128, Earnings Per Share” (“EITF 03-6”):

	For the Three Months Ended September 30,
	2004								2005
	Loss			Shares		Per Share			Loss			Shares		Per Share
	(Numerator)			(Denominator)		Amount			(Numerator)			(Denominator)		Amount
Basic EPS:
Loss available to common stockholders	$	(1,268	)		5,758,888	$	(0.22	)	$	(1,915	)		5,788,042	$	(0.33	)
Effect of dilutive securities:
Options and warrants		—			—					—			—
Restricted stock units		—			—					—			—
Dilutive EPS:
Loss available to common stockholders	$	(1,268	)		5,758,888	$	(0.22	)	$	(1,915	)		5,788,042	$	(0.33	)

	For the Nine Months Ended September 30,
	2004								2005
	Loss			Shares		Per Share			Loss			Shares		Per Share
	(Numerator)			(Denominator)		Amount			(Numerator)			(Denominator)		Amount
Basic EPS:
Loss available to common stockholders	$	(2,714	)		5,752,287	$	(0.47	)	$	(2,358	)		5,779,727	$	(0.41	)
Effect of dilutive securities:
Options and warrants		—			—					—			—
Restricted stock units		—			—					—			—
Dilutive EPS:
Loss available to common stockholders	$	(2,714	)		5,752,287	$	(0.47	)	$	(2,358	)		5,779,727	$	(0.41	)

Inventories

Inventories consist of (a) production-in-process which primarily represents tooling costs which are deferred and amortized over the life of the products and deferred costs on service contracts and (b) purchased finished goods held for sale to customers and purchased finished goods in transit to customers’ distribution centers. Inventories are stated at the lower of average cost or market. As of December 31, 2004 and September 30, 2005, inventories consisted of the following:

	December 31,		September 30,
	2004		2005
Production-in-process	$	861	$	2,238
Finished goods		17,902		14,291
Total inventories, net	$	18,763	$	16,529

Foreign Currency Translation

Net foreign exchange gains or losses resulting from the translation of foreign subsidiaries’ accounts whose functional currency is not the United States dollar are recognized as a component of accumulated other comprehensive income in stockholders’ equity. For such subsidiaries, accounts are translated into United States dollars at the following rates of exchange: assets and liabilities at period-end exchange rates, equity accounts at historical rates, and income and expense accounts at average exchange rates during the period.

For subsidiaries with transactions denominated in currencies other than their functional currency, net foreign exchange transaction gains or losses are included in determining net income (loss). Transaction gains included in net loss for the quarters ended September 30, 2004 and 2005 were $186 and $257, respectively. Transaction gains or (losses) included in net loss for the nine months ended September 30, 2004 and 2005 were $(136) and $354, respectively.

9

Derivative Instruments

The Company adopted SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” which establishes accounting and reporting standards for derivative instruments and for hedging activities. SFAS No. 133 requires that an entity recognize derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation.

The Company designates its derivatives based upon criteria established by SFAS No. 133. For a derivative designated as a fair value hedge, the gain or loss is recognized in earnings in the period of change together with the offsetting loss or gain on the hedged item attributed to the risk being hedged. For a derivative designated as a cash flow hedge, the effective portion of the derivative’s gain or loss is initially reported as a component of accumulated other comprehensive income and subsequently reclassified into earnings when the hedged exposure affects earnings. The ineffective portion of the gain or loss is reported in earnings immediately.

The Company adopted SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” which amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The guidance was applied prospectively.

The Company uses derivatives to manage exposures to foreign currency. The Company’s objective for holding derivatives is to decrease the volatility of earnings and cash flows associated with changes in foreign currency. The Company enters into foreign exchange forward contracts to minimize the short-term impact of foreign currency fluctuations on foreign currency receivables, investments, and payables. The gains and losses on the foreign exchange forward contracts offset the transaction gains and losses on the foreign currency receivables, investments, and payables recognized in earnings. The Company does not enter into foreign exchange forward contracts for trading purposes. Gains and losses on the contracts are included in other income (expense) in the condensed consolidated statements of operations and offset foreign exchange gains or losses from the revaluation of intercompany balances or other current assets, investments, and liabilities denominated in currencies other than the functional currency of the reporting entity. The Company’s foreign exchange forward contracts related to current assets and liabilities generally range from one to eleven months in original maturity.

The Company’s Logistix subsidiary entered into foreign currency forward contracts aggregating 2,735 GBP to sell Euros in exchange for British pounds and United States dollars and to sell British pounds in exchange for United States dollars. The contracts will expire by May 2006. At September 30, 2005, the foreign currency forward contracts had an estimated fair value of 80 GBP. The fair value of the foreign currency forward contracts is recorded in prepaid expenses and other current assets in the accompanying condensed consolidated balance sheet as of September 30, 2005. The unrealized gain on the contracts is reflected in accumulated other comprehensive income.

Goodwill and Other Intangibles

The change in the carrying amount of goodwill from $41,723 as of December 31, 2004 to $40,031 as of September 30, 2005 reflects: a decrease of $1,449 for the Johnson Grossfield impairment of assets (see Note 6), a foreign currency translation adjustment of $(1,648), an adjustment to reflect the decrease to goodwill for the Upshot acquisition of $75, an adjustment to reflect the net increase to goodwill for Megaprint Group of $1,223 (see Note 6) and $257 for earnout consideration related to the acquisition of Johnson Grossfield (see Note 6). The $75 adjustment to goodwill for the Upshot acquisition reflects the return of purchase price from the seller as a result of a settlement of claims made against funds escrowed as security for warranties and indemnification pursuant to the asset purchase agreement, dated May 22, 2002, by and among the Company, Promotional Marketing, LLC and HA-LO Industries, Inc. All of the goodwill balance relates to the Marketing Services segment.

The change in the carrying amount of identifiable intangibles from $3,686 as of December 31, 2004 to $1,305 as of September 30, 2005 reflects: a decrease of $1,982 for the Johnson Grossfield impairment of assets (see Note 6), a decrease of $312 for amortization expense and a foreign currency translation adjustment of $(87). A portion of identifiable intangibles are subject to amortization and are reflected as other intangibles in the condensed consolidated balance sheets.

10

Royalties

The Company enters into agreements to license intellectual properties such as trademarks, copyrights, and patents. The agreements may call for minimum amounts of royalties to be paid in advance and throughout the term of the agreement, which are non-refundable in the event that product sales fail to meet certain minimum levels. Advance royalties resulting from such transactions are stated at the lower of the amounts paid or the amounts estimated to be recoverable from future sales of the related products. Furthermore, minimum guaranteed royalty commitments are reviewed on a periodic basis to ensure that amounts are recoverable based on estimates of future sales of the products under license. A loss provision will be recorded in the condensed consolidated statements of operations to the extent that future minimum royalty guarantee commitments are not recoverable. Estimated future sales are projected based on historical experience, including that of similar products, and anticipated advertising and marketing support by the licensor. In the fourth quarter of 2004, the Company recorded a pre-tax charge of $7,722 relating to minimum royalty guarantee shortfalls on several consumer products licenses. These shortfalls are the result of the Company’s decision to wind down its consumer products business, Pop Rocket, which resulted in a decrease in expectations of future sales under several licenses.

On May 18, 2005, 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 retains product distribution rights under the licenses for 2005. As a result of this settlement, the Company’s overall commitment for royalty guarantees is reduced by approximately $4,000. The Company is required to pay the licensor a total of $1,800 through March 31, 2006. As a result of this settlement, $2,325 of the fourth quarter 2004 charge for minimum royalty guarantee shortfalls was reversed in the second quarter of 2005. During the three months ended September 30, 2005, an additional $399 was reversed due to higher than expected Scooby-Doo™ revenues that exceeded the Company’s initial estimates. The reversals are recorded as a minimum royalty guarantee shortfall gain in the accompanying condensed consolidated statements of operations for the three and nine months ended September 30, 2005. The Company continues to monitor royalty accruals in light of the wind down of Pop Rocket and continues its negotiations with its licensors for the termination of several of its license agreements.

Stock-Based Compensation

As of September 30, 2005, the Company had three stock-based compensation plans — the 2000 Stock Option Plan, the 2004 Non-Employee Director Stock Incentive Plan and the 2004 Stock Incentive Plan. In accordance with provisions of SFAS No. 123, the Company applies Accounting Principles Board (“APB”) Opinion No. 25 and related interpretations in accounting for its stock-based compensation plans and, accordingly, does not recognize compensation cost for grants whose exercise price equals the market price of the stock on the date of grant. If the Company had elected to recognize compensation cost based on the fair value of the options granted at grant date as prescribed by SFAS No. 123, net loss and loss per share would have been increased to the pro forma amounts indicated in the table below:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2004			2005			2004			2005
Net loss — as reported	$	(893	)	$	(1,540	)	$	(1,589	)	$	(1,233	)
Plus:
Stock-based compensation expense, net of tax, included in reported net loss		126			189			316			462
Less:
Compensation expense (a)		245			264			758			503
Net loss — pro forma	$	(1,012	)	$	(1,615	)	$	(2,031	)	$	(1,274	)
Loss per share:
Basic loss per share, as reported	$	(0.22	)	$	(0.33	)	$	(0.47	)	$	(0.41	)
Pro forma basic loss per share	$	(0.24	)	$	(0.34	)	$	(0.55	)	$	(0.42	)
Diluted loss per share, as reported	$	(0.22	)	$	(0.33	)	$	(0.47	)	$	(0.41	)
Pro forma diluted loss per share	$	(0.24	)	$	(0.34	)	$	(0.55	)	$	(0.42	)

(a) Determined under fair value based method for all awards, net of tax.

11

ERP reimplementation costs

The Company recorded enterprise resource planning (“ERP”) reimplementation costs of $22 and $124 for the three and nine months ended September 30, 2005, respectively. This represents consulting costs which were not capitalized into fixed assets. The costs were incurred in connection with a significant upgrade and reimplementation of the Company’s ERP software which is designed to enhance management information, financial reporting, inventory management, cost evaluation and controls while assisting in compliance with the Sarbanes-Oxley Act of 2002.

Recent Accounting Pronouncements

In September 2004, the consensus of EITF Issue No. 04-10, “Applying Paragraph 19 of Financial Accounting Standards Board (“FASB”) FASB Statement No. 131, ‘Disclosures about Segments of an Enterprise and Related Information,’ in Determining Whether to Aggregate Operating Segments That Do Not Meet the Quantitative Thresholds,” was published. EITF Issue No. 04-10 addresses how an enterprise should evaluate the aggregation criteria of SFAS No. 131 when determining whether operating segments that do not meet the quantitative thresholds may be aggregated in accordance with SFAS No. 131. The consensus in EITF 04-10 should be applied for fiscal years ending after September 15, 2005. The Company is still evaluating the impact of this issue on the Company’s disclosures as reported in the Annual and Quarterly reports. The Company does not expect adoption of this issue to have a significant effect on the Company’s consolidated financial condition or results of operations.

