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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________________ to _____________________
Commission File Number 23346
EQUITY MARKETING, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 13-3534145
(State of or other jurisdiction of (I.R.S. employer identification no.)
incorporation or organization)
6330 SAN VICENTE BLVD.
LOS ANGELES, CALIFORNIA 90048
(Address of principal executive offices)
(323) 932-4300
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act:
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Title of each Class Name of each exchange on which registered
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None None
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Securities registered pursuant to Section 12(g) of the Act:
Title of each class
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Common Stock, $0.001 par value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Approximate aggregate market value of the voting stock held by non-affiliates of
the registrant as of March 22, 2000 was $36,548,220.
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date:
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Number of Shares
outstanding on
March 22, 2000
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Common Stock, $0.001 par value...................................... 6,249,767
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Documents Incorporated by Reference: Certain portions of the Registrant's Proxy
Statement relating to Registrant's annual meeting of stockholders scheduled to
be held on June 27, 2000 are incorporated by reference into Part III of this
Form 10-K.
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EQUITY MARKETING, INC.
INDEX TO ANNUAL REPORT ON FORM 10-K
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
YEAR ENDED DECEMBER 31, 1999
ITEMS IN FORM 10-K
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Page
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Part I
Item 1. Business 3
Item 2. Properties 6
Item 3. Legal Proceedings 6
Item 4. Submission of Matters to a Vote of Security Holders 7
Part II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters 8
Item 6. Selected Financial Data 9
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 17
Item 8. Financial Statements and Supplementary Data 17
Item 9. Changes In and Disagreements With Accountants on Accounting
and Financial Disclosure 17
Part III
Item 10. Directors and Executive Officers of the Registrant 18
Item 11. Executive Compensation 19
Item 12. Security Ownership of Certain Beneficial Owners and Management 20
Item 13. Certain Relationships and Related Transactions 20
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 21
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FORWARD-LOOKING STATEMENTS
Certain expectations and projections regarding the future performance of Equity
Marketing, Inc., a Delaware corporation (the "Company"), discussed in this
document are forward-looking and are made under the "safe harbor" provisions of
the Private Securities Litigation Reform Act of 1995. These expectations and
projections are based on currently available competitive, financial and economic
data along with the Company's operating plans and are subject to future events
and uncertainties. Readers should not place undue reliance on any such
forward-looking statements, which speak only as of the date made. Actual results
could vary materially from those anticipated for a variety of reasons. The
Company undertakes no obligation to publicly release the results of any
revisions to these forward-looking statements which may be made to reflect
events or circumstances after the date hereof or to reflect the occurrence of
unanticipated events. Readers are advised to review "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Cautionary Statements
and Risk Factors."
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PART I
ITEM 1. BUSINESS
($000's omitted)
GENERAL
Equity Marketing, Inc., a Delaware corporation ("Equity Marketing" or the
"Company"), is a provider of integrated custom promotional products and services
that builds sales and brand awareness for domestic and international quick
service restaurant chains, oil and gas companies, packaged goods companies and
mass market retailers. The Company also designs, develops, manufactures and
promotes consumer products that complement its promotions business and that are
distributed primarily through mass market and specialty retailers, as well as
international distributors. The Company's products include character figurines,
action vehicles, plush toys, dolls, play sets and a variety of other items.
Programs of the promotions division of the Company, Equity Promotions ("Equity
Promotions" or "Promotions"), are utilized primarily in promotional campaigns
implemented by quick service restaurant and consumer products customers, which
include Burger King Corporation ("Burger King"), The Coca-Cola Company, Exxon
Company USA, Sunoco, Inc. and CVS/pharmacy. Equity Consumer Products ("Equity
Consumer Products" or "Consumer Products"), the consumer products division of
the Company, designs and produces niche products based on trademarks owned by
the Company such as Headliners(R) and Tub Tints(R) or on classic, time-tested
licensed properties such as Scooby-Doo(TM) for sale to major mass market and
specialty market retailers such as Toys 'R' Us, Inc. ("Toys 'R' Us"), Wal-Mart
Stores, Inc. ("Wal-Mart"), Target Stores, Inc. ("Target"), Spencer Gifts, Inc.,
and to various international distributors worldwide.
The Company's promotional programs are typically based upon characters from
entertainment properties licensed by television and motion picture studios and
others. Licenses for characters upon which Equity Promotions' programs are based
are generally obtained directly by the Company's customers (often with the
Company's assistance) from licensors, including Warner Bros. Inc. ("Warner
Bros."), Universal Studios ("Universal"), Nickelodeon, a division of MTV
Networks, a division of Viacom, DreamWorks SKG, The Walt Disney Company, Sony
Pictures Entertainment and Twentieth Century Fox. Such licenses are typically
specific to the promotional campaign implemented by the Company's customers and
generally do not extend beyond the end of the promotional campaign. In contrast,
Equity Consumer Products generally obtains licenses directly from licensors.
These licenses generally grant the Company rights to design, manufacture and
distribute certain specific items or types of items in specific United States
and/or international markets for defined terms, typically one to three years.
The Company believes its principal competitive advantages are its extensive
brand-building and sales-building experience developed over years of serving
Burger King and other customers, extensive creative capabilities, access to a
broad range of intellectual property from the worlds of entertainment, music and
sports and an infrastructure that can deliver unique, high-quality and
cost-effective products and services in a timely manner.
The Company is seeking to acquire other companies and is also investing in its
sales force and infrastructure to target new markets through internal growth. No
assurance can be given that the Company will find suitable acquisition
candidates or that it will be successful in consummating such transactions.
Beginning in December 1998, the Company stopped pursuing new event movie
licenses for the consumer products business. In addition, the Company has
terminated the majority of existing master toy licenses utilized by Equity
Consumer Products. (see "Equity Consumer Products" below and Notes 2 and 3 of
the accompanying Notes to Consolidated Financial Statements)
EQUITY PROMOTIONS
The Company's largest current market is the design and implementation of fully
integrated promotional programs which incorporate products used as free premiums
or sold in conjunction with the purchase of meals at Burger King. The Company
also produces products for use in promotional programs run by its consumer
products and oil and gas company customers. Premium-based promotions are used
for marketing purposes by both the companies sponsoring the promotions and the
licensors of the entertainment, music or sports properties on which the
promotional products are based. The use of promotional products based upon
entertainment, music or sports properties allows promotion sponsors to draw upon
the popular identity developed by the licensed characters through exposure in
various media such as television programs, motion pictures and publishing.
Promotions are designed to benefit sponsors by generating consumer loyalty,
building market share and enhancing the sponsors' images as providers of
value-added products and services. In addition, motion picture and television
studio licensors often incorporate such promotions into their own marketing
plans because of the substantial advertising expenditures made by sponsors of
promotions and because the broad exposure of the licensed property to consumers
in the sponsors' restaurants and other retail outlets supplements the marketing
of motion pictures and television programs by the studios.
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Equity Promotions performs a wide range of creative design, development,
production and fulfillment services for its customers. The Company assists
customers with promotional strategy, calendar planning, and concept development,
provides an initial evaluation of intellectual properties for which licenses are
available; advises customers as to which licenses are consistent with their
marketing objectives and sometimes assists customers in procuring such licenses.
The Company also proposes specific product and non-product based promotions
utilizing the properties secured by its customers; develops promotional concepts
and designs based on the property; provides the development and engineering
necessary to translate the property, which often consists of two-dimensional
artwork, into finished products; obtains or coordinates licensor approval of
product designs, prototypes and finished products; contracts for and supervises
the manufacture of products; arranges for safety testing to customer and
regulatory specifications by an independent testing laboratory; and arranges
insurance, customs clearance and, in most instances, the shipping of finished
products to the customer. In some instances, the Company also provides
warehousing, fulfillment and billing services. The Company also provides
creative services as needed to customers for packaging and point-of-sale
advertising. In some cases, customers obtain license rights or develop
promotions concepts independently and engage the Company only to design and
produce specific products. In other cases, the Company provides the full range
of its services.
Equity Promotions' principal strategy is to be a market-driven and
customer-driven organization that seeks to be a strategic marketing partner with
its clients through recommending, executing and measuring a broad range of fully
integrated brand-building and sales-building programs that may or may not be
product-based. Equity Promotions also intends to continue to diversify its
promotions customer base outside of quick service restaurants and to continue to
expand its relationship with Burger King. In connection with these strategic
goals, in July 1998, the Company acquired substantially all of the assets of
U.S. Import & Promotions Co., Inc. ("USI") and Contract Marketing, Inc. ("CMI",
referred to collectively as "USI"), two related companies with a primary focus
on collectible toy truck promotions for oil and gas retailers (see Note 4 of the
accompanying Notes to Consolidated Financial Statements). USI provides sales and
account management services, creative and design services, management of
overseas production of promotional products and warehousing and fulfillment
services to their customers. In addition, in late 1998, the Company launched a
sports promotions business designed to leverage the Company's existing
Headliners(R), sports experience and sports licenses and aimed at major
professional leagues and collegiate associations as well as individual teams and
their corporate sponsors. (see "Equity Consumer Products" below)
In 1999, Equity Promotions adopted the objective of expanding beyond its
existing product-based services to include a full array of marketing services,
ranging from premiums and sweepstakes to print and Internet marketing. In
connection with this objective, the Company launched a marketing services
division and an interactive division in August 1999 and December 1999,
respectively. In 1999, the marketing services division finalized its strategic
plan, hired staff and commenced pursuing new clients. Based on results that were
initially less promising than expected, the sports marketing division was
incorporated into the new marketing services division. The Company intends to
recommend sports properties in the same manner as it currently recommends music
and entertainment properties. The marketing services division's first project
was a year-end promotional calendar for The Wherehouse. In 1999, the interactive
division developed a Pokemon(TM) web site for Burger King which included a
database to help enthusiasts keep track of their collections, games, movie clips
and information on Burger King's Pokemon(TM) promotion. The site generated six
times the normal number of Burger King web site traffic. The Company believes
that the marketing services and internet divisions are key components of the
Company's future growth. The statements set forth herein are forward looking and
actual results may differ materially.
The Company's international promotions include unique products and programs
tailored to local markets and the use of products from promotions originally run
in the United States. American entertainment properties are generally released
in other countries subsequent to the date of their release in the United States.
Because the Company has already made its investment in the creative development
of concepts based upon such entertainment properties by the time of their
domestic release, it often has completed both creative, and in some instances,
production work in advance of their foreign release. The Company pursues
promotions opportunities worldwide. In 1999, the Company sold promotional
products internationally in the United Kingdom, Germany, Spain, Australia,
Philippines, South Africa, Mexico and throughout Latin America.
Promotions revenues for the years ended December 31, 1997, 1998 and 1999 were
$116,022, $116,280 and $202,195 or 79%, 73% and 89% of the Company's revenues,
respectively. A single promotions customer, Burger King, accounted for
approximately 67%, 63% and 80% of the Company's total revenues for the years
ended December 31, 1997, 1998 and 1999, respectively. (see "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Cautionary Statements and Risk Factors")
EQUITY CONSUMER PRODUCTS
Equity Consumer Products designs and manufactures toys and other consumer
products for sale to major mass market retailers such as Toys 'R' Us, Wal-Mart
and Target, specialty market retailers such as Spencer Gifts, Inc., Store of
Knowledge, Zany Brainy, Blockbuster and to various international distributors
worldwide. These products incorporate trademarks the Company owns such as
Headliners(R) and Tub Tints(R) or licenses of classic, time-tested properties
the Company has obtained from entertainment companies such as Warner Bros. In
some cases, the products are based on the same licensed properties that are used
by Equity Promotions.