In December 2004, the FASB issued SFAS No. 123 (revised 2004) (“SFAS No. 123(R)”), “Share-Based Payment”, which replaced SFAS No. 123 and superseded APB Opinion No. 25. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The pro forma disclosures previously permitted under SFAS No. 123 will no longer be an alternative to financial statement recognition. Under SFAS No. 123(R), the Company must determine the appropriate fair value method to be used for valuing share-based payments, the amortization method of compensation cost and the transition method to be used at the date of adoption. The transition methods include prospective and retroactive adoption options. Under the retroactive option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The prospective method requires that compensation cost be recorded for all unvested stock options and nonvested stock at the beginning of the first quarter of adoption of SFAS No. 123(R), whereas the retroactive method requires recording compensation cost for all unvested stock options and nonvested stock beginning with the first period restated.

In April 2005, the Securities Exchange Commission amended Regulation S-X to delay the effective date for compliance with SFAS No. 123(R). Based on the amended regulation, the Company is required to adopt SFAS No. 123(R) on January 1, 2006. The Company is evaluating the requirements of SFAS No. 123(R) and expects that the adoption of SFAS No. 123(R) may have a material adverse effect on its results of operations and earnings per share. The Company has not yet determined the method of adoption of SFAS No. 123(R), or whether the amounts recorded in the condensed consolidated statements of operations in future periods will be similar to the current pro forma disclosures under SFAS No. 123.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs — An Amendment of ARB No. 43, Chapter 4”. SFAS No. 151 amends the guidance in Chapter 4, “Inventory Pricing,” of Accounting Research Bulletin (“ARB”) No. 43, “Restatement and Revision of Accounting Research Bulletins”, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (“spoilage”). Among other provisions, the statement requires that items such as idle facility expense, excessive spoilage, double freight, and rehandling costs be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal” as stated in ARB No. 43. Additionally, SFAS No. 151 requires that the allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 is effective for fiscal years beginning after June 15, 2005. The Company is currently evaluating the effect that the adoption of SFAS No. 151 will have on its results of operations and financial position, but does not expect it to have a material impact.

In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143” (“FIN 47”), which requires an entity to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. FIN 47 is effective for fiscal years ending after December 15, 2005. The Company is currently evaluating the effect that the adoption of FIN 47 will have on its condensed consolidated statements of operations and financial condition but does not expect it to have a material impact.

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In October 2005, the FASB issued FASB Staff Position (“FSP”) 13-1, “Accounting for Rental Costs Incurred During a Construction Period.” FSP 13-1 requires rental costs associated with ground or building operating leases that are incurred during a construction period to be recognized as rental expense. FSP 13-1 applies to reporting periods beginning after December 15, 2005. Retrospective application in accordance with FASB SFAS No. 154 “Accounting Changes and Error Corrections”, is permitted but not required. The Company does not believe that the adoption of FSP 13-1 will have a significant impact on its operations or financial position.

NOTE 3 — LINE OF CREDIT

On April 24, 2001, the Company signed a credit facility (the “Facility”) with Bank of America. On April 26, 2004, the maturity date of the Facility was extended through June 30, 2005. Effective March 30, 2005, the maturity date of the Facility was further extended through March 31, 2006. The credit facility is secured by substantially all of the Company’s assets and provides for a line of credit of up to $20,000 with borrowing availability determined by a formula based on qualified assets. Interest on outstanding borrowings will be based on either a fixed rate equivalent to LIBOR plus an applicable spread of between 1.50 and 2.25 percent or a variable rate equivalent to the bank’s reference rate plus an applicable spread of between zero and 0.50 percent. The Company is also required to pay an unused line fee of between zero and 0.60 percent per annum and certain letter of credit fees. The applicable spread is based on the achievement of certain financial ratios. The Facility also requires the Company to comply with certain restrictions and covenants as amended from time to time. As of December 31, 2004 and September 30, 2005, the Company was in compliance with the restrictions and covenants. The Facility may be used for working capital and acquisition financing purposes. As of December 31, 2004 and September 30, 2005, $2,975 and $2,000, respectively, was outstanding under the Facility.

Letters of credit outstanding under the Facility as of December 31, 2004 and September 30, 2005 totaled $2,694 and $3,431, respectively.

In addition to the Facility, in October, 2003 the Company’s Logistix agency in the United Kingdom established an import/letter of credit facility with Hong Kong Shanghai Bank Corp. (“HSBC”) to provide short-term financing of product purchases in Asia. The total availability under this facility is 1,500 GBP. The total availability under this facility was increased from 1,000 GBP to 1,500 GBP in 2005. Under this facility HSBC may pay the agency’s vendors directly upon receipt of invoices and shipping documentation. Logistix (U.K.) in turn is obligated to repay HSBC within 120 days. As of December 31, 2004 and September 30, 2005, $1,797 and $0 were outstanding under this facility.

In connection with the acquisition of Megaprint Group, the Company assumed a mortgage loan secured by a building in the Netherlands. The mortgage loan had a 24 year term and carried an interest rate fixed at 5 percent per annum for three years from December 2002. During the quarter ended June 30, 2005, the Company repaid the remaining balance on the mortgage loan and subsequently sold the building. The Company applied the balance of the mortgage loan against monies owed to the sellers of Megaprint Group. The proceeds from the sale of the building were paid to the sellers of Megaprint Group in the third quarter of 2005 (see Note 6 — “Acquisitions”). As of December 31, 2004, the balance on the mortgage loan was 919 Euros (approximately US $1,253).

Megaprint Group had an overdraft facility of 750 Euros from ING Bank, Nederland. This facility was cancelled in the quarter ending September 30, 2005. As of December 31, 2004 and September 30, 2005, there were no amounts outstanding under this facility.

NOTE 4 — RESTRUCTURING

On February 24, 2005, the Company finalized a decision to pursue the wind down of a substantial majority all of its consumer products business, Pop Rocket. The Company’s determination is to significantly scale back this business during 2005 while exiting a substantial majority of the business permanently as soon as is feasible. In the near term, this includes restructuring the Pop Rocket division and exiting certain licenses. In connection with this decision, the Company expects to incur charges for one-time employee termination benefits and other costs totaling approximately $700 in 2005. During the three and nine months ended September 30, 2005, $40 and $672, respectively, of such costs were incurred for employee terminations completed through September 30, 2005. Such costs are recorded as a restructuring charge in the condensed consolidated statement of operations for the three and nine months ended September 30, 2005. The entire amount is attributable to the Consumer Products segment. The remaining costs are expected to be incurred and expensed throughout the remainder of 2005 for employees expected to be terminated by December 31, 2005. Of the $672 of costs incurred to date, $361 has been paid as of September 30, 2005.

In April 2005, the Company eliminated two centralized management positions as a result of a realignment of centralized resources. During the three and nine months ended September 30, 2005, $51 and $321, respectively, of such costs were incurred. Such costs are recorded as a restructuring charge in the condensed consolidated statement of operations for the three and nine months ended September 30, 2005. The entire amount is attributable to the corporate segment. Of the $321 of costs incurred to date, $178 has been paid as of September 30, 2005. The Company does not expect to incur any further costs in connection this restructuring. The remaining costs are expected to be paid by March 31, 2006.

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In September 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 expects to incur charges for one-time employee termination benefits and other costs totaling approximately $600 in 2005. During the three and nine months ended September 30, 2005, $219 of such costs were incurred. Such costs are recorded as a restructuring charge in the condensed consolidated statements of operations. The entire amount is attributable to the Marketing Services segment. All of the $219 of costs incurred to date have been paid as of September 30, 2005.

In August, the Company made the determination to close Johnson Grossfield’s Minneapolis office effective October 31, 2005. During the three months ended September 30, 2005, the Company recorded a charge of approximately $106 for one-time employee termination benefits related to the closure of the Minneapolis office. The Company expects to incur approximately $250 in additional costs during the fourth quarter of 2005. No additional costs are expected to be incurred after December 31, 2005. Such costs are recorded as a restructuring charge in the condensed consolidated statement of operations for the three and nine months ended September 30, 2005. The entire amount is attributable to the Marketing Services segment. Of the $106 of costs incurred to date, $0 has been paid as of September 30, 2005. These costs are expected to be paid by June 30, 2006.

NOTE 5 — SEGMENTS

The Company has identified two reportable segments through which it conducts its continuing operations: marketing services and consumer products. The factors for determining the reportable segments were based on the distinct nature of their operations. They are managed as separate business units because each requires and is responsible for executing a unique business strategy. The marketing services segment designs and produces promotional products used as free premiums or sold in conjunction with the purchase of other items at a retailer or quick service restaurant and provides various services such as strategic planning and research, entertainment marketing, promotion, event marketing, collaborative marketing, retail design, and environmental branding. Marketing services programs are used for marketing purposes by both the companies sponsoring the promotions and the licensors of the entertainment properties on which the promotional programs are often based. The consumer products segment designs and contracts for the manufacture of toys and other consumer products for sale to major mass market and specialty retailers, who in turn sell the products to consumers.

Earnings of industry segments and geographic areas exclude interest income, interest expense, depreciation expense, 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) before provision (benefit) for income taxes.

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Industry Segments

	As of and For the Three Months Ended September 30, 2004
	Marketing		Consumer
	Services		Products			Corporate			Total
Total revenues	$	50,717	$	7,338		$	—		$	58,055
Segment income (loss) before provision (benefit) for income taxes	$	3,726	$	(347	)	$	(4,838	)	$	(1,459	)
Provision (benefit) for income taxes		1,461		(132	)		(1,895	)		(566	)
Net income (loss)	$	2,265	$	(215	)	$	(2,943	)	$	(893	)
Fixed asset additions	$	—	$	—		$	144		$	144
Depreciation and amortization	$	89	$	—		$	453		$	542
Total assets	$	93,886	$	9,626		$	22,828		$	126,340

	As of and For the Three Months Ended September 30, 2005
	Marketing			Consumer
	Services			Products		Corporate			Total
Total revenues	$	41,754		$	8,056	$	—		$	49,810
Segment income (loss) before provision (benefit) for income taxes	$	1,375		$	436	$	(4,217	)	$	(2,406	)
Provision (benefit) for income taxes		(433	)		15		(448	)		(866	)
Net income (loss)	$	1,808		$	421	$	(3,769	)	$	(1,540	)
Fixed asset additions	$	—		$	—	$	297		$	297
Depreciation and amortization	$	99		$	—	$	456		$	555
Total assets	$	75,830		$	13,424	$	19,697		$	108,951

	As of and For the Nine Months Ended September 30, 2004
	Marketing		Consumer
	Services		Products			Corporate			Total
Total revenues	$	144,400	$	17,245		$	—		$	161,645
Segment income (loss) before provision (benefit) for income taxes	$	12,971	$	(1,186	)	$	(14,386	)	$	(2,601	)
Provision (benefit) for income taxes		5,046		(461	)		(5,597	)		(1,012	)
Net income (loss)	$	7,925	$	(725	)	$	(8,789	)	$	(1,589	)
Fixed asset additions	$	—	$	—		$	1,080		$	1,080
Depreciation and amortization	$	249	$	—		$	1,280		$	1,529
Total assets	$	93,886	$	9,626		$	22,828		$	126,340