In April 1998, the Company acquired Corinthian Marketing, Inc., a Delaware
corporation ("Corinthian"), the producer and distributor of the Headliners(R)
brand of collectible sports figurines. Headliners(R) are uniquely designed with
oversized heads to capture the look and personality of popular professional
athletes and are based on licensing relationships with Major League Baseball and
the M.L.B. Players' Association, and the National Football League, N.F.L.
Players, Inc., N.F.L. Quarterback Club and the Collegiate Licensing Corporation.
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To counteract soft 1999 sales in the sports collectibles market, the Company
repositioned the Headliners(R) brand as a personality collectible, including
figures based on licensed entertainment properties such as Austin Powers(TM),
the rock group KISS(TM) and horror film favorites. In June 1998, the Company
obtained a three-year licensing agreement with Warner Bros. to design,
manufacture, market and distribute toys based on characters from Scooby-Doo(TM),
one of the longest-running children's cartoon shows in television history. In
July 1998, the Company acquired the worldwide rights to manufacture, market and
distribute Tub Tints(R), a children's bath product consisting of effervescent
tablets which dissolve in the bath and currently come in three colors: red,
yellow and blue. Depending on which color tablets are mixed, a wide variety of
colors can be created.
Equity Consumer Products' principal strategy is to focus on distinctive, niche
products that compliment the Company's promotions business and are based on
trademarks owned by the Company or on classic, time-tested licensed properties
that are likely to produce revenue for several years, thus increasing the
predictability of the Company's revenues. The Company intends to implement this
strategy through internal growth. No assurance can be given that the Company
will be successful in obtaining or renewing licenses under satisfactory terms.
Beginning in December 1998 and consistent with its strategy, the Company stopped
pursuing new event movie licenses for the consumer products business. In
addition, the Company has terminated the majority of existing master toy
licenses utilized by Equity Consumer Products. In June 1999, the Company
terminated a three-year licensing agreement with Universal to design,
manufacture, market and distribute toys for Babe, Curious George and Woody
Woodpecker & Friends. In December 1999, the Company terminated a three-year
licensing and distribution agreement with NASCAR, the governing body of U.S.
stock car racing to design, produce and distribute NASCAR-related collectible
pins. The estimated costs associated with the termination of these licenses were
included in the Company's 1998 year-end restructuring charges (see Notes 2 and 3
in the accompanying Notes to Consolidated Financial Statements).
Equity Consumer Products' revenues were $30,306, $42,856 and $24,868 or 21%,
27% and 11% of the Company's total revenues, for the years ended December
31, 1997, 1998 and 1999, respectively.
BACKLOG
Order backlog at December 31, 1998 and 1999 was approximately $68,792 and
$93,699, respectively. The Company expects the 1999 order backlog to be filled
by December 31, 2000.
MANUFACTURING
The Company's products are manufactured according to Company and customer
specifications by unaffiliated contract manufacturers. Equity Marketing Hong
Kong, Ltd., a wholly owned subsidiary of the Company ("Equity Marketing HK"),
manages production of the Company's products by third parties in the Far East
and currently is responsible for performing and/or procuring product sourcing,
product engineering, quality control inspections, independent safety testing and
export/import documentation. The Company believes that the presence of a
dedicated staff in Hong Kong results in lower net costs, increased ability to
respond rapidly to customer orders and maintenance of more effective quality
control standards. Products manufactured in the Far East represented
approximately 95% of the Company's 1999 production. The Company's products are
also manufactured by third parties in the United States. Equity Marketing
generally retains, for itself or on behalf of its customers, ownership of the
molds and tooling required for the manufacture of its products. The Company is
not a party to any long-term contractual arrangements with any manufacturer.
During 1999, approximately 95% of the Company's products were manufactured in
China. China currently enjoys "normal trade relations" ("NTR") status under US
tariff laws, which provides a favorable category of US import duties. As a
result of continuing concerns in the US Congress regarding China's human rights
policies, and disputes regarding Chinese trade policies, including the country's
inadequate protection of US intellectual property rights, there has been, and
may be in the future, opposition to the annual extension of NTR status for
China. In 2000, however, there will be, for the first time, a major effort in
the US Congress to pass legislation that would make permanent China's NTR status
in return for the country's expected accession to the World Trade Organization.
The loss of NTR status for China would result in a substantial increase in the
import duty for the Company's products manufactured in China and imported into
the US and would result in increased costs for the Company. The impact of such
an event on the Company could be somewhat mitigated by the Company's ability to
source product for the US market from countries other than China. (see
"Cautionary Statements and Risk Factors")
Virtually all of the Company's raw materials are available from numerous
suppliers. Prices for plastics, a major component of the Company's products,
began rising in late 1999 as a result of the increase in petroleum prices. This
trend is continuing in 2000. The Company does not have long-term supply
contracts in place with its suppliers. Accordingly, continued petroleum price
increases could result in higher prices for the Company's products which the
Company may not be able to pass on to its customers. Any such failure could
negatively impact the Company's business, financial condition or results of
operations.
TRADEMARKS AND COPYRIGHTS
The Company does not own trademarks or copyrights on properties on which most of
its current products are based. These rights are typically owned or controlled
by the creator of the property or by the entity which develops or promotes a
property, such as a motion picture or television producer. Equity Marketing is
the owner of the Headliners(R) trademark.
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COMPETITION
The domestic and international promotions and consumer products businesses are
highly competitive. In its core domestic promotions business, Equity Marketing
competes with several other companies, the most significant of which is Alcone
Marketing Group, a subsidiary of the Omnicom Group, Inc. Other competitors in
promotions include HA-LO Industries, Inc., Promotional Partners International
and Simon Marketing, Inc., a division of Cyrk, Inc. Competition in the
international promotions industry includes local companies in each market and a
small number of emerging international promotions companies. The Company expects
that in 2000, the principal competitors to the Company's consumer products
business will be smaller toy companies like Play By Play Toys & Novelties, Inc.
and Toy Biz, Inc. However, the toy industry includes major toy and game
manufacturers such as Hasbro, Inc. and Mattel, Inc. that compete in some of the
same product categories as Equity Consumer Products. The Company believes the
principal competitive factors affecting its business are creative execution,
license selection, price, product quality and speed of production. The Company's
consumer products competitors include companies which have far more extensive
sales and development staffs and significantly greater financial resources than
does the Company. There can be no assurance that the Company will be able to
compete effectively against such companies in the future.
GOVERNMENT REGULATION
In the United States, the Company is subject to the provisions of, among other
laws, the Federal Consumer Product Safety Act and the Federal Hazardous
Substances Act (the "Acts"). The Acts empower the Consumer Product Safety
Commission (the "CPSC") to protect the public against unreasonable risks of
injury associated with consumer products, including toys and other articles. The
CPSC has the authority to exclude from the market articles which are found to be
hazardous and can require a manufacturer to repair or repurchase such toys under
certain circumstances. Any such determination by the CPSC is subject to court
review. Violations of the Acts may also result in civil and criminal penalties.
Similar laws exist in some states and cities in the United States and in many
jurisdictions throughout the world. The Company performs quality control
procedures (including the inspection of goods at factories and the retention of
independent testing laboratories) to ensure compliance with applicable laws.
Notwithstanding the foregoing, there can be no assurance that all of the
Company's products are or will be hazard-free. Any material product recall could
have a material adverse effect on the Company's results of operations and
financial condition and could also negatively effect the Company's reputation
and the sales of its other products. (see "Legal Proceedings" below)
EMPLOYEES
As of December 31, 1999, Equity Marketing employed 148 individuals, including 40
individuals employed by and located at Equity Marketing HK. In addition, the
Company utilizes, on an ongoing basis, the services of freelance artists and
other temporary staff. Equity Marketing believes it maintains satisfactory
relations with its employees.
ITEM 2. PROPERTIES
On January 4, 1999, Equity Marketing occupied its corporate offices and studio
facilities of approximately 54,000 square feet of leased space in Los Angeles,
California. The lease expires July 31, 2005. Equity Marketing Hong Kong, Ltd.
occupies approximately 6,000 square feet of leased space in Hong Kong, under a
lease which expires August 31, 2002.
ITEM 3. LEGAL PROCEEDINGS
POKEMON RECALL AND RELATED MATTERS
On December 27, 1999, Burger King announced that in cooperation with the CPSC it
would conduct a voluntary recall of Pokemon(TM) balls included with Burger King
kids meals. The recall resulted primarily from the death of a 13 month old child
in Sonora, California on December 11, 1999. The child reportedly suffocated when
one half of a Pokemon(TM) ball covered her nose and mouth. In announcing the
recall, Burger King stated that the balls may pose a suffocation hazard to
children under three years of age. Burger King further stated that consumers
should immediately take the balls away from children under the age of three and
either discard the balls or return them to a Burger King restaurant in exchange
for a free small order of french fries. Subsequent to the announcement of the
recall, on January 25, 2000, a 4 month old child in Indianapolis, Indiana also
reportedly suffocated when one half of a Pokemon(TM) ball covered his nose and
mouth.
The Company designed and manufactured 151 trading cards and 57
gift-with-purchase products based on Pokemon(TM) for Burger King. The Company
believes that these products met or exceeded federal safety guidelines and
underwent rigorous safety testing by an independent, third party laboratory
during and after production.
Burger King and its franchisees incurred substantial costs in the conduct of the
Pokemon(TM) ball recall, including costs for legal expenses, advertising,
collection and destruction of Pokemon (TM) balls, and free goods. Although the
Company strongly believes it met all of its contractual obligations with respect
to the Pokemon (TM) ball, Burger King and its franchisees may request
indemnification for some or all of these costs. While the Company cannot
currently estimate the amount of such costs, management believes that the
payment by the Company of the costs incurred in the conduct of the Pokemon(TM)
ball recall could have a material adverse effect on the Company's business,
financial condition and results of operations. As of the date hereof, Burger
King has not requested indemnification for such costs.
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On January 21, 2000, a purported class action lawsuit entitled Domingo
Quintinilla v. Tex-Best Travel Centers, Inc., Burger King Corporation, and
Equity Marketing, Inc. was filed in the District Court of Hidalgo County, Texas.
The lawsuit was filed by an individual purporting to represent all individuals
in the United States that received a Pokemon(TM) ball from a Burger King(R)
restaurant. The lawsuit alleges that the Pokemon(TM) ball is unsafe and asserts
causes of action for breach of contract, breach of warranty, negligence,
negligent misrepresentation and gross negligence and seeks an unspecified amount
of damages and attorneys fees. Equity Marketing filed its answer on February 23,
2000. The lawsuit is in the early discovery phase.
On February 28, 2000, a class action lawsuit entitled Scott Pace and Diane
Mitchell Bubonic v. Burger King Corporation, Case No. 310285, was filed in the
Superior Court of the State of California for the City and County of San
Francisco. The lawsuit was filed by individuals purporting to represent all
individuals in the State of California that received a Pokemon(TM) ball from a
Burger King(R) restaurant. The lawsuit alleges that the Pokemon(TM) ball is
unsafe and asserts causes of action for breach of implied warranty and fraud in
the sale of consumer goods, and seeks an unspecified amount of damages and
attorneys fees.
The Company may be contractually required to indemnify Burger King and its
franchisees for the expenses and damages, if any, incurred in connection with
these lawsuits. Burger King has requested indemnification for such expenses and
damages, if any. While the Company believes these lawsuits are without merit and
intends to defend them vigorously, they may, regardless of the outcome, result
in substantial expenses and damages to the Company and may significantly divert
the attention of the Company's management. There can be no assurance that the
Company will be able to achieve a favorable settlement of these lawsuits or
obtain a favorable resolution of such lawsuits if they are not settled. An
unfavorable resolution of these lawsuits or prolonged litigation, the costs of
which may be substantial, could have a material adverse effect on the Company's
business, financial condition and results of operations.
GENERAL LITIGATION
The Company is involved in various other legal proceedings generally incidental
to its business. While the result of any litigation contains an element of
uncertainty, management presently believes that the outcome of any other known,
pending or threatened legal proceeding or claim, individually or combined, will
not have a material adverse effect on the Company's financial position or
results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock is traded on the Nasdaq National Market under the
symbol EMAK.
As of March 15, 1999 there were approximately 1,750 holders of record of the
Company's Common Stock.
The Company currently has no plans to pay dividends on its Common Stock. The
Company intends to retain all earnings for use in its business. Under the
Company's current credit facility, the Company cannot pay dividends on its
Common Stock without the prior consent of the lenders (see Note 7 of the
accompanying Notes to Consolidated Financial Statements).
The following table sets forth the high and low sales prices on the Nasdaq
National Market for the calendar periods indicated:
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PRICE RANGE OF COMMON STOCK
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1998 1999
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HIGH LOW HIGH LOW
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First Quarter 27 19 15/16 9 11/16 5 1/4
Second Quarter 24 1/8 19 5/8 10 7/8 5 1/2
Third Quarter 21 7/8 6 1/4 15 11/16 10 1/16
Fourth Quarter 11 1/2 5 3/8 19 7/16 11 5/8
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ITEM 6. SELECTED FINANCIAL DATA
The following table presents certain selected consolidated financial and
operating data for the Company as of and for each of the years in the five-year
period ended December 31, 1999. The selected consolidated financial and
operating data in the tables should be read in conjunction with the Company's
Consolidated Financial Statements and the notes thereto, which have been audited
by Arthur Andersen LLP, independent public accountants, as indicated in their
reports included elsewhere herein and in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
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YEAR ENDED DECEMBER 31, 1995 1996 1997 1998 1999
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(in thousands, except share and per share data)
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CONSOLIDATED STATEMENTS OF OPERATIONS AND PER SHARE DATA:
Revenues $ 84,015 $ 111,687 $ 146,328 $ 159,136 $ 227,063
Cost of sales 63,398 79,295 105,310 112,153 170,416
Provision for production-in-process losses -- -- -- 2,666 --
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Gross Profit 20,617 32,392 41,018 44,317 56,647
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Operating expenses:
Salaries, wages and benefits 6,678 9,617 11,563 14,550 17,350
Selling, general and administrative 6,987 11,360 14,330 22,127 22,829
AmeriServe bankruptcy bad debt expense -- -- -- -- 1,014
Impairment of assets -- -- -- 6,712 --
Business process reengineering -- -- -- 2,220 --
Restructuring loss (gain) -- -- -- 4,121 (604)
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Total operating expenses 13,665 20,977 25,893 49,730 40,589
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Income (loss) from operations 6,952 11,415 15,125 (5,413) 16,058
Other income (expense), net 449 259 522 (511) (510)
- -----------------------------------------------------------------------------------------------------------------------
Income (loss) before provision
for income taxes 7,401 11,674 15,647 (5,924) 15,548
Provision for income taxes 2,812 4,231 6,024 69 6,134
- -----------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 4,589 $ 7,443 $ 9,623 $ (5,993) $ 9,414
=======================================================================================================================
Basic Income (Loss) Per Share:
Earnings (loss) per share $ 0.83 $ 1.33 $ 1.63 $ (0.98) $ 1.51
=======================================================================================================================
Basic weighted average shares
outstanding 5,527,429 5,598,268 5,913,313 6,089,618 6,227,842
=======================================================================================================================
Diluted Income (Loss) Per Share:
Earnings (loss) per share $ 0.80 $ 1.26 $ 1.55 $ (0.98) $ 1.46
=======================================================================================================================
Diluted weighted average shares
outstanding 5,728,549 5,891,357 6,216,794 6,089,618 6,440,738
=======================================================================================================================
</TABLE>
9
<PAGE> 10
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1995 1996 1997 1998 1999
- ------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Working capital $ 12,446 $ 17,952 $ 28,128 $ 4,268 $ 11,045
Total assets 26,262 37,193 57,153 115,480 97,244
Long-term debt -- -- -- -- --
Stockholders' equity 14,882 25,033 36,140 32,407 42,025
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the Company's operating
expenses as a percentage of its total revenues:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997 1998 1999
- -----------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues 100.0% 100.0% 100.0%
Cost of sales 72.0% 70.5% 75.1%
Provision for production-in-process losses --% 1.7% --%
- -----------------------------------------------------------------------------------
Gross Profit 28.0% 27.8% 24.9%
- -----------------------------------------------------------------------------------
Operating expenses:
Salaries, wages and benefits 7.9% 9.1% 7.6%
Selling, general and administrative 9.8% 13.9% 10.1%
AmeriServe bankruptcy bad debt expense --% --% .4%
Impairment of assets --% 4.2% --%
Business process reengineering --% 1.4% --%
Restructuring loss (gain) --% 2.6% (0.3)%
- -----------------------------------------------------------------------------------
Total operating expenses 17.7% 31.2% 17.8%
- -----------------------------------------------------------------------------------
Income (loss) from operations 10.3% (3.4)% 7.1%
Other income (expense), net .4% (0.4)% (0.2)%
- -----------------------------------------------------------------------------------
Income (loss) before provision for
income taxes 10.7% (3.8)% 6.9%
Provision for income taxes 4.1% 0.0% 2.7%
- -----------------------------------------------------------------------------------
Net income (loss) 6.6% (3.8)% 4.2%
===================================================================================
</TABLE>
EBITDA
While many in the financial community consider earnings before interest, taxes,
depreciation and amortization, interest, other income, business process
reengineering, impairment of assets, restructuring charges, and provision for
production-in-process losses ("EBITDA") to be an important measure of
comparative operating performance, it should be considered in addition to, but
not as a substitute for or superior to, operating income, net earnings, cash
flow and other measures of financial performance prepared in accordance with
accounting principles generally accepted in the United States. EBITDA does not
reflect cash available to fund cash requirements, and the items excluded from
EBITDA, such as depreciation and amortization, are significant components in
assessing the Company's financial performance. Other significant uses of cash
flows are required before cash will be available to the Company, including debt
service, taxes and cash expenditures for various long-term assets. The Company's
calculation of EBITDA may be different from the calculation used by other
companies and, therefore, comparability may be limited. The following table sets
forth EBITDA for the years indicated:
10
<PAGE> 11
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997 1998 1999
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income (loss) $ 9,623 $ (5,993) $ 9,414
Less: Interest income (611) (272) (138)
Other income -- -- (233)
Restructuring gain -- -- (604)
Add: Depreciation and amortization 1,247 2,022 2,708
Interest expense 89 783 881
Provision for production-in-process losses -- 2,666 --
Business process reengineering -- 2,220 --
Restructuring charge -- 4,121 --
Impairment of assets -- 6,712 --
Provision for income taxes 6,024 69 6,134
---------------------------------------
EBITDA $ 16,372 $ 12,328 $ 18,162
=======================================
</TABLE>
Year ended December 31, 1999 compared to year ended December 31, 1998
Revenues in 1999 increased $67,927 or 43% to $227,063 from $159,136 in 1998.
Promotions revenues increased $85,915 or 73.9% to $202,195 primarily as a result
of large Burger King promotions in 1999 associated with Warner Bros.' Wild Wild
West movie and Pokemon: The First Movie. Promotions revenue also increased as a
result of the addition of oil and gas promotion revenue generated by USI which
was acquired in the third quarter of 1998. Consumer products revenues decreased
$17,988 or 42% to $24,868 from $42,856 in 1998 primarily due to decreased sales
under event-based-licensed consumer products which the Company decided to exit
in December 1998.
Cost of sales, excluding the provision for production-in-process losses in 1998,
increased $58,263 to $170,416 (75.1% of revenues) from $112,153 (70.5% of
revenues) in 1998 due primarily to higher sales in 1999. The provision for
production-in-process losses of $2,666 recorded in 1998 represents a write-off
of tooling and development costs of consumer product lines which the Company has
decided to exit. The gross margin percentage for the year decreased to 24.9%
from 27.8% in 1998 due primarily to the planned shift in the company's revenue
mix, which was 89% promotions and 11% consumer products, compared to 73% and
27% for promotions and consumer products, respectively, in 1998.
Salaries, wages and benefits increased $2,800, or 19.2% to $17,350 (7.6% of
revenues). This increase was primarily attributable to the accrual of
bonuses for employees in 1999 and the full year impact of addition of employees
from the acquisitions of Corinthian and USI. This increase was partially offset
by staffing reductions resulting from the Company's decision to exit the
event-based-license consumer products business in December 1998.
Selling, general and administrative expenses increased $702, or 3.2% to $22,829
(10.1% of revenues). This increase is due to increased depreciation and
amortization expense associated with higher fixed asset levels in 1999 and
amortization of intangibles related to the acquisitions of Corinthian in April
1998 and USI in July 1998. The increase is also attributable to increased
freight out and warehousing costs resulting from the increase in sales volume,
increased support costs associated with the Company's new enterprise resource
planning system (see "Information Systems"), and increased occupancy costs
partially offset by a decrease in advertising expense and development costs.
Selling, general and administrative expenses decreased as a percentage of
revenues from 13.9% to 10.1% as a result of revenues which increased at a
greater rate.
The AmeriServe bad debt expense represents a charge resulting from the
bankruptcy of AmeriServe Food Distribution, Inc. ("AmeriServe"). (see
"AmeriServe Bankruptcy")
The restructuring gain primarily represents a reversal of a portion of the 1998
restructuring charge related to projected minimum royalty guarantee shortfalls
as a result of negotiated settlements with certain licensors.
Other expense is composed primarily of net interest expense of $743 and gains on
sales of fixed assets of $233. Net interest expense increased $232 from $511 in
1998 as a result of the Company's short-term debt borrowing throughout 1999
compared to borrowings primarily in the second half of 1998.
The effective tax rate changed in 1999 to 39.5% from .01% in 1998. The 1998 tax
rate was a result of taxable income generated despite a book loss being recorded
for 1998. Taxable income in 1998 was due to the writedown of non-deductible
goodwill related to EPI and amortization of other non-deductible goodwill.