	As of and For the Nine Months Ended September 30, 2005
	Marketing		Consumer
	Services		Products		Corporate			Total
Total revenues	$	146,064	$	19,090	$	—		$	165,154
Segment income (loss) before provision (benefit) for income taxes	$	10,471	$	1,773	$	(14,106	)	$	(1,862	)
Provision (benefit) for income taxes		3,534		598		(4,761	)		(629	)
Net income (loss)	$	6,937	$	1,175	$	(9,345	)	$	(1,233	)
Fixed asset additions	$	—	$	—	$	1,289		$	1,289
Depreciation and amortization	$	312	$	—	$	1,372		$	1,684
Total assets	$	75,830	$	13,424	$	19,697		$	108,951

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NOTE 6 — ACQUISITIONS

On February 2, 2004 (effective January 31, 2004), the Company acquired certain assets of Johnson Grossfield, Inc. (“JGI-MN”), a privately held promotional marketing services company based in Minneapolis, Minnesota. The Company financed the acquisition through its existing cash reserves. The acquisition was consummated pursuant to an Asset Purchase Agreement dated January 16, 2004 (the “Johnson Grossfield Purchase Agreement”). Under the terms of the Purchase Agreement, the Company purchased the assets of JGI-MN’s promotional agency business for approximately $4,325 in cash (net of a holdback of $250) and 35,785 shares of the Company’s Common Stock (which, based upon the January 30, 2004 closing market price of $14.80, had a value of $530), plus related transaction costs of $184 and a commitment to pay additional earnout consideration of up to $4,500 based upon future performance of the acquired business. During 2004, additional consideration was paid in the amount of $105 as a working capital adjustment. The Company also assumed the operating liabilities of the promotional agency business in connection with the acquisition. The earnout consideration is based upon the acquired business achieving targeted levels of EBITDA over the period from 2004 through 2008. The earnout payments, if required, are payable 50% in cash and 50% in shares of the Company’s Common Stock. The additional consideration, if any, will be recorded as goodwill. On April 19, 2005, the Company reached agreement with the sellers of Johnson Grossfield on the amount of earnout attributable to 2004 performance. Such earnout consideration totaled $257, of which $148 was paid in cash and the remainder payable in shares of the Company’s common stock (10,616 shares valued at $109 as of April 19, 2005). This earnout consideration was recorded as goodwill in the second quarter of 2005.

The Johnson Grossfield acquisition has been accounted for under the purchase method of accounting. The financial statements reflect the allocation of the purchase price to the acquired net assets based on their estimated fair values as of the acquisition date. The Company’s allocation of purchase price for the Johnson Grossfield acquisition, based upon estimated fair values is as follows:

Net current assets	$	2,758
Property, plant and equipment		8
Other non-current assets		7
Net current liabilities		(1,214	)
Estimated fair value, net assets acquired		1,559
Goodwill		1,449
Other intangible assets		2,393
Total purchase price	$	5,401

The other intangible assets of $2,393 are comprised of customer relationships and a non-competition agreement, and are being amortized over estimated useful lives ranging from 2 years to 12 years.

On August 9, 2005, the Company was notified by the Subway Franchisee Advertising Fund Trust (“SFAFT”) that following completion of fulfillment on Subway Restaurant’s kids meal programs by Johnson Grossfield in November 2005, the relationship between Johnson Grossfield and Subway Restaurants will be terminated. As a result, the Company recorded a charge of $3,431 for the impairment of goodwill and other intangible assets of Johnson Grossfield. Of the $3,431 impairment charge $1,449 was attributable to goodwill and $1,982 was attributable to other intangible assets. The carrying value remaining of the goodwill and other intangible assets as of September 30, 2005 was $0. The impairment of assets charge was recorded in the condensed consolidated statement of operations for the three and nine months ended September 30, 2005.

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On November 10, 2004, the Company acquired all of the outstanding capital stock of Megaprint Group Limited (“Megaprint Group”), a privately held creative promotions agency headquartered in the United Kingdom. The Company financed the Megaprint Group acquisition through short-term debt. The Company paid 1,824 GBP (approximately $3,388) in cash (net of a hold back for working capital adjustments of 180 GBP), plus related transaction costs of 305 GBP (approximately $566). Under the terms of the Stock Purchase Agreement, the Company is committed to pay, subject to offset for any shortfall in the target level of net working capital at December 31, 2004, a minimum of 850 GBP and up to a maximum of 1,300 GBP in 2005 based on the performance of Megaprint Group for the year ended December 31, 2004 (“2004 Earnout Payment”). The Company has accrued a liability for the minimum payment of 850 GBP as purchase price as of the acquisition date. The Company is also committed to pay additional consideration up to a maximum of 2,450 GBP based on future performance through 2009. The additional consideration is based upon the business achieving targeted levels of margin after direct overhead (“MADO”) over the period from 2005 through 2009. During the nine months ended September 30, 2005, the preliminary allocation of the purchase price was adjusted to revise the estimated value of accrued liabilities ($706 increase). During the second quarter of 2005, an additional 256 GBP (approximately $461) was paid to the sellers of Megaprint Group for a working capital adjustment. The additional consideration was recorded as goodwill in the accompanying condensed consolidated balance sheet. The Company’s preliminary allocation of purchase price for the acquisition, based upon estimated fair values is as follows:

Net current assets	$	8,512
Property, plant and equipment		1,265
Net current liabilities		(7,995	)
Estimated fair value, net assets acquired		1,782
Goodwill		3,887
Other intangible assets		338
Total purchase price	$	6,007

Included in net current liabilities for the Megaprint Group was a mortgage loan for a building in the Netherlands (see Note 3). The balance of the mortgage loan as of the acquisition date totaled approximately 900 Euros (approximately $1,200). The building was recorded under fixed assets and was recorded at the same value as the balance of the mortgage loan. The building and mortgage loan were held in trust by the Megaprint Group on behalf of its former shareholders (the “Sellers”). In June 2005, the Company repaid the mortgage loan. The amount repaid of 900 Euros (approximately $1,090) was applied against monies owed to the Sellers for the 2004 Earnout Payment. As a result, in June 2005, the Company paid the sellers 199 GBP (approximately $360) of the 850 GBP owed for the 2004 Earnout Payment. Subsequent to the repayment of the mortgage loan, the building was sold in June 2005 for 747 Euros (approximately $939). The proceeds from the sale were paid to the Sellers in the third quarter of 2005.

The other intangible assets of $338 are comprised of sales order backlog and customer relationships, and are being amortized over estimated useful lives ranging from 7 months to 15 years.

The following selected unaudited pro forma consolidated results of operations are presented as if the Johnson Grossfield and Megaprint Group acquisitions had occurred as of the beginning of the period immediately preceding the period of acquisition after giving effect to certain adjustments for the amortization of intangibles, reduced interest income and related income tax effects. The pro forma data is for informational purposes only and does not necessarily reflect the results of operations had the businesses operated as one during the period. No effect has been given for synergies, if any, that may have been realized through the acquisitions.

	Three Months Ended			Nine Months Ended
	September 30,			September 30,
	2004			2004
Pro forma revenues	$	61,381		$	171,554
Pro forma net loss	$	(762	)	$	(1,363	)
Pro forma basic loss per share	$	(0.20	)	$	(0.43	)
Pro forma diluted loss per share	$	(0.20	)	$	(0.43	)

Refer to Note 2 for further discussion of the method of computation of earnings per share.

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NOTE 7 — MANDATORILY REDEEMABLE 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.

On March 19, 2004, the Company entered into a Warrant Exchange Agreement with Crown whereby Crown received new warrants to purchase an aggregate of 916,666 shares of Common Stock (“New Warrants”) in exchange for cancellation of the existing Warrants to purchase shares of Series B Stock and Series C Stock (which, upon issuance, would also have been convertible into 916,666 shares of Common Stock). The New Warrants consist of warrants to purchase 750,000 shares and 166,666 shares of Common Stock at exercise prices of $16.00 and $18.00 per common share, respectively. Of each tranche, 47.6% expire on March 29, 2010 and 52.4% expire on June 20, 2010. As a result of the exchange transaction, Crown received an extension of time in which to exercise its right to purchase additional equity in the Company, and the Company obtained an elimination of the preferred rights and preferences as well as the preferred dividend associated with the Series B Stock and Series C Stock. The exchange was recorded as a reduction to preferred stock of $531 and an increase to additional paid-in-capital of $487, net of transaction costs of $44. The exchange was approved by an independent committee of the Board, which relied upon a fairness opinion provided by an outside advisory firm.

On December 30, 2004, the Company entered into an Exchange Agreement with Crown whereby Crown received 25,000 shares of Series AA mandatorily redeemable senior cumulative preferred stock, par value $0.001 per share, (the “Series AA Stock”) with a conversion price of $14.75 per common share, in exchange for 25,000 shares of Series A Stock. The Series AA Stock has substantially the same rights and preferences as the Series A Stock, but does not participate in cash dividends paid on Common Stock. The exchange was effected in response to the impact of EITF 03-6 on reported earnings. 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.

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. Crown is also entitled to receive a quarterly dividend equal to 6% of the Liquidation Preference per share outstanding, payable in cash. The dividends for the quarter ended September 30, 2005 totaled $375 and were paid in October 2005 and recorded in accounts payable in the accompanying condensed consolidated balance sheet as of September 30, 2005.

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 condensed consolidated balance sheets at its Liquidation Preference net of issuance costs. The issuance costs total approximately $1,951.

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NOTE 8—COMMITMENTS AND CONTINGENCIES

Operating Leases
The Company has operating leases for its properties and equipment, which expire at various dates through 2014.

Future minimum lease payments under non-cancelable operating leases as of September 30, 2005 are as follows:

Year
2005 (remainder of)	$	1,234
2006		4,801
2007		4,472
2008		3,957
2009		3,791
Thereafter		2,699
Total	$	20,954

Aggregate rental expenses for operating leases were $1,012 and $945 for the three months ended September 30, 2004 and 2005, respectively. Aggregate rental expenses for operating leases were $2,991 and $3,024 for the nine months ended September 30, 2004 and 2005, respectively.

Guaranteed Royalties
For the three months ended September 30, 2004 and 2005, the Company incurred $1,067 and $1,165, respectively, in royalty expense. For the nine months ended September 30, 2004 and 2005, the Company incurred $2,404 and $3,063, respectively, in royalty expense. License agreements for certain copyrights and trademarks require minimum guaranteed royalty payments over the respective terms of the licenses. As of September 30, 2005, the Company has committed to pay total minimum guaranteed royalties as follows:

Year
2005 (remainder of)	$	1,488
2006		1,121
2007		330
Total	$	2,939

License agreements for certain copyrights and trademarks in the Consumer Products segment require minimum commitments for advertising over the respective terms of the licenses. The commitment for advertising expenditures is determined as a percentage of the sales (typically up to 10 percent) of certain licensed properties over the terms of their respective agreements.

See Note 2 — “Basis of Presentation and Summary of Significant Accounting Policies” — Royalties.