11
<PAGE> 12
Net income (loss) increased $15,407 or 257% to $9,414 in 1999 (4.2% of revenues)
from $(5,993) ((3.8%) of revenues) primarily due to greater gross profit earned
on the increased revenues in 1999 and the restructuring gain of $604. The 1998
net loss resulted from charges for restructuring, business process
reengineering, and impairment of assets discussed below. Net income for 1999 was
partially offset by increases in salaries, wages and benefits, selling, general
and administrative expenses, and the AmeriServe bankruptcy bad debt expense.
Excluding the impact of the restructuring gain and the AmeriServe bad debt
expense, the Company would have reported net income of approximately $9,700 or
$1.50 per diluted share in 1999.
EBITDA in 1999 increased $5,834 or 47.3% to $18,162 from $12,328 in 1998
primarily due to greater gross profit earned on increased revenues in 1999. This
increase was partially offset by the increase in salaries, wages and benefits
and selling, general and administrative for the year ended December 31, 1999.
Year ended December 31, 1998 compared to year ended December 31, 1997
Revenues in 1998 increased $12,808 or 8.8% to $159,136 from $146,328 in 1997.
This increase was the result of increased revenues for both Consumer Products
and Promotions. Revenues for the Consumer Products division increased $12,550 or
41.4% to $42,856 from $30,306 primarily due to sales of Headliners(R) product
subsequent to the acquisition of Corinthian. Promotions' revenues increased $258
or 0.2% to $116,280 due to a large promotion associated with Nickelodeon's The
Rugrats Movie as well as additional oil and gas promotion revenue generated
subsequent to the acquisition of USI. These increases were offset by slowed
promotional activities in Latin America and Asia due to those regions' weak
economic conditions compared to the corresponding period in the prior year.
Cost of sales, excluding the provision for production-in-process losses,
increased $6,843, or 6.5% to $112,153 in 1998 (70.5% of revenues) from $105,310
(72% of revenues) in 1997. This increase was due to increased sales in 1998. The
provision for production-in-process losses of $2,666 recorded in 1998 represents
a write-off of tooling and development costs of consumer product lines which the
Company has decided to exit. Gross profit as a percentage of revenues decreased
slightly in 1998 from 1997 due primarily to write-downs on excess inventories of
toys based on licenses that the Company has decided not to renew for 1999 and
the provision for production-in-process losses, offset by a more profitable mix
of revenues in 1998.
Salaries, wages and benefits increased $2,987, or 25.8% to $14,550 (9.1% of
revenues). This increase was attributable to the full year impact of employees
added throughout 1997, the addition of employees in the first half of 1998 and
to the addition of employees from the acquisitions of Corinthian and USI.
Selling, general and administrative expenses increased $7,797, or 54.4% to
$22,127 (13.9% of revenues). This increase is due to increased depreciation and
amortization expense (increase of $775) associated with higher fixed asset
levels in 1998 and amortization of intangibles related to the acquisitions of
Corinthian in April 1998 and USI in July 1998. The increase is also attributable
to increased marketing costs for the consumer product lines (increase of
$2,930), increased commissions and other selling expenses associated with the
increase in sales (increase of $979), increased development costs (increase of
$1,383), increased occupancy costs for facilities to support the higher number
of employees (increase of $566) and increased bad debt expense (increase of
$1,343) in 1998. The Company recorded a charge for impairment of assets of
$6,712 for write-downs associated with the impairment of the goodwill and other
intangibles generated by the Company's purchase of EPI Group Limited ("EPI") in
1996, as a result of that subsidiary's loss of its primary customer, Shell Oil
Company, as a result of that Company's merger with Texaco, as well as for
write-offs of royalty advances paid on long-term licenses the Company has
decided to exit.
The Company recorded a restructuring charge of $4,121 in the fourth quarter of
1998. This charge is related to the Company's decision to exit the event-based-
license consumer product business along with its retail pin business. This
charge reflected royalty guarantees yet to be paid on licenses the Company has
exited or is planning to exit as well as severance and other charges associated
with staff reductions and the closure of the Company's warehouse facility. For
the years ended December 31, 1997 and 1998 the total Consumer Product revenues
from the licenses that the Company has decided not to continue amounted to
$28,807 and $30,046, respectively. For the years ended December 31, 1997 and
1998, the cost of sales associated with these revenues totaled $20,412 and
$23,657, respectively.
Business process reengineering of $2,220 for the year ended December 31, 1998,
represents costs associated with the replacement of the Company's computer
systems. (see "INFORMATION SYSTEMS")
Other expense is composed primarily of net interest expense. Net interest
expense was $511 in 1998 compared to net interest income of $522 in 1997
primarily as a result of the Company's short-term borrowings in the second half
of 1998.
The effective tax rate changed in 1998 to 0.01% from 38.5% in 1997. This change
is attributable primarily to the addition of non-deductible goodwill from the
purchase of Corinthian as well as to the write-down of non-deductible goodwill
related to EPI. This resulted in taxable income despite the loss recorded in
1998.
Net income (loss) decreased $15,616, or 162.3% to $(5,993) ((3.8) % of revenues)
in 1998 from $9,623 (6.6% of revenues) in 1997 primarily due to the factors
previously discussed. Excluding the impact of restructuring charges, asset
impairment charges, provisions for production-in-process losses and the business
process reengineering costs related to replacement of its information systems
incurred in 1998, the Company would have reported net income for 1998 of
approximately $5,700, or $0.90 per diluted share.
12
<PAGE> 13
EBITDA in 1998 decreased $4,044 or 24.7% to $12,328 from $16,372 in 1997
primarily due to the various factors discussed above.
FINANCIAL CONDITION AND LIQUIDITY
As of December 31, 1999, the Company's investment in net accounts receivable
decreased $19,686 from the balance at December 31, 1998. This decrease was
primarily attributable to the sale of the AmeriServe trade receivables to
Restaurant Services, Inc. ("RSI") in exchange for a note receivable and
satisfaction of certain contractual obligations owed to RSI (see "AmeriServe
Bankruptcy" below). At December 31, 1999, inventory decreased $4,375 from
December 31, 1998 primarily as a result of reduced consumer products inventory
subsequent to the Company's decision to exit the event-based-licensed consumer
product business.
At December 31, 1999, accounts payable and due to customer decreased $6,706 and
$4,248, respectively, from the prior year. Accrued liabilities, including
accrued payroll and payroll related costs, increased $302 to $14,283 from
$13,981. The decrease in accounts payable was primarily attributable to payments
to vendors associated with the manufacturing related to the large fourth quarter
1998 promotional programs. The decrease in due to customer was primarily as a
result of the satisfaction of certain contractual obligations owed to RSI. The
increase in accrued liabilities, including accrued payroll and payroll related
costs, was primarily attributable to increased accruals for employee bonuses.
At December 31, 1999, working capital was $11,045 compared to $4,268 at December
31, 1998. The increase in working capital was primarily due to the cash
generated by operating activities in 1999. The Company did not have any
significant investing activities during the year. The Company believes that its
cash from operations, cash on hand at December 31, 1999 and its credit facility
will be sufficient to fund its working capital needs for at least the next
twelve months. The statements set forth herein are forward-looking and actual
results may differ materially. (see "Credit Facilities" and Note 7 of the
accompanying Notes to Consolidated Financial Statements)
At December 31, 1999, the Company has commitments for guaranteed royalty and
advertising payments totaling $1,295 for the years ended December 31, 2000 and
2001. The Company had no material commitments for capital expenditures at
December 31, 1999. (see Note 11 of the accompanying Notes to Consolidated
Financial Statements)
CREDIT FACILITIES
The Company maintains and periodically amends or replaces a credit agreement
with two commercial banks that is utilized to finance the seasonal working
capital requirements of its operations. The credit facility is secured by
substantially all of the Company's assets. The agreement, as amended on March
13, 2000, provides for a line of credit of $25,000 through June 30, 2001 with
borrowing availability determined by a formula based on qualified assets. As of
December 31, 1999, $12,500 was outstanding under the credit facility. Letters of
credit outstanding as of December 31, 1999 was $401. The credit agreement
requires the Company to comply with certain financial covenants, including
minimum tangible net worth, minimum current ratio, ratio of total liabilities to
net worth, maximum funded debt coverage ratio, minimum fixed charge coverage
ratio and net profit after taxes. As of December 31, 1999, the Company was in
compliance with these covenants.
INFLATION
The effect of inflation on the Company's operations during 1999 was
insignificant. The Company will continue its policy of controlling costs and
adjusting prices to the extent permitted by competitive factors.
INFORMATION SYSTEMS
Year 2000 Update
To address the year 2000 issue the Company established and implemented a plan to
remediate and test its most critical computer systems and applications,
including its enterprise resource planning system, computer networks and desktop
applications. The plan also included steps to verify that all key third-party
suppliers and customers were taking measures to ensure their own readiness.
Based on strategic and operational assessments, the Company decided to replace
its existing information systems in 1998. The new enterprise resource planning
system is designed to enhance management information, financial reporting,
inventory management, order entry and cost evaluation and control and has the
added benefit of addressing the year 2000 issue. The new enterprise resource
planning system went into operation in January 1999. All phases of the year 2000
readiness plan were completed as scheduled. To date, the Company has not
experienced any material year 2000 issues with its internal systems or with its
third party customers and suppliers. In addition, the Company did not experience
any loss of revenues due to the year 2000 issue.
Although unlikely given that the Company has not experienced any year 2000
issues to date, there can be no assurance that any future unforeseen year 2000
issues will not materially adversely affect the Company's results of operations,
liquidity and financial position or adversely affect the Company's relationships
with customers, vendors or others.
13
<PAGE> 14
Costs to Address the Year 2000 Issue
As of December 31, 1999 the Company has spent approximately $4,302 on the
conversion to the new enterprise resource planning system, of which
approximately $2,220 was spent on business process reengineering in 1998. In
accordance with Emerging Issues Task Force Issue no. 97-13, such business
process reengineering costs were expensed as incurred. Approximately $2,082 of
these costs have been capitalized and are reflected in fixed assets in the
accompanying consolidated balance sheets.
AMERISERVE BANKRUPTCY
The Company regularly extends credit to several distribution companies in
connection with its business with Burger King. One of these distribution
companies, AmeriServe Food Distribution, Inc. together with certain of its
affiliates (including its affiliates, "AmeriServe") accounted for more than 50
percent of the products purchased from the Company by the Burger King system in
1999. AmeriServe filed a voluntary petition under Chapter 11 of the United
States Bankruptcy Code on January 31, 2000. As of January 31, 2000, AmeriServe
owed the Company approximately $28.8 million in trade receivables. AmeriServe
was able to secure temporary debtor in possession funding to enable it to
continue operating in the short-term post bankruptcy.
RSI, a not-for-profit purchasing cooperative that has as its members Burger King
franchisees and Burger King, is the exclusive purchasing agent for the Burger
King system of franchisee-owned and company-owned restaurants located in the
United States. Subsequent to January 31, 2000, the Company reached an agreement
with RSI in which RSI purchased all pre-petition trade receivables owed to the
Company by AmeriServe in exchange for a two-year non-interest-bearing note
valued at approximately $16.0 million and satisfaction of certain contractual
obligations owed by the Company to RSI. This agreement resulted in a net pre-tax
charge of approximately $1.0 million for the quarter ended December 31, 1999. A
note receivable of approximately $10.5 million, $5.5 million of which has been
classified as long-term, has been recorded on the accompanying consolidated
balance sheet as of December 31, 1999. Approximately $6.6 million of the $28.8
million pre-petition trade receivables relate to sales made in January 2000.
Accordingly, the remaining $5.5 million portion of the note receivable was
recorded in January 2000, and will result in a net pre-tax charge of
approximately $0.5 million for the quarter ending March 31, 2000.
Burger King has assumed responsibility for all payments of the Company's
post-petition shipments to AmeriServe. There can be no assurance, however, that
AmeriServe will successfully reorganize and emerge from Chapter 11 proceedings.
In this event, the Company believes it can either ship Burger King product
directly to franchisees or to alternative distribution companies established in
place of AmeriServe; provided, however, that direct shipments to franchisees may
result in substantial additional expenses to the Company and that alternative
distribution companies may not be available to service certain or all of the
geographic areas currently serviced by AmeriServe. Accordingly, any failure by
AmeriServe to successfully reorganize and emerge from Chapter 11 proceedings
could negatively impact the Company's business, financial condition, and results
of operations. The statements set forth herein are forward looking and actual
results may differ materially.
CAUTIONARY STATEMENTS AND RISK FACTORS
This section is written to be responsive to the Securities and Exchange
Commission's "Plain English" guidelines. In this section the words "we", "our",
"ours" and "us" refer only to Equity Marketing, Inc. and its subsidiaries and
not any other person. Set forth below and elsewhere in this Form 10-K and in
other documents we file with the Securities and Exchange Commission are
important risks and uncertainties that could cause our actual results of
operations, business and financial condition to differ materially from the
results contemplated by the forward looking statements contained in this Form
10-K.
We Depend On One Key Customer
Our success depends on a single customer, Burger King, which accounted for
approximately 67%, 63% and 80% of our revenues for the years ended December 31,
1997, 1998 and 1999, respectively. Burger King has no contractual commitment to
do business with us. There can be no assurance that Burger King will do business
with us in the future. The termination or a significant reduction by Burger King
of its business with us would adversely affect our business. (see
"Business--Equity Promotions" and Note 12 of Notes to Consolidated Financial
Statements)
We Face Credit Risk
We regularly extend credit to several distribution companies in connection with
our business with Burger King. Failure by one or more distribution companies to
honor their payment obligations to us could have a material adverse effect on
our operations.
One of these distribution companies, AmeriServe, accounted for more than 50
percent of the products purchased from us by the Burger King system in 1999.
AmeriServe filed a voluntary petition under Chapter 11 of the United States
Bankruptcy Code on January 31, 2000. As of January 31, 2000, AmeriServe owed us
approximately $28.8 million in trade receivables. AmeriServe was able to secure
temporary debtor in possession funding to enable it to continue operating in the
short-term post bankruptcy.
14
<PAGE> 15
RSI, a not-for-profit purchasing cooperative that has as its members Burger King
franchisees and Burger King, is the exclusive purchasing agent for the Burger
King system of franchisee-owned and company-owned restaurants located in the
United States. Subsequent to January 31, 2000, we reached an agreement with RSI
in which RSI purchased all pre-petition trade receivables owed to us by
AmeriServe in exchange for a two-year non-interest-bearing note valued at
approximately $16.0 million and the satisfaction of certain contractual
obligations which we owed to RSI. This agreement resulted in a net pre-tax
charge of approximately $1.0 million for the quarter ended December 31, 1999. A
note receivable of approximately $10.5 million, $5.5 million of which has been
classified as long-term, has been recorded on the accompanying consolidated
balance sheet as of December 31, 1999. Approximately $6.6 million of the $28.8
million pre-petition trade receivables relate to sales made in January 2000.
Accordingly, the remaining $5.5 million portion of the note receivable was
recorded in January 2000, and will result in a net pre-tax charge of
approximately $0.5 million for the quarter ending March 31, 2000.
Burger King has assumed responsibility for all payments of our post-petition
shipments to AmeriServe. There can be no assurance, however, that AmeriServe
will successfully reorganize and emerge from Chapter 11 proceedings. In this
event, we believe we can either ship Burger King product directly to franchisees
or to alternative distribution companies established in place of AmeriServe;
provided, however, that direct shipments to franchisees may result in
substantial additional expenses to us and that alternative distribution
companies may not be available to service certain or all of the geographic areas
currently serviced by AmeriServe. Accordingly, any failure by AmeriServe to
successfully reorganize and emerge from Chapter 11 proceedings could negatively
impact our business, financial condition, and results of operations.
Our Future Operating Results are Unpredictable
We experience significant quarter-to-quarter variability in our revenues and net
income. The promotions business tends to include larger promotions in the summer
and during the winter holiday season. Major movie and television release
schedules also vary year-to-year, influencing the promotional schedules of our
customers, as well as the particular promotions for which we are retained. The
motion picture or television characters on which the promotions business is
based may only be popular for short periods of time or not at all. There may not
be comparable popular characters or similar promotional campaigns in the future.
Due to the foregoing factors, we believe that quarter-to-quarter comparisons of
our operating results are not a good indication of our future performance. It is
likely that in some future quarter our operating results may fall below the
expectations of securities analysts and investors. In this event, the trading
price of our Common Stock may fall significantly.
The Success of Our Products Depend on the Popularity of Licensed Materials
Our promotional and consumer products are typically based on entertainment
properties, such as characters from current motion pictures or television
programs. The success of these products depends on the popularity of the
entertainment properties on which they are based. Each motion picture and
television program is an individual artistic work, and its commercial success is
dependent on unpredictable consumer preferences. Often we spend substantial
resources in obtaining licenses and developing and manufacturing products prior
to a release of the motion picture or television program upon which the products
are based. Our customers, such as Burger King, typically require delivery
schedules that coincide with the release of the underlying entertainment
properties. Our results of operations may be adversely affected if the
entertainment properties upon which our products are based turn out to be less
popular than we anticipate. Also, delays in the release of motion pictures or
television programs could result in delays or cancellations of our promotions.
(see "Business--Equity Promotions")
We Rely on a Limited Number of Nonrenewable Product Orders
A large portion of our revenues come from a relatively limited number of
promotional programs by Burger King, which promotions are in effect for only a
limited period of time and generally are not repeated. We must continually
develop and sell new products and services for utilization in new promotional
programs (see "Business--Equity Promotions"). Many consumer products are
successfully marketed for only one or two years as a result of changing consumer
preferences. Accordingly, our consumer products business depends on the ability
to develop and market new products associated with new entertainment properties
or proprietary concepts. There can be no assurance that any new retail product
line will be successful (see "Business--Equity Consumer Products"). The
cancellation or premature termination of one or more retail product lines or
promotional programs, because of our inability to renew or extend licenses
(which typically have terms of three years or less) on favorable terms or
otherwise, or a significant change in promotional practices within the fast-food
restaurant industry, could have a material adverse effect on us. In addition,
there can be no assurance that we or our customers will be able to secure
licenses for additional entertainment properties on which to base our
promotional and consumer products or that, if secured, such licenses will result
in successful products.
Our Markets Are Highly Competitive
The markets in which our businesses operate are highly competitive. Our
competitors include companies which have far more extensive sales and
development staffs and significantly greater financial, marketing and other
resources than we do. There can be no assurance that we will be able to compete
effectively against such companies.
15
<PAGE> 16
We Rely on Foreign Manufacturers
During 1999, approximately 95% of our products were manufactured in China.
Foreign manufacturing is subject to a number of risks, including transportation
delays and interruptions, political and economic disruptions, the imposition of
tariffs, quotas and other import or export controls, and changes in governmental
policies. China currently enjoys "normal trade relations" ("NTR") status under
US tariff laws, which provides a favorable category of US import duties. As a
result of continuing concerns in the US Congress regarding China's human rights
policies, and disputes regarding Chinese trade policies, including the country's
inadequate protection of US intellectual property rights, there has been, and
may be in the future, opposition to the annual extension of NTR status for
China. In 2000, however, there will be, for the first time, a major effort in
the US Congress to pass legislation that would make permanent China's NTR status
in return for the country's expected accession to the World Trade Organization.
The loss of NTR status for China would result in a substantial increase in the
import duty for our products manufactured in China and imported into the US and
would result in increased costs for us. The impact of such an event on us could
be somewhat mitigated by our ability to source product for the US market from
countries other than China.
We Face Foreign Currency Risk
As part of our business, we enter into contracts for the purchase and sale of
products with entities in foreign countries. While the vast majority of our
contracts are denominated in U.S. dollars, significant fluctuations in the local
currencies of the entities with whom we transact business may adversely affect
these entities' abilities to fulfill their obligations under their contracts.
There Are Risks Associated with Acquisitions
We acquired USI and Corinthian in 1998. Both of these acquisitions were based on
the expectation that they would result in a number of benefits, including cost
savings, operating efficiencies, revenue enhancements and other synergies.
Products acquired in the Corinthian acquisition, principally the Headliners(R)
brand, did not perform as planned in 1999. To counteract soft 1999 sales in the
sports collectibles market, the Company repositioned the Headliners(R) brand as
a personality collectible. There can be no assurance that the results of the
Headliners(R) brand will improve in 2000. Any such failure could negatively
impact the Company's business, financial condition or results of operations and
result in the write-off of some or all of the goodwill associated with the
Corinthian acquisition currently carried on the Company's balance sheet.
If we are presented with appropriate opportunities, we intend to make
investments in complementary companies, products or technologies. We may not
realize the anticipated benefits of any acquisitions or investment. If we buy a
company, we could have difficulty in assimilating that company's personnel and
operations. In addition, the key personnel of the acquired company may decide
not to work for us. If we make other types of acquisitions, we could have
difficulty in assimilating the acquired technology or products into our
operations. These difficulties could disrupt our ongoing business, distract our
management and employees and increase our expenses. Future acquisitions could
result in potentially dilutive issuances of equity securities, the incurrence of
debt, contingent liabilities and/or amortization expenses related to goodwill
and other intangible assets, which could adversely affect our results of
operations and financial condition.
We May Need Additional Capital
We require substantial working capital to fund our business. Although we believe
that we have adequate working capital to fund operations through at least
December 31, 2000, we may need to raise additional funds in the future. If we
raise additional funds through the issuance of equity, equity-related or debt
securities, such securities may have rights, preferences or privileges senior to
those of the rights of our Common Stock and our stockholders may experience
additional dilution. We cannot be certain that additional financing will be
available to us on favorable terms when required, or at all. (see "Credit
Facilities" and Note 7 of the accompanying Notes to Consolidated Financial
Statements)
We are involved in several litigation matters in which the outcome is uncertain
and could entail significant expense
As described under Item 3 "Legal Proceedings", we are currently involved in a
number of litigation matters, including a number of purported class action
claims stemming from the recall by Burger King of Pokemon(TM) balls in December
1999. We may be contractually required to indemnify Burger King and its
franchisees for the expenses and damages, if any, incurred in connection with
these lawsuits. Burger King has requested indemnification for such expenses and
damages, if any. While we believe these lawsuits are without merit and intend to
defend them vigorously, they may, regardless of the outcome, result in
substantial expenses and damages to us and may significantly divert the
attention of our management. There can be no assurance that we will be able to
achieve a favorable settlement of these lawsuits or obtain a favorable
resolution of such lawsuits if they are not settled. An unfavorable resolution
of these lawsuits or prolonged litigation, the costs of which may be
substantial, could have a material adverse effect on our business, financial
condition and results of operations.