Employment Agreements
The Company has employment agreements with key executives. Guaranteed compensation under these agreements as of September 30, 2005 are as follows:

Year
2005 (remainder of)	$	552
2006		1,015
2007		466
2008		200
2009		200
Thereafter		1,600
Total	$	4,033

On May 19, 2005, the Company announced the resignation of Donald A. Kurz as President and Chief Executive Officer effective May 13, 2005. In connection with Mr. Kurz’ departure, the Company entered into a separation agreement and mutual release with Mr. Kurz on May 18, 2005. The material terms of the separation agreement and mutual release include a continuation of his current base compensation of $635 per annum through December 31, 2006, continuation of substantially all of his current health and welfare benefits and perquisites through December 31, 2006, and a one time payment of $100 upon signing. The agreement also provides that

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Mr. Kurz will provide consulting services for a period of six months to assist with transitional matters without additional compensation. Mr. Kurz is bound by certain restrictive covenants through December 31, 2006.

Subsequent to September 30, 2005, the Compant entered into employment agreements with Kim H. Thomsen and Jonathan Banks pursuant to which they will serve as Co-Chief Executive Officers of Equity Marketing. The new employment agreements expires December 31, 2007 and provides for a continuation of Ms. Thomsen’s and Mr. Banks’ 2005 base salary levels of $364 and $300, respectively, with minimum annual cost of living increases in 2006 and 2007. The employment agreements are not reflected in the table above, but the table does reflect the previous employment agreement with Kim H. Thomsen. (See Note 9—Subsequent Events)

NOTE 9—SUBSEQUENT EVENTS

On October 3, 2005, the Company and Equity Marketing (a wholly-owned subsidiary of the Company) entered into employment agreements with Kim H. Thomsen and Jonathan Banks pursuant to which they will serve as Co-Chief Executive Officers of Equity Marketing. Ms. Thomsen previously served as President and Chief Creative Officer of the Company. Ms. Thomsen’s new employment agreement supersedes her previously existing employment agreement with the Company, pursuant to which she had the right to retire from full-time service and serve as a part-time consultant beginning January 1, 2006. Her new employment agreement is intended to provide for a tax favorable restructuring of her deferred compensation annuity with no significant change in expense to the Company.

The employment agreements provide for a continuation of Ms. Thomsen’s and Mr. Banks’ 2005 base salary levels of $364 and $300, respectively, with minimum annual cost of living increases in 2006 and 2007. In addition, the employment agreements provide for a formulaic annual bonus pool, to be equally shared by Ms. Thomsen and Mr. Banks, based upon the achievement of specified levels of earnings before interest, taxes, depreciation and amortization (“EBITDA”) of Equity Marketing over certain thresholds. Based upon the Company’s expected range of EBITDA growth for the Equity Marketing business over the 2005 to 2007 employment term, the Company currently anticipates that the annual bonus opportunity for each executive for superior performance will range from approximately 95% to 130% of base salary. These annual bonuses are payable 25% in shares of the Company’s Common Stock and 25% in cash, with the remainder payable in either shares or cash at the election of the executive.

In lieu of annual equity based compensation, the employment agreements provide for the grant to each executive of 200,000 contingent stock appreciation rights payable, if at all, in cash (“SARs”). The SARs are payable only if Equity Marketing experiences positive EBITDA growth over a 2004 base year and only upon a change of control of the Company occurring during the employment term or, provided that the executive continues to serve on the Equity Marketing board of directors and comply with certain restrictive covenants, the five year period following the end of the employment term.

The employment agreements provide for post-employment severance for each executive determined by the EBITDA performance of the Equity Marketing business in 2008 using the same formula as the annual bonus opportunity during the employment term. The employment agreements also contain three-year post-employment restrictive covenants.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Except as expressly indicated or unless the context otherwise requires, as used herein, “EMAK,” the “Company,” “we,” “our,” or “us,” means EMAK Worldwide, Inc., a Delaware corporation and its subsidiaries. Unless otherwise specifically indicated, all dollar amounts herein are expressed in thousands.

Organization and Business

EMAK Worldwide, Inc., a Delaware corporation and subsidiaries, is a leading global integrated marketing services company. EMAK has expertise in the areas of: strategic planning and research, entertainment marketing, design and manufacturing of custom promotional products, promotion, event marketing, collaborative marketing, retail design and environmental branding. Our clients include Burger King, Kellogg’s, Frito Lay, Kohl’s, Macy’s, Kraft, Procter & Gamble, and, Miller Brewing Company among others. EMAK is headquartered in Los Angeles, with operations in Chicago, New York, Ontario (California), Dublin, Frankfurt, London, Paris, The Netherlands, Hong Kong and Shanghai. The Company primarily sells to customers in the United States and Europe.

Our Equity Marketing agency services our largest client, Burger King. Equity Marketing serves as Burger King’s primary creative and manufacturing agency for its Kids Meals business. In addition, in the second half of 2004, Equity Marketing expanded its role with Burger King and is now the agency of record for promotional categories outside of the kids segment, including Adult Promotions and Youth & Family Promotions.

In July 2001, EMAK acquired Logistix (U.K.), gaining a presence in Europe with broad-based strategic client relationships, including research, new concept development, licensing guidance and the development of premium-based promotions. In January 2005, we officially expanded the Logistix brand to the U.S., with the establishment of our Logistix (U.S.) agency in Chicago.

In July 2002, EMAK acquired Upshot, a strategic marketing agency with expertise in promotional, event and collaborative marketing, retail design and environmental branding, thereby providing us with a broader range of services and the ability to develop a more diverse client base.

In September 2003, EMAK acquired SCI Promotion, establishing us as a leading provider of gift-with-purchase and purchase-with-purchase promotional programs to the retail department store industry.

In February 2004, EMAK acquired Johnson Grossfield.

In November 2004, EMAK acquired Megaprint Group, a pan-European market leader in the design and production of innovative paper and board engineered (2-D) premiums, providing EMAK’s family of companies with an important complementary service offering and expanding our client roster and geographic presence in Europe.

Overview

Revenues for the third quarter of 2005 decreased $8,245 to $49,810 as compared to $58,055 recorded in the prior year as a result of a 17.7% decrease in revenues in our Marketing Services segment partially offset by a 9.8% increase in Consumer Products revenues. The decrease in Marketing Services revenues is primarily attributable to our Logistix (U.K.) agency which experienced a considerable decline in revenues from the third quarter of 2004. The agency won an exceptionally high percentage of promotional programs from its largest client in 2004, and is experiencing a lower win rate this year compared to the prior year. In addition, the decline in revenues is attributable to reduced revenues from certain low margin logistical services that we decided not to pursue this year. Excluding the impact of these low margin logistical services, Marketing Services revenues decreased by 14.1% during the third quarter of 2005 as compared to 2004. Despite the decrease in revenues, a significantly improved gross margin percentage resulted in higher gross margin dollars than in 2004. Gross profit in the Marketing Services segment increased from the prior year due to a deferral of higher margin, fee based service revenues from the second quarter to the third quarter of 2005. Gross profit in the Consumer Products segment improved due to an improved sales mix.

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Our third quarter 2005 performance was negatively impacted by an impairment charge of $3,431 for the write-off the remaining balance of goodwill and other intangibles related to the Johnson Grossfield agency as a result of the loss of that agency’s primary client in August 2005. As a result of this loss, we decided to close the Johnson Grossfield office. Also, during the third quarter, we recorded restructuring charges totaling $416 related to staff reductions at Logistix in the U.K., the closure of the Johnson Grossfield office in Minneapolis, the elimination of a centralized management position and the continued wind-down of Pop Rocket. The costs related to the restructuring charge, however, were partially offset by a gain of $399 for the reversal of a portion of a charge taken in the fourth quarter of 2004 for minimum royalty guarantee shortfalls on several consumer products licenses. The reversal is due to better than anticipated performance of the Scooby-Doo toy line.

We recorded a net loss of $1,540 for the third quarter of 2005 compared to a net loss of $893 in the prior year quarter. The higher net loss during the current period was attributable to the impairment charge.

During the third quarter of 2005, we continued to experience positive trends at Equity Marketing and Upshot in our Marketing Services segment:

• Our Equity Marketing agency, performed well during the quarter, despite a decrease in revenues as compared to the prior year quarter resulting from certain low margin logistical services that we decided not to pursue this year. During the third quarter we executed three domestic premium programs and three international premium programs. We are seeing the continuation of a trend of higher unit volumes for domestic as well as international programs as a result of recent improvements in Burger King system sales of Kids Meals.

• The performance of our Upshot agency continues to improve as a result of significant new business wins earlier in the year. In March 2005, Upshot was one of two agencies of record selected for the promotional business of Miller Brewing Company. In its new role, Upshot began providing promotional work for most of Miller’s beer brand portfolio including trademark brands such as Miller Lite and Miller Genuine Draft in the U.S., beginning in April 2005.

On the other hand, the third quarter performance of our SCI Promotion agency decreased relative to the third quarter of 2004. Despite the addition of new clients such as Kraft, SCI Promotion experienced a lower win rate of third quarter 2005 promotional programs. While the agency is expected to have a better year than 2004, SCI Promotion is expected to under-perform relative to plan.

As discussed above, our Logistix agency in the U.K. experienced a decrease in revenues compared to the third quarter of 2004, despite the addition of revenues from Megaprint Group acquisition. The agency is experiencing a lower win rate of promotional programs from its largest client as well as a scale back of previously awarded programs.

In light of these trends and the loss of Subway® as a client, we expect that EMAK’s 2005 revenues will be marginally lower than 2004. Sequentially, we expect that fourth quarter 2005 revenues will be higher than the third quarter, in-line with seasonal norms, but down compared to 2004.

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Results of Operations

The following table sets forth, for the periods indicated, the Company’s operating results as a percentage of total revenues:

	Three Months						Nine Months
	Ended September 30,						Ended September 30,
	2004			2005			2004			2005
Revenues		100.0	%		100.0	%		100.0	%		100.0	%
Cost of sales		78.6			70.8			75.6			73.6
Minimum royalty shortfall gain		—			(0.8	)		—			(1.6	)
Gross profit		21.4			30.0			24.4			28.0
Operating expenses:
Salaries, wages and benefits		13.8			16.4			14.3			15.8
Selling, general and administrative		10.4			11.2			11.2			10.4
Integration costs		—			0.0			0.1			0.0
Loss on Chicago lease		—			—			0.2			—
Restructuring charge		—			0.8			0.1			0.8
Impairment of assets		—			6.9			—			2.1
ERP reimplementation costs		—			0.0			—			0.1
Total operating expenses		24.2			35.3			25.9			29.2
Loss from operations		(2.8	)		(5.3	)		(1.5	)		(1.2	)
Other income (expense), net		0.3			0.5			(0.1	)		0.1
Loss before benefit for income taxes		(2.5	)		(4.8	)		(1.6	)		(1.1	)
Benefit for income taxes		(1.0	)		(1.7	)		(0.6	)		(0.4	)
Net loss		(1.5	)%		(3.1	)%		(1.0	)%		(0.7	)%

Three Months Ended September 30, 2005 Compared to Three Months Ended September 30, 2004 (In Thousands):

Revenues

Revenues for the three months ended September 30, 2005 decreased $8,245, or 14.2%, to $49,810 from $58,055 in the comparable period in 2004. Marketing Services revenues decreased $8,963, or 17.7%, to $41,754 primarily attributable to lower revenues at our Logistix (U.K.) agency and reduced revenues at our Equity Marketing agency for certain low margin logistical services that we decided not to pursue this year. The lower Marketing Services revenues are also attributable to lower revenues at our SCI Promotion agency as a result of a lower program win rate for the third quarter of 2005 as compared to the third quarter of 2004. The decrease in Logistix (U.K.) revenues is the result of fewer programs awarded to this agency from their largest client Kellogg’s in the third quarter 2005 compared to the same period in 2004. The decrease in revenues from Logistix (U.K.), Equity Marketing and SCI Promotion was partially offset by an increase in the Upshot revenues due to an increase in promotional work for Miller. Net foreign currency translation had an unfavorable impact to revenues of approximately $76 for Logistix (U.K.) versus the prior year period average exchange rates. Results for the third quarter of 2004 exclude Megaprint Group (acquired November 10, 2004).