16
<PAGE> 17
We Face the Risk of Product Liability Claims
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.
We Face the Risk of Product Recalls
Products that we develop or sell may expose us to liability for the costs
related to product recalls. These costs can include legal expenses, advertising,
collection and destruction of product, and free goods. Our product liability
insurance coverage generally excludes such costs and damages resulting from
product recalls.
On December 27, 1999, Burger King announced that in cooperation with the CPSC it
would conduct a voluntary recall of Pokemon(TM) balls included with Burger King
kids meals. The recall resulted primarily from the death of a 13 month old child
in Sonora, California on December 11, 1999. The child reportedly suffocated when
one half of a Pokemon(TM) ball covered her nose and mouth. In announcing the
recall, Burger King stated that the balls may pose a suffocation hazard to
children under three years of age. Burger King further stated that consumers
should immediately take the balls away from children under the age of three and
either discard the balls or return them to a Burger King restaurant in exchange
for a free small order of french fries. Subsequent to the announcement of the
recall, on January 25, 2000, a 4 month old child in Indianapolis, Indiana also
reportedly suffocated when one half of a Pokemon(TM) ball covered his nose and
mouth.
We designed and manufactured 151 trading cards and 57 gift-with-purchase
products based on Pokemon(TM) for Burger King. We believe that these products
met or exceeded federal safety guidelines and underwent rigorous safety testing
by an independent, third party laboratory during and after production.
Burger King and its franchisees incurred substantial costs in the conduct of the
Pokemon(TM) ball recall, including costs for legal expenses, advertising,
collection and destruction of Pokemon(TM) balls, and free goods. Although we
strongly believe we met all of our contractual obligations with respect to the
Pokemon(TM) ball, Burger King and its franchisees may request indemnification
for some or all of these costs. While we cannot currently estimate the amount of
such costs, we believe that the payment by us of the costs incurred in the
conduct of the Pokemon(TM) ball recall could have a material adverse effect on
our business, financial condition and results of operations. As of the date
hereof, Burger King has not requested indemnification for such costs.
A Significant Portion of our Common Stock is Controlled by our Officers and
Directors
Donald A. Kurz and Stephen P. Robeck beneficially own approximately 25% and 17%,
respectively, of our outstanding Common Stock. Mr. Kurz is our Chairman of the
Board and Chief Executive Officer. Mr. Robeck is a member of the Board of
Directors and serves as a consultant to us. These stockholders, either
individually or acting together, would be able to significantly influence all
matters requiring approval by our stockholders, including the election of
directors and the approval of mergers or other business combination
transactions.
We May Issue Preferred Stock
The Board of Directors has authority to issue up to one million shares of
preferred stock, and to fix the rights, preferences, privileges and restrictions
of those shares without any further vote or action by our stockholders. The
potential issuance of preferred stock may have the effect of delaying, deferring
or preventing a change in control of the Company, may discourage bids for the
Common Stock at a premium over the market price of the Common Stock and may
adversely affect the market price of, and the voting and other rights of, the
holders of Common Stock.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Impact of Interest Rate Changes
The amounts borrowed under the Company's credit facility are at variable
interest rates and the Company is thus subject to market risk resulting from
interest rate fluctuations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the Financial Statements referred to in the accompanying
Index setting forth the consolidated financial statements of the Company,
together with the reports of Arthur Andersen LLP dated March 23, 2000.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
17
<PAGE> 18
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table provides information with respect to the executive
officers and directors of the Company.
<TABLE>
<CAPTION>
NAME AGE POSITION
------------------------------------------------------------------------------------------------
<S> <C> <C>
Donald A. Kurz 44 Chairman of the Board and Chief Executive Officer
Kim H. Thomsen 47 President, Marketing and Interactive Services, Chief
Creative Officer
Edward T. Boyd 45 Senior Vice President, Corporate Operations
Gaetano A. Mastropasqua 35 Senior Vice President, Client Services
Leland P. Smith 36 Senior Vice President, General Counsel and Secretary
John M. Weems 45 Senior Vice President, Consumer Products
Megan E. Wilde 37 Senior Vice President, Marketing Services
Teresa P. Covington 36 Vice President, Finance
Sanford R. Climan 44 Director
Lawrence Elins 52 Director
Mitchell H. Kurz 48 Director
Bruce Raben 46 Director
Stephen P. Robeck 51 Director
</TABLE>
DONALD A. KURZ became Chairman and Chief Executive Officer of Equity Marketing
in January 1999, after serving as President and Co-CEO from 1991 through 1998.
He has also served as a director since 1990, when he joined Equity Marketing as
Executive Vice President. Mr. Kurz was previously a management consultant with
the general management consulting division of Towers Perrin, where he was a vice
president and senior partner and eventually headed the firm's New York office.
Mr. Kurz earned a bachelor's degree from Johns Hopkins University and a master's
in business administration from Columbia University Graduate School of Business.
KIM H. THOMSEN joined Equity Marketing in 1991 and is currently responsible for
the creative direction for all of the company's promotions and consumer
products. She was promoted to her current post in early 2000, and has added
oversight for the company's interactive division to her responsibilities. Prior
to joining Equity Marketing, she operated her own business as a creative
consultant. Ms. Thomsen earned her bachelor's degree from Cornell University.
EDWARD T. BOYD joined Equity Marketing in early 1998 and is responsible for all
product realization, including manufacturing, quality control and distribution.
He was promoted to his current post in early 2000, and has added oversight for
the company's finance, accounting, management information systems and office
administration functions. He was previously a Senior Vice President of worldwide
operations and sourcing for Harman International Industries, a Vice President of
operations for Mattel, Inc., and Director of operations for Thomson Consumer
Electronics. He holds a bachelor's degree from the University of Portland and a
master's degree in international management from the American Graduate School of
International Management.
GAETANO A. MASTROPASQUA joined Equity Marketing in 1997 as a Senior Director
responsible for the company's Burger King account. Mr. Mastropasqua oversees the
company's Burger King business. He was promoted to his current post in early
2000, and has added oversight of the company's USI division to his
responsibilities. His prior experience includes approximately seven years with
American Express, where he ultimately became a vice president of business
development, and more than three years with Anderson Consulting in Europe. He
holds a bachelor's degree from McGill University and a master's in business
administration from the Kellogg Graduate School of Management, Northwestern.
LELAND P. SMITH joined Equity Marketing in 1998 as Senior Vice President,
General Counsel and Secretary. He is responsible for the company's legal, human
resources, corporate development and board administration. Mr. Smith was
previously Assistant General Counsel for Mattel, Inc., and an associate in the
corporate department with Riordan & McKinzie. He holds a bachelor's degree from
Amherst College and a J.D. and a master's in business administration from the
University of Southern California.
JOHN M. WEEMS joined Equity Marketing in April 1998 with the acquisition of
Corinthian Marketing, Inc. Mr. Weems was promoted to his current post in early
2000. He is responsible for management of all aspects of Equity Consumer
Products, including brand selection and management, product development,
customer service and sales and marketing. Prior to joining Equity Marketing, he
co-founded Corinthian Marketing and served as that company's chief operating
officer. In 1989, he also co-founded Morrison Entertainment Group, the creator
of the successful In My Pocket brand of collectible figurines. From 1982 to
1989, Mr. Weems held positions of increasing responsibility at Mattel, Inc.,
becoming a Senior Vice President for entertainment and marketing services in
1988. Between 1977 and 1982, he held brand manager positions at the Coca-Cola
Foods Division and at Procter & Gamble. He holds a bachelor's degree from North
Carolina State University and a master's in business administration from the
University of North Carolina.
18
<PAGE> 19
MEGAN E. WILDE joined Equity Marketing in August 1999 as Senior Vice President
of Marketing Services. In this capacity, she is responsible for the growth and
management of the Company's marketing services business. Prior to joining Equity
Marketing, Ms. Wilde was Vice President and Account Director for Frankel, a
leading, Chicago-based marketing services company. Before joining Frankel in
1996, Ms. Wilde was an Account Executive with RTC Industries, Inc., a
manufacturer of point-of-purchase and permanent merchandising. She also spent
nine years at Baxter Healthcare Corporation, where she held several sales and
marketing management positions. She earned her bachelor's degree from Duke
University.
TERESA P. COVINGTON joined Equity Marketing as Vice President of finance in
January 1999 and is responsible for the company's finance, accounting and
management information systems functions. She was previously Vice President of
operations for Harman International Industries, where she was responsible for
managing finance, accounting, quality assurance, human resources and other
activities. Ms. Covington also held several senior level operations and finance
positions at Mattel, Inc. She earned a bachelor's degree from the University of
Illinois, a master's degree in electrical engineering from the University of
Southern California and a master's in business administration from Stanford
Graduate School of Business.
SANFORD R. CLIMAN is Managing Director of Entertainment Media Ventures, a Los
Angeles-based venture capital fund focused on investment in the areas of
technology, media, and the internet. He has been an Equity Marketing director
since 1998. From June 1997 through February 1999, he was a senior executive with
Creative Artists Agency (CAA). From October 1995 through May 1998, he was an
Executive Vice President for Universal Studios and, from June 1986 through
September 1995, he was employed with CAA. Mr. Climan holds a bachelor's degree
from Harvard College, a master's of science in health policy and management from
Harvard School of Public Health and a master's in business administration from
Harvard Business School.
LAWRENCE ELINS is President of Elins Enterprises, a financial and real estate
investment company. He has been an Equity Marketing director since 1994 and was
formerly President of Applause, Inc., a toy and gift manufacturer. Mr. Elins
received his bachelor's degree from California State University, Northridge.
MITCHELL H. KURZ is the Chairman and founder of Kurz and Friends, a consulting
company to the global advertising and marketing services business. He has been
an Equity Marketing director since March 1999. Mr. Kurz retired from Young &
Rubicam Inc. in December 1998, following a 24-year career during which he held
numerous executive positions. His most recent position at Young & Rubicam was
Chairman of client services, where he oversaw key global client relationships
representing approximately 50% of the company's annual revenues. From 1996 to
1998, he was President and Chief Operating Officer of Young & Rubicam
Advertising, and from 1992 to 1996, he was Worldwide Chief Executive Officer of
Wunderman Cato Johnson, a Young & Rubicam operating unit. Mr. Kurz received his
master's in business administration from Harvard College and his bachelor's
degree from Dartmouth College. Mr. Kurz is the brother of Donald A. Kurz, the
Company's Chairman and Chief Executive Officer.
BRUCE RABEN is a managing director with CIBC Oppenheimer, an investment banking
firm. He has been an Equity Marketing director since 1993. From 1990 through
1995, he was an Executive Vice President with Jeffries & Company, an
investment-banking firm. Mr. Raben is also a director of Global Crossings, Ltd.
and Evercom Holdings, Inc. Mr. Raben received a bachelor's degree from Vassar
College and a master's in business administration from Columbia University
Graduate School of Business.
STEPHEN P. ROBECK has been an Equity Marketing director since 1989 and currently
serves as a consultant to the Company. He was elected Chairman and Co-Chief
Executive officer in September 1991 and served in that role through December
1998. Between 1987 and September 1991, he served as Chief Operating Officer. Mr.
Robeck received his bachelor's degree from Lake Forest College.