Our Consumer Products segment revenues increased $718, or 9.8%, to $8,056. The increase is primarily attributable to the introduction of Disney’s JoJo’s Circus™ in 2005 and continued revenue growth in Baby Einstein™and Scooby- Doo™ product lines, partially offset by a decline in revenues for Kim Possible™. Our third quarter 2005 Consumer Product revenues were primarily comprised of Scooby-Doo™, Baby Einstein™, Crayola® and JoJo’s Circus™ product. In 2005, we began distributing the first toy products based on JoJo’s Circus™, the popular Disney series produced in stop-motion animation.

Cost of sales and gross profit

Cost of sales decreased $10,384 to $35,261 (70.8% of revenues) for the three months ended September 30, 2005 from $45,645 (78.6% of revenues) in the comparable period in 2004 primarily due to lower sales volume in 2005.

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Our gross margin percentage increased to 30.0% for the three months ended September 30, 2005 from 21.4% in the comparable period for 2004. This increase is the result of the deferral of some higher margin fee-based revenues at Equity Marketing and Upshot to the third quarter, and an improved sales mix since we have been phasing out the low margin logistical services for our largest client. In addition, there was a gain on the partial reversal of a previously recorded minimum royalty guarantee shortfall charge recorded in the fourth quarter of 2004. The reversal is due to Scooby-Doo™ revenues exceeding our initial estimates. Excluding the impact of the gain on the reversal of previously recorded minimum royalty guarantee shortfalls, the gross profit percentage increased to 29.2% from 21.4% in 2004.

The gross profit percentage for our Marketing Services segment for the three months ended September 30, 2005 increased to 30.3% compared to 21.8% for the comparable period in 2004. This increase is attributable to the deferral of some higher margin fee-based revenues at Equity Marketing and Upshot to the third quarter, and an improved sales mix since we have been phasing out the low margin logistical services for our largest client.

Excluding the impact of the gain on the partial reversal of a previously recorded minimum royalty guarantee shortfall charge, the gross profit percentage in our Consumer Products segment increased to 23.6% from 18.5% in 2004. This increase is the result of a sales mix of higher margin Baby Einstein™ and JoJo’s Circus™ product.

Salaries, wages and benefits

Salaries, wages and benefits increased $161, or 2.0%, to $8,147 (16.4% of revenues) for the three months ended September 30, 2005 from $7,986 (13.8% of revenues) in the comparable period for 2004. This increase was primarily attributable to annual employee merit pay increases, the addition of approximately 27 employees from the Megaprint Group acquisition, an increase in recruiting costs and signing bonuses for two senior executives, partially offset by headcount reductions at Logistix (U.K.), in our Consumer Products segment as a result of the wind-down of the Pop Rocket business and by the elimination of certain centralized management positions.

Selling, general and administrative expenses

Selling, general and administrative expenses decreased $523, or 8.6%, to $5,564 (11.2% of revenues) for the three months ended September 30, 2005 from $6,087 (10.5% of revenues) in the comparable period for 2004. The decrease is attributable to a reduction in freight costs, lower creative development and marketing costs as a result of the wind-down of Pop Rocket, and a reduction in travel costs, partially offset by additional operating expenses resulting from the inclusion of Megaprint Group in the current year quarter.

Integration costs

We recorded integration costs of $8 (0.0% of revenues) for the three months ended September 30, 2005 compared to $0 in 2004. These are primarily travel, training and consulting costs directly related to the integration of Megaprint Group.

Restructuring charge (gain)

We recorded a restructuring charge of $416 (0.8% of revenues) for the three months ended September 30, 2005 compared to $(25) (0.0% of revenues) for the same period in 2004. This charge consists primarily of severance expense and other termination costs related to staff reductions at Logistix (U.K), to the closure of the Johnson Grossfield office in Minneapolis, and resulting from our decision to wind down substantially all of our consumer products business, Pop Rocket. See “Restructuring” below. The gain in 2004 represents a reversal of a portion of the 2003 restructuring charge related to the severance for workforce reductions at Upshot.

Impairment of assets

We recorded a charge for the impairment of assets of $3,431 (6.9% of revenues) for the three months ended September 30, 2005. This charge relates to impairment of goodwill and other intangible assets of Johnson Grossfield as a result of the loss of the Johnson Grossfield’s primary client in August 2005.

ERP reimplementation costs

We recorded enterprise resource planning (“ERP”) reimplementation costs of $22 (0.0% of revenues) for the three months ended September 30, 2005. This represents consulting costs which were not capitalized into fixed assets. The costs were incurred in connection with a significant upgrade and reimplementation of the Company’s ERP software which is designed to enhance management information, financial reporting, inventory management, cost evaluation and controls while assisting in compliance with the Sarbanes-Oxley Act of 2002.

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Other income

Other income increased $55 to $234 for the three months ended September 30, 2005 from $179 in the comparable period for 2004. The increase is primarily due to foreign currency gains as a result of the strengthening of the U.S. dollar relative to the British pound.

Benefit for income taxes

The effective tax rate for the three months ended September 30, 2005 was 36.0% compared to 38.8% for the same period in 2004. The decrease in the effective tax rate is the result of an increase in the relative mix of our loss being generated in the United Kingdom, which has a lower tax rate than the United States, partially offset by an increase in our state income tax rate as a result of changes in business operations in the United States.

Net loss

Net loss increased $647 to $(1,540) ((3.1)% of revenues) in 2005 from a $(893) ((1.5)% of revenues) in 2004 primarily due to the impairment of assets, restructuring charge and increased salaries, wages and benefits. This was partially offset by an increase in gross margins in 2005 as compared to 2004 and the gain on the reversal of a portion of the minimum royalty guarantee shortfalls.

Nine Months Ended September 30, 2005 Compared to Nine Months Ended September 30, 2004 (In Thousands):

Revenues

Revenues for the nine months ended September 30, 2005 increased $3,509, or 2.2%, to $165,154 from $161,645 in the comparable period in 2004. Marketing Services revenues increased $1,664, or 1.2%, to $146,064, as a result of revenue growth in our SCI Promotion and Equity Marketing agencies, and as a result of the Megaprint Group acquisition, partially offset by decreased revenues for our Logistix (U.K.) agency. Growth in revenues for SCI Promotion are attributable to new client wins as well as programs that were deferred from the fourth quarter of 2004 into the first quarter of 2005. Revenues for Equity Marketing increased as the volume of units for Burger King domestic promotional programs were higher in the nine months of 2005 compared to the same period in 2004. Burger King revenues grew during the nine months as compared to the prior year quarter despite reduced revenues for certain low margin logistical services that we decided not to pursue this year. The increase in revenues from Equity Marketing and SCI Promotion was partially offset by a decrease in Logistix (U.K.) revenues. Net foreign currency translation impact contributed approximately $538 to revenues for Logistix (U.K.) versus the prior year period average exchange rates. Results for the nine months ended September 30, 2004 include eight months of revenues for Johnson Grossfield (acquired February 2, 2004) and exclude Megaprint Group (acquired November 10, 2004).

Consumer Product revenues increased $1,845, or 10.7%, to $19,090. The increase is primarily attributable to the introduction of Disney’s JoJo’s Circus™ in 2005 and continued revenue growth of Baby Einstein™and Crayola® product lines, partially offset by a decline in sales of Scooby-Doo™ product. Our nine months of 2005 Consumer Product revenues were primarily comprised of Crayola®, Scooby-Doo™, Baby Einstein™, and JoJo’s Circus™ product. In 2005, we began distributing the first toy products based on JoJo’s Circus™, the popular Disney series produced in stop-motion animation. The continued growth in our Crayola® line of bath toys was attributable to an expanded product line and expanded distribution channels.

Cost of sales and gross profit

Cost of sales decreased $636 to $121,596 (73.6% of revenues) for the nine months ended September 30, 2005 from $122,232 (75.6% of revenues) in the comparable period in 2005 primarily due to the lower cost fee-based revenues in 2005.

The gross margin percentage increased to 28.0% for the nine months ended September 30, 2005 from 24.4% in the comparable period for 2004. This increase is primarily the result of a gain on the partial reversal of a previously recorded minimum royalty guarantee shortfall charge in the fourth quarter of 2004. The reversal is due to an agreement reached with one of our major licensors to exit certain licenses early in exchange for a reduction in overall royalty guarantee requirements. Excluding the impact of the gain on the reversal of previously recorded minimum royalty guarantee shortfalls, the gross profit percentage decreased to 26.4% from 24.4% in 2004.

The gross profit percentage for Marketing Services for the nine months ended September 30, 2005 was 26.9% compared to 24.5% for the comparable period in 2004. This increase is attributable to higher margins from our Equity Marketing agency compared to the same period in 2004 partially offset by a decrease from our Logistix and SCI agencies.

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Excluding the impact of a gain on the partial reversal of a previously recorded minimum royalty guarantee shortfall charge, the gross profit percentage in Consumer Products decreased to 22.7% from 23.0% in 2004. This decrease is primarily the result of a highly competitive retail pricing environment and the wind down of the Pop Rocket business, partially offset by a sales mix of higher margin Baby Einstein™and JoJo’s Circus™ product.

Salaries, wages and benefits

Salaries, wages and benefits increased $2,971, or 12.8%, to $26,134 (15.8% of revenues) for the nine months ended September 30, 2005 from $23,163 (14.3% of revenues) in the comparable period for 2004. This increase was primarily attributable to costs related to the departure of the Company’s CEO ($1,350), annual employee merit pay increases, additional compensation expense resulting from grants of restricted stock units in the second and fourth quarters of 2004, an increase in recruiting costs and the addition of approximately 34 employees from the Johnson Grossfield and Megaprint Group acquisitions.

Selling, general and administrative expenses

Selling, general and administrative expenses decreased $951, or 5.2%, to $17,192 (10.4% of revenues) for the nine months ended September 30, 2005 from $18,143 (11.2% of revenues) in the comparable period for 2004. The decrease is attributable to a reduction in freight, creative development and marketing costs, partially offset by additional operating expenses resulting from the inclusion of the Johnson Grossfield and Megaprint Group businesses in the current year quarter and by increased commissions resulting from higher revenues.

Integration costs

We recorded integration costs of $76 (0.0% of revenues) for the nine months ended September 30, 2005 compared to $136 (0.1% of revenues) for the same period in 2004. These are primarily travel, training and consulting costs directly related to the integration of Megaprint Group. The costs in 2004 are primarily travel costs directly related to the integration of SCI Promotion and Johnson Grossfield.

Restructuring charge

We recorded a restructuring charge of $1,318 (0.8% of revenues) for the nine months ended September 30, 2005 compared to $80 (0.0% of revenues) for the same period in 2004. This charge consists primarily of severance expense and other termination costs resulting from our decision to wind down substantially all of our consumer products business, Pop Rocket, from staff reductions at Logistix (U.K.), and from the closure of the Johnson Grossfield office in Minneapolis. See “Restructuring” below. The costs in 2004 are associated with the realignment of centralized resources in our Marketing Services business, partially offset by a reversal of a portion of the 2003 restructuring charge related to the severance for workforce reductions at Upshot.

Impairment of assets

We recorded a charge for the impairment of assets of $3,431 (2.1% of revenues) for the nine months ended September 30, 2005. This charge relates impairment of goodwill and other intangible assets of Johnson Grossfield as a result of the loss of the agency’s primary client in August 2005.

ERP reimplementation costs

We recorded enterprise resource planning (“ERP”) reimplementation costs of $124 (0.1% of revenues) for the nine months ended September 30, 2005. This represents consulting costs which were not capitalized into fixed assets. The costs were incurred in connection with a significant upgrade and reimplementation of the Company’s ERP software which is designed to enhance management information, financial reporting, inventory management, cost evaluation and controls while assisting in compliance with the Sarbanes-Oxley Act of 2002.

Other income (expense)

Other income increased $312 to $131 for the nine months ended September 30, 2005 from $(181) in the comparable period for 2004. The increase is primarily due to foreign currency gains as a result of the strengthening of the U.S. dollar relative to the British pound. This was partially offset by an increase in interest expense relating to increased short-term borrowings compared to the same period in 2004.

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Benefit for income taxes

The effective tax rate for the nine months ended September 30, 2005 was 33.8% compared to 38.9% for the same period in 2004. The decrease in the effective tax rate is the result of an increase in the relative mix of losses being generated in the United Kingdom, which has a lower tax rate than the United States, partially offset by an increase in our state income tax rate as a result of changes in business operations in the United States.

Net loss

Net loss decreased $356 to a net loss of $(1,233) ((0.7)% of revenues) in 2005 from a net loss of $(1,589) ((1.0)% of revenues) in 2004. This is primarily due to the impairment of assets, the restructuring charge and increased salaries, wages and benefits. This was partially offset by an increase in gross margins in 2005 as compared to 2004 and the gain on the reversal of a portion of the minimum royalty guarantee shortfalls.

Financial Condition and Liquidity

At September 30, 2005, cash and cash equivalents were $4,909, compared to $4,406 as of December 31, 2004. The increase in cash and cash equivalents was attributable to cash flows generated from operating activities.

As of September 30, 2005, working capital was $18,714 compared to $17,934 at December 31, 2004. Cash provided by operations for the nine months ended September 30, 2005 were $7,914 compared to cash used of $5,638 in the prior year. Cash flows provided by operations in the nine months ended September 30, 2005 were primarily the result of the collections of accounts receivable from large fourth quarter 2004 promotional programs. Cash flows used in investing activities for the nine months ended September 30, 2005 were $2,278 compared to $5,674 in the prior year. This decrease is primarily the result of the acquisition of Johnson Grossfield in the nine months ending September 30, 2004 and the sale in 2005 of a building in the Netherlands that was acquired in connection with the acquisition of Megaprint Group, partially offset by the payment of additional consideration in 2005 in connection with the 2004 acquisition of the Megaprint Group. Cash flows used in financing activities for the nine months ended September 30, 2005 were $5,035 compared to cash provided of $65 in the prior year primarily as a result of the repayment of short-term borrowings used to finance the purchase of the Megaprint Group and the repayment of bank advances at Logistix (U.K.).

As of September 30, 2005, our net accounts receivable decreased $15,778 to $31,402 from $47,180 at December 31, 2004. Due to the seasonal nature of our business, the fourth quarter tends to be the highest volume quarter of the year resulting in our highest accounts receivable levels each year.

As of September 30, 2005, inventories decreased $2,234 to $16,529 from $18,763 at December 31, 2004. This decrease is attributable to shipments of promotional products in the Marketing Services segment related to first quarter 2005 programs. This decrease is also attributable to reduced inventory levels in the Consumer Products segment as a result of the wind down of Pop Rocket. Marketing Services inventories represent 51% and 65% of total inventories as of September 30, 2005 and December 31, 2004, respectively. Promotional product inventory used in Marketing Services generally has lower risk than Consumer Product inventory, as it usually represents product made to order.

As of September 30, 2005, short-term debt decreased $4,025 to $2,000 from $6,025 at December 31, 2004. This decrease is associated with the repayment of short-term borrowings used to finance the purchase of Megaprint Group and the reduction of bank advances at Logistix (U.K.).

As of September 30, 2005, accounts payable decreased $7,005 to $23,991 from $30,996 at December 31, 2004. This decrease was attributable to the payment of liabilities related to fourth quarter 2004 promotional programs. Due to the seasonal nature of our business, the fourth quarter tends to be the highest volume quarter of the year.

As of September 30, 2005, accrued liabilities decreased $7,241 to $13,619 from $20,860 at December 31, 2004. This decrease is primarily attributable to the payment of administrative fees collected from distribution companies during the fourth quarter of 2004 on behalf of promotional customers, as well as the payment of royalties and commissions on fourth quarter 2004 revenues.

As of the date hereof, we believe that cash from operations, cash on hand at September 30, 2005 and our credit facility will be sufficient to fund our working capital needs for at least the next twelve months. The statements set forth herein are forward-looking and actual results may differ materially.

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Future minimum annual commitments for guaranteed minimum royalty payments under license agreements, non-cancelable operating leases and employment agreements as of September 30, 2005 are as follows:

	2005		2006		2007		2008		2009		Thereafter		Total
Operating Leases	$	1,234	$	4,801	$	4,472	$	3,957	$	3,791	$	2,699	$	20,954
Guaranteed Royalties		1,488		1,121		330		—		—		—		2,939
Employment Agreements		552		1,015		466		200		200		1,600		4,033
Total	$	3,274	$	6,937	$	5,268	$	4,157	$	3,991	$	4,299	$	27,926

Subsequent to September 30, 2005, we entered into employment agreements with Kim H. Thomsen and Jonathan Banks pursuant to which they will serve as Co-Chief Executive Officers of Equity Marketing. The new employment agreements expires December 31, 2007 and provides for a continuation of Ms. Thomsen’s and Mr. Banks’ 2005 base salary levels of $364 and $300, respectively, with minimum annual cost of living increases in 2006 and 2007. The employment agreements are not reflected in the table above, but the table does reflect the previous employment agreement with Kim H. Thomsen. (See Subsequent Events)

We had no material commitments for capital expenditures at September 30, 2005. Letters of credit outstanding as of December 31, 2004 and September 30, 2005 totaled $2,694 and $3,431, respectively.

Restructuring

On February 24, 2005, we finalized a decision to pursue the wind down of a substantial majority of our consumer products business, Pop Rocket. Our determination is to significantly scale back this business during 2005 while exiting a substantial majority of the business permanently as soon as is feasible. In the near term, this includes restructuring the Pop Rocket division and exiting certain licenses. In connection with this decision, we expect to incur charges for one-time employee termination benefits and other costs totaling approximately $700 in 2005. During the three and nine months ended September 30, 2005, $40 and $672, respectively, of such costs were incurred for employee terminations completed through September 30, 2005. Such costs are recorded as a restructuring charge in the condensed consolidated statement of operations for the three and nine months ended September 30, 2005. The entire amount is attributable to our Consumer Products segment. The remaining costs are expected to be incurred and expensed throughout the remainder of 2005 for employees expected to be terminated by December 31, 2005. Of the $672 of costs incurred to date, $361 has been paid as of September 30, 2005.

In April 2005, we eliminated two centralized management positions as a result of a realignment of centralized resources. During the three and nine months ended September 30, 2005, $51 and $321, respectively, of such costs were incurred. Such costs are recorded as a restructuring charge in the condensed consolidated statement of operations for the three and nine months ended September 30, 2005. The entire amount is attributable to the corporate segment. Of the $321 of costs incurred to date, $178 has been paid as of September 30, 2005. We do not expect to incur any further costs in connection with this restructuring. The remaining costs are expected to be paid by March 31, 2006.

In September 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 expect to incur charges for one-time employee termination benefits and other costs totaling approximately $600 in 2005. During the three and nine months ended September 30, 2005, $219 of such costs were incurred. Such costs are recorded as a restructuring charge in the condensed consolidated statements of operations. The entire amount is attributable to the Marketing Services segment. All of the $219 of costs incurred to date have been paid as of September 30, 2005.

In August, we made the determination to close Johnson Grossfield’s Minneapolis office effective October 31, 2005. During the three months ended September 30, 2005, we recorded a charge of approximately $106 for one-time employee termination benefits related to the closure of the Minneapolis office. We expect to incur approximately $250 in additional costs during the fourth quarter of 2005. No additional costs are expected to be incurred after December 31, 2005. Such costs are recorded as a restructuring charge in the condensed consolidated statement of operations for the three and nine months ended September 30, 2005. The entire amount is attributable to the Marketing Services segment. Of the $106 of costs incurred to date, $0 has been paid as of September 30, 2005. These costs are expected to be paid by June 30, 2006.

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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 condensed consolidated statements of operations to the extent that future minimum royalty guarantee commitments are not recoverable. Estimated future sales are projected based on historical experience, including that of similar products, and anticipated advertising and marketing support by the licensor. In the fourth quarter of 2004, we recorded a pre-tax charge of $7,722 relating to minimum royalty guarantee shortfalls on several consumer products licenses. These shortfalls are the result of our decision to wind down its consumer products business, Pop Rocket, which resulted in a decrease in expectations of future sales under several licenses.

On May 18, 2005, we reached a settlement with one of our licensors affecting several licenses. Under the terms of the settlement, we agreed to forgo our rights to certain licensed properties for 2006 and 2007 in exchange for a reduction in the overall royalty guarantees. We retain product distribution rights under the licenses for 2005. As a result of this settlement, our overall commitment for royalty guarantees is reduced by approximately $4,000. We are required to pay the licensor a total of $1,800 through March 31, 2006. As a result of this settlement, $2,325 of the fourth quarter 2004 charge for minimum royalty guarantee shortfalls was reversed in the second quarter of 2005. The reversal was recorded as a minimum royalty guarantee shortfall gain in the accompanying condensed consolidated statements of operations for the three and six months ended June 30, 2005. During the three months ended September 30, 2005, an additional $399 was reversed due to higher than expected Scooby-Doo™ revenues that exceeded our initial estimates. We continue to monitor royalty accruals in light of the wind down of Pop Rocket and we continue our negotiations with our licensors for the termination of several of our license agreements.