ITEM 11. EXECUTIVE COMPENSATION
Information relating to this item appears under the captions "ELECTION OF
DIRECTORS", "EXECUTIVE COMPENSATION AND RELATED MATTERS" and "REPORT OF THE
COMPENSATION COMMITTEE ON EXECUTIVE COMPENSATION" in the Company's Proxy
Statement relating to the Company's 2000 Annual Meeting of Stockholders, which
are incorporated herein by reference.
19
<PAGE> 20
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information relating to this item appears under the caption "SECURITY OWNERSHIP
OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" in the Proxy Statement relating to
the Company's 2000 Annual Meeting of Stockholders, which is incorporated herein
by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information relating to this item appears under the captions "ELECTION OF
DIRECTORS" and "EXECUTIVE COMPENSATION AND RELATED MATTERS", in the Proxy
Statement relating to the Company's 2000 Annual Meeting of Stockholders, which
are incorporated herein by reference.
20
<PAGE> 21
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K
(A). List of documents filed as part of this Report.
Financial Statements:
EQUITY MARKETING, INC.
INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Public Accountants.................................................................. 22
CONSOLIDATED FINANCIAL STATEMENTS:
Balance Sheets as of December 31, 1998 and 1999........................................................ 23
Statements of Operations for the Years Ended December 31, 1997, 1998 and 1999.......................... 24
Statements of Stockholders' Equity for the Years Ended December 31, 1997, 1998 and 1999................ 25
Statements of Cash Flows for the Years Ended December 31, 1997, 1998 and 1999.......................... 26
Notes to Consolidated Financial Statements.............................................................. 27
Supplemental Schedule:
Report of Independent Public Accountants on Schedule II............................................... 41
Schedule II Valuation and Qualifying Accounts......................................................... 42
</TABLE>
Note: All other supplementary schedules are omitted since they are not
applicable or the required information can be obtained from the
consolidated financial statements.
(B). Reports on Form 8-K
Report on Form 8-K filed with the Securities and Exchange Commission on
February 26, 1999 (Item 5).
Report on Form 8-K filed with the Securities and Exchange Commission on
April 16, 1999 (Item 7).
Report on Form 8-K filed with the Securities and Exchange Commission on
April 29, 1999 (Item 5).
Report on Form 8-K filed with the Securities and Exchange Commission on
July 23, 1999 (Item 5).
Report on Form 8-K filed with the Securities and Exchange Commission on
October 22, 1999 (Item 5).
21
<PAGE> 22
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Equity Marketing, Inc.:
We have audited the accompanying consolidated balance sheets of Equity
Marketing, Inc. (a Delaware corporation) and Subsidiaries as of December 31,
1998 and 1999, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1999. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Equity Marketing, Inc. and
subsidiaries as of December 31, 1998 and 1999, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States.
/s/ ARTHUR ANDERSEN LLP
- -----------------------
Arthur Andersen LLP
Los Angeles, California
March 23, 2000
22
<PAGE> 23
EQUITY MARKETING, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
ASSETS 1998 1999
-------------------------------------------------------------------------------------------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 7,250 $ 7,131
Accounts receivable (net of allowances of $3,684 and $5,370
as of December 31, 1998 and 1999, respectively) 57,071 37,385
Notes receivable, current portion -- 5,024
Inventory 13,117 8,742
Deferred income taxes 4,331 4,457
Prepaid expenses and other current assets 3,584 1,239
-----------------------------------------------------------------------------------------------
Total current assets 85,353 63,978
Fixed Assets, net 5,892 4,907
Goodwill, net 20,662 19,222
Trademarks, net 2,780 2,624
Note Receivable, long-term portion -- 5,491
Other Assets 793 1,022
-----------------------------------------------------------------------------------------------
Total assets $ 115,480 $ 97,244
===============================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
-------------------------------------------------------------------------------------------------
CURRENT LIABILITIES:
Short-term debt $ 30,000 $ 12,500
Accounts payable 28,432 21,726
Due to customer 8,672 4,424
Accrued payroll and payroll related costs 1,791 4,015
Accrued liabilities 12,190 10,268
-----------------------------------------------------------------------------------------------
Total current liabilities 81,085 52,933
Deferred Income Taxes 746 1,012
Long-Term Liabilities 1,242 1,274
-----------------------------------------------------------------------------------------------
Total liabilities 83,073 55,219
-----------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (Note 11)
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value per share, 1,000,000 shares
authorized, none issued or outstanding -- --
Common stock, par value $.001 per share, 20,000,000
shares authorized, 6,227,718 and 6,220,100 shares
outstanding as of December 31, 1998 and
1999, respectively -- --
Additional paid-in capital 15,343 15,942
Retained earnings 19,063 28,477
-----------------------------------------------------------------------------------------------
34,406 44,419
LESS--
Treasury stock, 1,892,841 and 1,921,299 shares at cost as
of December 31, 1998 and 1999, respectively. (1,279) (2,129)
Stock subscription receivable (32) (21)
Unearned compensation (688) (244)
------------------------------------------------------------------------------------------------
Total stockholders' equity 32,407 42,025
------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 115,480 $ 97,244
================================================================================================
</TABLE>
The accompanying notes are an integral part of
these consolidated balance sheets.
23
<PAGE> 24
EQUITY MARKETING, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------
1997 1998 1999
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
REVENUES $ 146,328 $ 159,136 $ 227,063
Cost of sales 105,310 112,153 170,416
Provision for production-in-process losses -- 2,666 --
-------------------------------------------------------------------------------------------------
Gross Profit 41,018 44,317 56,647
-------------------------------------------------------------------------------------------------
OPERATING EXPENSES:
Salaries, wages and benefits 11,563 14,550 17,350
Selling, general and administrative 14,330 22,127 22,829
AmeriServe bankruptcy bad debt expense -- -- 1,014
Impairment of assets -- 6,712 --
Business process reengineering -- 2,220 --
Restructuring loss (gain) -- 4,121 (604)
-------------------------------------------------------------------------------------------------
Total operating expenses 25,893 49,730 40,589
-------------------------------------------------------------------------------------------------
Income (loss) from operations 15,125 (5,413) 16,058
OTHER (EXPENSE) INCOME:
Interest expense (89) (783) (881)
Interest income 611 272 138
Other Income -- -- 233
-----------------------------------------------------------------------------------------------
Income (loss) before provision for income taxes 15,647 (5,924) 15,548
PROVISION FOR INCOME TAXES 6,024 69 6,134
-------------------------------------------------------------------------------------------------
Net income (loss) $ 9,623 $ (5,993) $ 9,414
=================================================================================================
BASIC INCOME (LOSS) PER SHARE:
INCOME (LOSS) PER SHARE $ 1.63 $ (0.98) $ 1.51
=================================================================================================
BASIC WEIGHTED AVERAGE SHARES OUTSTANDING 5,913,313 6,089,618 6,227,842
=================================================================================================
DILUTED INCOME (LOSS) PER SHARE:
INCOME (LOSS) PER SHARE $ 1.55 $ (0.98) $ 1.46
=================================================================================================
DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING 6,216,794 6,089,618 6,440,738
=================================================================================================
</TABLE>
The accompanying notes are an integral part of these
consolidated statements.
24
<PAGE> 25
EQUITY MARKETING, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except share data)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
----------------------------- PAID-IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance, December 31, 1996 5,832,087 $ -- $ 11,297 $ 15,433
Net income -- -- -- 9,623
Issuance of shares pursuant to
restricted stock plan 27,620 -- 658 --
Amortization of restricted stock grants -- -- -- --
Exercise of underwriters' warrants 61,968 -- 467 --
Exercise of stock options 88,428 -- 459 --
Tax benefit from exercise of stock options -- 490 --
Loan forgiveness -- -- -- --
- --------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 6,010,103 -- 13,371 25,056
Net loss -- -- -- (5,993)
Issuance of shares pursuant to restricted
stock plan 47,367 -- 352 --
Cancellation of shares
pursuant to restricted stock plan (14,812) -- (381) --
Amortization of restricted stock grants -- -- -- --
Exercise of stock options 175,000 -- 1,191 --
Issuance of stock to 401(k) Tax
Deferred Savings Plan 10,060 -- 66 --
Consulting services rendered
in exchange for stock options -- -- 211 --
Tax benefit from exercise of stock options -- -- 533 --
Loan forgiveness -- -- -- --
- --------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 6,227,718 -- 15,343 19,063
Net income -- -- -- 9,414
Cancellation of shares pursuant to restricted
stock plan (33,450) -- (202) --
Amortization of restricted stock grants -- -- -- --
Exercise of stock options 54,290 -- 263 --
Issuance of treasury stock to 401(k)
Tax Deferred Savings Plan 21,542 -- 183 --
Consulting services rendered in exchange
for stock options -- -- 172 --
Tax benefit from exercise of stock options -- -- 183 --
Purchase of Treasury Stock (50,000) -- -- --
Loan forgiveness -- -- -- --
- --------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 6,220,100 $ -- $ 15,942 $ 28,477
==========================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
STOCK
TREASURY SUBSCRIPTION UNEARNED
STOCK RECEIVABLE COMPENSATION TOTAL
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance, December 31, 1996 $ (1,279) $ (53) $ (365) $ 25,033
Net income -- -- -- 9,623
Issuance of shares pursuant to
restricted stock plan -- -- (658) --
Amortization of restricted stock grants -- -- 58 58
Exercise of underwriters' warrants -- -- -- 467
Exercise of stock options -- -- -- 459
Tax benefit from exercise of stock options -- -- -- 490
Loan forgiveness -- 10 -- 10
- --------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 (1,279) (43) (965) 36,140
Net loss -- -- -- (5,993)
Issuance of shares pursuant to restricted
stock plan -- -- (352) --
Cancellation of shares
pursuant to restricted stock plan -- -- 381 --
Amortization of restricted stock grants -- -- 248 248
Exercise of stock options -- -- -- 1,191
Issuance of stock to 401(k) Tax
Deferred Savings Plan -- -- -- 66
Consulting services rendered
in exchange for stock options -- -- -- 211
Tax benefit from exercise of stock options -- -- -- 533
Loan forgiveness -- 11 -- 11
- --------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 (1,279) (32) (688) 32,407
Net income -- -- -- 9,414
Cancellation of shares pursuant to restricted
stock plan -- -- 202 --
Amortization of restricted stock grants -- -- 242 242
Exercise of stock options -- -- -- 263
Issuance of treasury stock to 401(k)
Tax Deferred Savings Plan 11 -- -- 194
Consulting services rendered in exchange
for stock options -- -- -- 172
Tax benefit from exercise of stock options -- -- -- 183
Purchase of Treasury Stock (861) -- -- (861)
Loan forgiveness -- 11 -- 11
- --------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 $ (2,129) $ (21) $ (244) $ 42,025
==========================================================================================================================
</TABLE>
The accompanying notes are an integral part of these
consolidated statements.