Credit Facilities

On April 24, 2001, we signed a credit facility (the “Facility”) with Bank of America. On April 26, 2004, the maturity date of the Facility was extended through June 30, 2005. Effective March 30, 2005 the maturity date of the Facility was further extended through March 31, 2006. The credit facility is secured by substantially all of our assets and provides for a line of credit of up to $20,000 with borrowing availability determined by a formula based on qualified assets. Interest on outstanding borrowings will be based on either a fixed rate equivalent to LIBOR plus an applicable spread of between 1.50 and 2.25 percent or a variable rate equivalent to the bank’s reference rate plus an applicable spread of between zero and 0.50 percent. We are also required to pay an unused line fee of between zero and 0.60 percent per annum and certain letter of credit fees. The applicable spread is based on the achievement of certain financial ratios. The Facility also requires us to comply with certain restrictions and covenants as amended from time to time. As of December 31, 2004 and June 30 2005, we were in compliance with the restrictions and covenants. The Facility may be used for working capital and acquisition financing purposes. As of December 31, 2004 and September 30, 2005, $2,975 and $2,000, respectively, was outstanding under the Facility.

In addition to the Facility, in October, 2003 our Logistix agency in the United Kingdom established an import/letter of credit facility with Hong Kong Shanghai Bank Corp. (“HSBC”) to provide short-term financing of product purchases in Asia. The total availability under this facility is 1,500 GBP. The total availability under this facility was increased from 1,000 GBP to 1,500 GBP in 2005. Under this facility HSBC may pay the agency’s vendors directly upon receipt of invoices and shipping documentation. Logistix (U.K.) in turn is obligated to repay HSBC within 120 days. As of December 31, 2004 and September 30, 2005, $1,797 and $0, respectively, was outstanding under this facility.

In connection with the acquisition of Megaprint Group, we assumed a mortgage loan secured by a building in the Netherlands. The mortgage loan had a 24 year term and carried an interest rate fixed at 5 percent per annum for three years from December 2002. During the quarter ended June 30, 2005, we repaid the balance on the mortgage loan and subsequently sold the building. We applied the balance of the mortgage loan against monies owed to the sellers of the Megaprint Group. The proceeds from the sale of the building were paid to the sellers of the Megaprint Group in the third quarter of 2005. As of December 31, 2004, the balance on the mortgage loan was 919 Euros (approximately US $1,253).

Megaprint Group had an overdraft facility of 750 Euros from ING Bank, Nederland. This facility was canceled in the quarter ending September 30, 2005. As of December 31, 2004 and September 30, 2005, there were no amounts outstanding under this facility.

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Acquisitions

On February 2, 2004, we acquired certain assets of Johnson Grossfield, Inc. (“JGI-MN”) a privately held promotional marketing services company based in Minneapolis, Minnesota (the “Johnson Grossfield Acquisition”). We financed the Johnson Grossfield Acquisition through our existing cash reserves. The Johnson Grossfield Acquisition was consummated pursuant to an Asset Purchase Agreement dated January 16, 2004, by and among the Company, Johnson Grossfield, Inc., a Delaware corporation wholly owned by us (“Johnson Grossfield”), JGI-MN, Marc Grossfield and Thom Johnson (the “Johnson Grossfield Purchase Agreement”). Under the terms of the Johnson Grossfield Purchase Agreement, we purchased the assets of JGI-MN’s promotional agency business for approximately $4,600 in cash and 35,785 shares of our common stock (which, based upon the January 30, 2004 closing market price of $14.80, had a value of $530), plus additional earnout consideration of up to $4,500 based upon future performance of the acquired business. We also assumed the operating liabilities of the promotional agency business in connection with the acquisition. The earnout consideration is based upon the acquired business achieving targeted levels of earnings before interest, taxes, depreciation and amortization (“EBITDA”) over the period from 2004 through 2008. The earnout payments, if required, are payable 50% in cash and 50% in shares of our common stock. On April 19, 2005, we reached agreement with the sellers of Johnson Grossfield on the amount of earnout attributable to 2004 performance. Such earnout consideration totaled $257, of which $148 was payable in cash and the remainder payable in shares of our common stock (10,616 shares valued at $109 as of April 19, 2005). This earnout consideration was recorded as goodwill in the second quarter of 2005.

On August 9, 2005, we were notified by the Subway Franchisee Advertising Fund Trust (“SFAFT”) that following completion of fulfillment on Subway Restaurant’s kids meal programs by Johnson Grossfield in November 2005, the relationship between Johnson Grossfield and Subway Restaurants will be terminated. As a result, we recorded a charge of $3,431 for the impairment of goodwill and other intangible assets of Johnson Grossfield. The impairment of assets charge was recorded in the condensed consolidated statement of operations for the three and nine months ended September 30, 2005.

On November 10, 2004, we acquired all of the outstanding capital stock of Megaprint Group Limited (“Megaprint Group”), a privately held creative promotions agency headquartered in the United Kingdom. We financed the Megaprint Group acquisition through short-term debt. We paid 1,824 GBP (approximately US $3,388) in cash (net of a hold back for working capital adjustments of 180 GBP), plus related transaction costs of 305 GBP (approximately US $566). Under the terms of the Stock Purchase Agreement, we are committed to pay, subject to offset for any shortfall in the target level of net working capital at December 31, 2004, a minimum of 850 GBP and up to a maximum of 1,300 GBP in 2005 based on the performance of Megaprint Group for the year ended December 31, 2004. The Company has accrued a liability for the minimum payment of 850 GBP as purchase price as of the acquisition date. We are also committed to pay additional consideration up to a maximum of 2,450 GBP based on future performance through 2009. The additional consideration is based upon the business achieving targeted levels of margin after direct overhead (“MADO”) over the period from 2005 through 2009. The additional consideration, if any, will be recorded as goodwill.

During the second quarter of 2005, an additional 256 GBP (approximately $461) was paid to the sellers of Megaprint Group for a working capital adjustment. The additional consideration was recorded as goodwill in the accompanying condensed consolidated balance sheet.

Included in net current liabilities for the Megaprint Group as of the acquisition date was a mortgage loan for a building in the Netherlands. The balance of the mortgage loan as of the acquisition date totaled approximately 900 Euros (approximately $1,200). The building was recorded under fixed assets and was recorded at the same value as the balance of the mortgage loan. The building and mortgage loan were held in trust by the Megaprint Group on behalf of its former shareholders (the “Sellers”). In June 2005, we repaid the mortgage loan. The amount repaid of 900 Euros (approximately $1,090) was applied against monies owed to the Sellers for the 2004 Earnout Payment. As a result, in June 2005, we paid the sellers 199 GBP (approximately $360) of the 850 GBP owed for the 2004 Earnout Payment. Subsequent to the repayment of the mortgage loan, the building was sold in June 2005 for 747 Euros (approximately $939). The proceeds from the sale were paid to the Sellers in the third quarter of 2005.

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Issuance of Preferred Stock

On March 29, 2000, Crown EMAK Partners, LLC, a Delaware limited liability company (“Crown”), invested $11,900 in EMAK in exchange for preferred stock and warrants to purchase additional preferred stock. Under the terms of the investment, Crown acquired 11,900 shares of Series A mandatorily redeemable senior cumulative participating convertible preferred stock, par value $.001 per share, (the “Series A Stock”) with a conversion price of $14.75 per common share. In connection with such purchase, we granted to Crown five year warrants (collectively, the “Warrants”) to purchase 5,712 shares of Series B senior cumulative participating convertible preferred stock, par value $.001 per share, (the “Series B Stock”) at an exercise price of $1,000 per share, and 1,428 shares of Series C senior cumulative participating convertible preferred stock, par value $.001 per share, (the “Series C Stock”) at an exercise price of $1,000 per share. The Warrants were immediately exercisable. The conversion prices of the Series B Stock and the Series C Stock were $16.00 and $18.00 per common share, respectively. On June 20, 2000, Crown paid us an additional $13,100 in exchange for an additional 13,100 shares of Series A Stock with a conversion price of $14.75 per common share. In connection with such purchase, we granted to Crown additional Warrants to purchase another 6,288 shares of Series B Stock and another 1,572 shares of Series C Stock. Each share of Series A Stock is convertible into 67.7966 shares of Common Stock, representing 1,694,915 shares of Common Stock in aggregate. Each share of Series B Stock and Series C Stock is convertible into 62.5 and 55.5556 shares of Common Stock, respectively, representing 916,666 shares of Common Stock in aggregate. Also in connection with such purchase, we agreed to pay Crown a commitment fee in the aggregate amount of $1,250, paid in equal quarterly installments of $62.5 commencing on June 30, 2000 and ending on March 31, 2005.

On March 19, 2004, we entered into a Warrant Exchange Agreement with Crown whereby Crown received new warrants to purchase an aggregate of 916,666 shares of Common Stock (“New Warrants”) in exchange for cancellation of the existing Warrants to purchase shares of Series B Stock and Series C Stock (which, upon issuance, would also have been convertible into 916,666 shares of Common Stock). The New Warrants consist of warrants to purchase 750,000 shares and 166,666 shares of Common Stock at exercise prices of $16.00 and $18.00 per share, respectively. Of each tranche, 47.6% expire on March 29, 2010 and 52.4% expire on June 20, 2010. As a result of the exchange transaction, Crown received an extension of time in which to exercise its right to purchase additional equity in EMAK, and EMAK obtained an elimination of the preferred rights and preferences as well as the preferred dividend associated with the now eliminated Series B Stock and Series C Stock.

On December 30, 2004, we entered into an Exchange Agreement with Crown whereby Crown received 25,000 shares of Series AA mandatorily redeemable senior cumulative preferred stock, par value $0.001 per share, (the “Series AA Stock”) with a conversion price of $14.75 per common share, in exchange for 25,000 shares of Series A Stock. The Series AA Stock has substantially the same rights and preferences as the Series A Stock, but does not participate in cash dividends paid on Common Stock. The exchange was effected in response to the requirements of Emerging Issues Task Force (“EITF”) Issue No. 03-6, “Participating Securities and the Two-Class Method under Financial Accounting Standards Board (“FASB”) No. 128, which requires companies having participating securities to calculate earnings per share using the two-class method.

Upon any voluntary or involuntary liquidation, dissolution or winding-up of our affairs, Crown, as holder of the Series AA Stock, will be entitled to payment out of our assets available for distribution of an amount equal to the greater of (a) the liquidation preference of $1,000 per share (the “Liquidation Preference”) plus all accrued and unpaid dividends or (b) the aggregate amount of payment that the outstanding preferred stock holder would have received assuming conversion to Common Stock immediately prior to the date of liquidation of capital stock, before any payment is made to other stockholders. The Series AA Stock is subject to 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. Crown is also entitled to receive a quarterly dividend equal to 6% of the Liquidation Preference per share outstanding, payable in cash. The dividends for the quarter ended September 30, 2005 totaled $375 and were paid in October 2005 and recorded in accounts payable in the accompanying condensed consolidated balance sheet as of September 30, 2005.

The holders of the Series AA Stock, voting separately as a class, are entitled to elect two directors of the Company, provided however, at ant time the Board of Directors is increased to include more than eight members, the holders of the Series AA Stock are entitled to elect one additional director. Crown currently holds 100% of the outstanding shares of Series AA Stock, and has designated one individual to our Board of Directors.

The Series AA Stock is recorded in the accompanying consolidated balance sheets at its Liquidation Preference net of issuance costs. The issuance costs total approximately $1,951.

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Subsequent Events

On October 3, 2005, We entered into employment agreements with Kim H. Thomsen and Jonathan Banks pursuant to which they will serve as Co-Chief Executive Officers of Equity Marketing (a wholly-owned subsidiary of the Company). Ms. Thomsen previously served as our President and Chief Creative Officer. Ms. Thomsen’s new employment agreement supersedes her previously existing employment agreement with us, pursuant to which she had the right to retire from full-time service and serve as a part-time consultant beginning January 1, 2006. Her new employment agreement is intended to provide for a tax favorable restructuring of her deferred compensation annuity with no significant change in expense to the Company.

The employment agreements provide for a continuation of Ms. Thomsen’s and Mr. Banks’ 2005 base salary levels of $364 and $300, respectively, with minimum annual cost of living increases in 2006 and 2007. In addition, the employment agreements provide for a formulaic annual bonus pool, to be equally shared by Ms. Thomsen and Mr. Banks, based upon the achievement of specified levels of earnings before interest, taxes, depreciation and amortization (“EBITDA”) of Equity Marketing over certain thresholds. Based upon the Company’s expected range of EBITDA growth for the Equity Marketing business over the 2005 to 2007 employment term, we currently anticipate that the annual bonus opportunity for each executive for superior performance will range from approximately 95% to 130% of base salary. These annual bonuses are payable 25% in shares of our Common Stock and 25% in cash, with the remainder payable in either shares or cash at the election of the executive.

In lieu of annual equity based compensation, the employment agreements provide for the grant to each executive of 200,000 contingent stock appreciation rights payable, if at all, in cash (“SARs”). The SARs are payable only if Equity Marketing experiences positive EBITDA growth over a 2004 base year and only upon a change of control of the Company occurring during the employment term or, provided that the executive continues to serve on the Equity Marketing board of directors and comply with certain restrictive covenants, the five year period following the end of the employment term.

The employment agreements provide for post-employment severance for each executive determined by the EBITDA performance of the Equity Marketing business in 2008 using the same formula as the annual bonus opportunity during the employment term. The employment agreements also contain three-year post-employment restrictive covenants.

Recent Accounting Pronouncements

In September 2004, the consensus of EITF Issue No. 04-10, “Applying Paragraph 19 of FASB Statement No. 131, ‘Disclosures about Segments of an Enterprise and Related Information,’ in Determining Whether to Aggregate Operating Segments That Do Not Meet the Quantitative Thresholds,” was published. EITF Issue No. 04-10 addresses how an enterprise should evaluate the aggregation criteria of SFAS No. 131 when determining whether operating segments that do not meet the quantitative thresholds may be aggregated in accordance with SFAS No. 131. The consensus in EITF 04-10 should be applied for fiscal years ending after September 15, 2005. We are still evaluating the impact of this issue on our disclosures as reported in the Annual and Quarterly reports. We do not expect adoption of this issue to have a significant effect on our consolidated financial condition or results of operations.

In December 2004, the FASB issued SFAS No. 123 (revised 2004) (“SFAS No. 123(R)”), “Share-Based Payment”, which replaced SFAS No. 123 and superseded APB Opinion No. 25. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The pro forma disclosures previously permitted under SFAS No. 123 will no longer be an alternative to financial statement recognition. Under SFAS No. 123(R), we must determine the appropriate fair value method to be used for valuing share-based payments, the amortization method of compensation cost and the transition method to be used at the date of adoption. The transition methods include prospective and retroactive adoption options. Under the retroactive option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The prospective method requires that compensation cost be recorded for all unvested stock options and nonvested stock at the beginning of the first quarter of adoption of SFAS No. 123(R), whereas the retroactive method requires recording compensation cost for all unvested stock options and nonvested stock beginning with the first period restated.

In April 2005, the Securities Exchange Commission amended Regulation S-X to delay the effective date for compliance with SFAS No. 123(R). Based on the amended regulation, we are required to adopt SFAS No. 123(R) on January 1, 2006. We are evaluating the requirements of SFAS No. 123(R) and expects that the adoption of SFAS No. 123(R) may have a material adverse effect on our results of operations and earnings per share. We have not yet determined the method of adoption of SFAS No. 123(R), or whether the amounts recorded in the consolidated statements of income in future periods will be similar to the current pro forma disclosures under SFAS No. 123.

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In November 2004, the FASB issued SFAS No. 151, “Inventory Costs — An Amendment of ARB No. 43”, Chapter 4. SFAS No. 151 amends the guidance in Chapter 4, “Inventory Pricing,” of Accounting Research Bulletin (“ARB”) No. 43, “Restatement and Revision of Accounting Research Bulletins”, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (“spoilage”). Among other provisions, the statement requires that items such as idle facility expense, excessive spoilage, double freight, and rehandling costs be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal” as stated in ARB No. 43. Additionally, SFAS No. 151 requires that the allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 is effective for fiscal years beginning after June 15, 2005. We are currently evaluating the effect that the adoption of SFAS No. 151 will have on our results of operations and financial position, but do not expect it to have a material impact.

In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143” (“FIN 47”), which requires an entity to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. FIN 47 is effective for fiscal years ending after December 15, 2005. We are currently evaluating the effect that the adoption of FIN 47 will have on our condensed consolidated statements of operations and financial condition but does not expect it to have a material impact.

In May 2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections-a replacement of APB Opinion No. 20 and FASB Statement No. 3”. This Statement requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine the period-specific effects or the cumulative effect of the change. This pronouncement will be effective December 15, 2005. Currently, we do not have changes in accounting principle; therefore, the adoption of SFAS 154 will not have any impact on our financial position or results of operations.

In October 2005, the FASB issued FASB Staff Position (“FSP”) 13-1, “Accounting for Rental Costs Incurred During a Construction Period.” FSP 13-1 requires rental costs associated with ground or building operating leases that are incurred during a construction period to be recognized as rental expense. FSP 13-1 applies to reporting periods beginning after December 15, 2005. Retrospective application in accordance with FASB SFAS No. 154 “Accounting Changes and Error Corrections”, is permitted but not required. We do not believe that the adoption of FSP 13-1 will have a significant impact on our operations or financial position.

Cautionary Statements and Risk Factors

Marketplace Risks

• Dependence on a single customer, Burger King, which may adversely affect our financial condition and results of operations.

• Concentration risk associated with accounts receivable. We regularly extend credit to a subsidiary of Burger King’s purchasing cooperative which accounts for approximately 80% of our sales to the Burger King.

• Dependence on nonrenewable product orders by Burger King, which promotions are in effect for a limited period of time.

• Dependence on the popularity of licensed entertainment properties, which may adversely affect our financial condition and results of operations.

• Significant quarter-to-quarter variability in revenues and net income, which may result in operating results below the expectations of securities analysts and investors.

• Increased competitive pressure, which may affect our sales of products and services.

• Dependence on foreign manufacturers, which may increase the costs of our products and affect the demand for such products.

• Variations in product costs due to fluctuations in raw materials prices, including plastic resin.

Financing Risks

• Currency fluctuations, which may affect our suppliers and reportable income.

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Other Risks

• Products that we develop or sell may expose us to liability from claims by users of such products for damages including, but not limited to, bodily injury or property damage. We currently maintain product liability insurance coverage in amounts that we believe are adequate. There can be no assurance that we will be able to maintain such coverage or obtain additional coverage on acceptable terms in the future, or that such insurance will provide adequate coverage against all potential claims.

• Exposure to liability for the costs related to product recalls. These costs can include legal expenses, advertising, collection and destruction of product, and free goods. Our product liability insurance coverage generally excludes such costs and damages resulting from product recall.

• Potential negative impact of past or future acquisitions, which may disrupt our ongoing business, distract senior management and increase expenses (including risks associated with the financial condition and integration of the businesses which we acquire).

• Adverse results of litigation, governmental proceedings or environmental matters, which may lead to increased costs or interruption in normal business operations.

• Changes in laws or regulations, both domestically and internationally, including those affecting consumer products or environmental activities or trade restrictions, which may lead to increased costs.

• Strike and other labor disputes which may negatively impact the distribution channels for our products.

• Exposure to liabilities for minimum royalty commitments in connection with license agreements for entertainment properties.

• Potential negative impact of Severe Acute Respiratory Syndrome (“SARS”), which could adversely affect our vendors in the Far East.

We undertake no obligation to publicly release the results of any revisions to forward-looking statements, which may be made to reflect events or circumstance after the date hereof or to reflect the occurrence of unanticipated events. The risks highlighted herein should not be assumed to be the only items that could affect future performance. In addition to the information contained in this document, readers are advised to review our Form 10-K for the year ended December 31, 2004, under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operation — Cautionary Statements and Risk Factors.”

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

For quantitative and qualitative disclosures about market risk affecting the Company, see “Item 7A Quantitative and Qualitative Disclosures About Market Risk” of our Annual Report on Form 10-K for the year ended December 31, 2004. Our exposure to market risks has not changed materially since December 31, 2004.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

As of September 30, 2005, the Company’s disclosure controls and procedures were evaluated. Based on this evaluation, Stephen Robeck, the Company’s interim principal executive officer, and Zohar Ziv, the Company’s principal financial officer, concluded that these disclosure controls and procedures were effective as of September 30, 2005, in timely alerting them to material information relating to the Company required to be included in the Company’s periodic reports.

Changes in Internal Control Over Financial Reporting

The Company made no change to its internal control over financial reporting or in other factors that materially affected, or were reasonably likely to have materially affected, its internal control over financial reporting during the quarter ended September 30, 2005.

The Company continues to implement a conversion to new and upgraded financial and human resources information technology systems that began in the fourth quarter of 2004. The Company has evaluated the effect on its internal control over financial reporting of this conversion and determined that this conversion has not materially affected, and is not reasonably likely to materially affect, as defined in Rule 13a-15(f) promulgated under the Exchange Act, the Company’s internal control over financial reporting. The Company has not made any material changes to its internal control over financial reporting or in other factors that could materially affect these controls subsequent to September 30, 2005.

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PART II. OTHER INFORMATION

ITEM 6. EXHIBITS

Exhibit 10.1	Employment agreement dated as of October 3, 2005 between Equity Marketing, Inc. and Kim H. Thomsen.
Exhibit 10.2	Employment agreement dated as of October 3, 2005 between Equity Marketing, Inc. and Jonathan Banks.
Exhibit 31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes—Oxley Act of 2002.
Exhibit 31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes—Oxley Act of 2002.
Exhibit 32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

		EMAK Worldwide, Inc.
Date	November 11, 2005	/s/ ZOHAR ZIV
		Zohar Ziv
		Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

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