25
<PAGE> 26
EQUITY MARKETING, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------
1997 1998 1999
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 9,623 $ (5,993) $ 9,414
Adjustments to reconcile net income (loss) to net cash provided
by (used in) operating activities:
Depreciation and amortization 1,247 2,022 2,708
Provision for bad debts 92 1,435 1,585
Gain on asset disposal -- -- (233)
Tax benefit from exercise of stock options 490 533 183
Amortization of restricted stock 58 248 242
Issuance of stock to 401(k) Tax Deferred Savings Plan -- 66 194
Impairment of assets -- 6,712 --
Consulting services rendered in exchange for stock options -- 211 172
Other 17 48 54
Changes in assets and liabilities-
Increase (decrease) in cash and cash equivalents
Accounts receivable (14,773) (28,570) (2,973)
Inventory (3,943) (2,814) 3,362
Deferred income taxes (89) (1,984) 202
Prepaid expenses and other current assets (731) (2,613) 2,885
Other assets 40 437 (24)
Accounts payable 9,676 11,554 (6,706)
Accrued liabilities (779) 13,330 7,043
Long-term liabilities (44) 280 322
- ----------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 884 (5,098) 18,430
- ----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payment for purchase of EPI Group Limited (280) (1,003) --
Payment for purchase of Corinthian Marketing, Inc. and Trademark -- (8,436) --
Payment for purchase of Contract Marketing, Inc. and U.S. Import &
Promotions Co. -- (15,088) (149)
Proceeds from sales of fixed assets -- -- 545
Purchases of fixed assets (1,097) (4,366) (847)
Other -- (68) --
- ----------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (1,377) (28,961) (451)
- ----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under line of credit 11,300 30,000 --
Repayments on line of credit (11,300) -- (17,500)
Purchase of treasury stock -- -- (861)
Proceeds from exercise of stock options 459 1,191 263
Proceeds from exercise of underwriters' warrants 467 -- --
- ----------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 926 31,191 (18,098)
- ----------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 433 (2,868) (119)
Cash acquired in acquisitions -- 1,183 --
CASH AND CASH EQUIVALENTS, beginning of year 8,502 8,935 7,250
- ----------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, end of year $ 8,935 $ 7,250 $ 7,131
======================================================================================================================
CASH PAYMENTS DURING YEAR FOR:
Interest $ 65 $ 616 $ 869
======================================================================================================================
Taxes $ 4,399 $ 2,143 $ 3,141
======================================================================================================================
</TABLE>
The accompanying notes are an integral part of these
consolidated statements.
26
<PAGE> 27
EQUITY MARKETING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS
Equity Marketing, Inc., a Delaware corporation (the "Company"), is a leading
marketing services company, providing a wide range of custom promotional
programs that build sales and brand awareness for retailers, restaurant chains
and consumer goods companies such as Burger King Corporation, The Coca-Cola
Company, Exxon Company USA, Sunoco, Inc., CVS/pharmacy and others. The Company
is also a developer and marketer of distinctive, branded consumer products that
complement its core promotions business and are based on trademarks it owns or
classic licensed properties. The Company primarily sells to customers in the
United States.
Equity Marketing Hong Kong, Ltd., a Delaware corporation ("EMHK"), is a 100%
owned subsidiary of the Company. EMHK manages production of the Company's
products by third parties in the Far East and currently is responsible for
procuring product sourcing, product engineering, quality control inspections,
independent safety testing and export/import documentation.
EPI Group Limited ("EPI"), a Delaware corporation, was a designer, developer,
producer and distributor of promotional products for sale to oil companies,
consumer products companies and retailers. The Company acquired EPI in 1996 for
cash plus a commitment to pay additional cash consideration based on the results
of operations of the EPI business during the three year period ending December
31, 1999. In July 1998, the Company paid $1,003 to the former stockholders of
EPI as additional cash consideration in settlement of this commitment. This
amount was allocated to goodwill at that time (see Note 3). Effective January
15, 1999, EPI was dissolved.
In April 1998, the Company purchased 100% of the common stock of Corinthian
Marketing, Inc., a Delaware corporation ("Corinthian"). Corinthian is engaged
principally in the design, manufacture, marketing and distribution of the
Headliners brand of collectible sports figurines (see Note 4).
In July 1998, the Company acquired substantially all of the assets of Contract
Marketing, Inc. ("CMI"), a Massachusetts corporation, and U.S. Import and
Promotions Co. ("USI"), a Florida corporation (CMI and USI are collectively
referred to herein as "USI"). USI focuses primarily on promotions for oil and
gas and other retailers. The Company intends to continue to use the acquired
assets for this purpose. The primary operations of USI are located in West
Boylston, Massachusetts and St. Augustine, Florida (see Note 4).
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. All significant accounts and transactions between
the Company and its subsidiaries have been eliminated in consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all short-term investments with a maturity at the date of
purchase of three months or less to be cash equivalents. Short-term investments
included in cash and cash equivalents are valued at amortized cost, which
approximates fair value as of December 31, 1998 and 1999.
REVENUE RECOGNITION
The Company records sales when title and risk of loss pass to the customer. When
a right of return exists, the Company's practice is to estimate and provide for
any future returns at the time of sale, in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 48.
27
<PAGE> 28
INVENTORY
Inventory consists of production-in-process which primarily represents tooling
costs which are deferred and amortized over the life of the products and
purchased finished products held for sale to customers and purchased finished
products in transit to customers' distribution centers. Inventory is stated at
the lower of average cost or market. As of December 31, 1998 and 1999, inventory
consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1998 1999
---------------------------------------------------------
<S> <C> <C>
Production-in-process $ 2,140 $1,088
Finished goods 10,977 7,654
---------------------------------------------------------
$13,117 $8,742
=========================================================
</TABLE>
FIXED ASSETS
Fixed assets are stated at cost. Depreciation and amortization is provided on a
straight-line basis over estimated useful lives as follows:
Leasehold improvements -- lesser of lease term or life of related asset
Furniture, fixtures, equipment and software--3-7 years
GOODWILL AND TRADEMARKS
Goodwill is the excess of the purchase price over the estimated fair values of
the net assets acquired in the purchases of EPI, Corinthian, and USI. Goodwill
is being amortized using the straight-line method over estimated useful lives
ranging from 5 to 20 years. Accumulated amortization for goodwill at December
31, 1998 and 1999 was $569 and $1,666, respectively. Trademarks are primarily
composed of the Headliners trademark acquired in the purchase of Corinthian.
Trademarks are being amortized over estimated useful lives ranging from 10 to 20
years. Accumulated amortization for the trademarks at December 31, 1998 and 1999
was $103 and $258, respectively. For the years ended December 31, 1997, 1998 and
1999, amortization expense amounted to $422, $932 and $1,252, respectively.
The Company has adopted Statement of Financial Accounting Standards ("SFAS") No.
121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets
to be Disposed of". This statement establishes accounting standards for the
impairment of long-lived assets, certain identifiable intangibles, and goodwill
related to those assets to be held and used and for long-lived assets and
certain identifiable intangibles to be disposed of. The carrying value of
existing assets are reviewed when events or changes in circumstances indicate
that an impairment test is necessary in order to determine if an impairment has
occurred. When factors indicate that such assets should be evaluated for
possible impairment, the Company will estimate undiscounted future cash flows
before interest expected to result from the use of the assets over their
remaining amortization period and their eventual disposition, and compare the
amounts to the carrying value of the assets to determine if an impairment loss
has occurred (see Note 3). If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
value of the assets exceeds their estimated fair value.
DUE TO CUSTOMER
Pursuant to the terms of certain contracts between the Company and a certain
promotions customer, the Company collects certain fees from the customer's
distribution companies on behalf of that customer. Once these fees are collected
from the distribution companies, the Company remits the fees to the customer. As
of December 31, 1998 and 1999, the amounts due to customer were $8,672 and
$4,424, respectively.
INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes", which requires recognition of deferred tax assets
and liabilities for the expected future tax consequences of events that have
been included in the financial statements or tax returns. Under this method,
deferred tax assets and liabilities are determined based on the difference
between the financial statements and tax basis of assets and liabilities using
the tax rates in effect for the years in which the differences are expected to
reverse (see Note 10).
NET INCOME PER SHARE
Earnings Per Share ("EPS") reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock. When dilutive, stock options are included as share
equivalents in computing diluted earnings per share using the treasury stock
method. During a loss period, the assumed exercise of in-the-money stock options
and warrants has an antidilutive effect. As a result, these shares are not
included with the weighted average shares outstanding of 6,089,618 used in the
calculation of diluted earnings per share for the year ended December 31, 1998.
The impact of including unexercised dilutive options and warrants was to
increase weighted average shares outstanding by 303,481 in 1997 and 212,896 in
1999. The impact of including dilutive options and warrants (assuming net
income) would have been to increase the weighted average number of shares
outstanding by 246,513 in 1998. Options to purchase 268,000, 1,115,101 and
280,000 shares of common stock as of December 31, 1997, 1998 and 1999,
respectively, were excluded from the computation of diluted income per share as
they would have been anti-dilutive.
28
<PAGE> 29
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.
CONCENTRATION OF RISK
Accounts receivable represent unsecured balances due from its customers and the
Company is at risk to the extent such amounts become uncollectible. The Company
regularly extends credit to several distribution companies in connection with
its business with Burger King Corporation ("Burger King"). Failure by one or
more distribution companies to honor their payment obligations to the Company
could have a material adverse effect on the Company's operations.
One of these distribution companies, AmeriServe Food Distribution, Inc. together
with certain of its affiliates (including its affiliates, "AmeriServe")
accounted for more than 50 percent of the products purchased from the Company by
the Burger King system in 1999. AmeriServe filed a voluntary petition under
Chapter 11 of the United States Bankruptcy Code on January 31, 2000. As of
January 31, 2000, AmeriServe owed the Company approximately $28.8 million in
trade receivables. AmeriServe was able to secure temporary debtor in possession
funding to enable it to continue operating in the short-term post bankruptcy.
Restaurant Services, Inc. ("RSI"), a not-for-profit purchasing cooperative that
has as its members Burger King franchisees and Burger King, is the exclusive
purchasing agent for the Burger King system of franchisee-owned and
company-owned restaurants located in the United States. Subsequent to January
31, 2000, the Company reached an agreement with RSI in which RSI purchased all
pre-petition trade receivables owed to the Company by AmeriServe in exchange for
a two-year non-interest-bearing note valued at approximately $16.0 million and
the satisfaction of certain contractual obligations owed by the Company to RSI.
This agreement resulted in a net pre-tax charge of approximately $1.0 million
for the quarter ended December 31, 1999. A note receivable of approximately
$10.5 million, $5.5 million of which has been classified as long-term, has been
recorded on the accompanying consolidated balance sheet as of December 31, 1999.
Approximately $6.6 million of the $28.8 million pre-petition trade receivables
relate to sales made in January 2000. Accordingly, the remaining $5.5 million
portion of the note receivable was recorded in January 2000, and will result in
a net pre-tax charge of approximately $0.5 million for the quarter ending March
31, 2000.
Burger King has assumed responsibility for all payments of the Company's
post-petition shipments to AmeriServe. There can be no assurance, however, that
AmeriServe will successfully reorganize and emerge from Chapter 11 proceedings.
In this event, the Company believes it can either ship Burger King product
directly to franchisees or to alternative distribution companies established in
place of AmeriServe; provided, however, that direct shipments to franchisees may
result in substantial additional expenses to the Company and that alternative
distribution companies may not be available to service certain or all of the
geographic areas currently serviced by AmeriServe. Accordingly, any failure by
AmeriServe to successfully reorganize and emerge from Chapter 11 proceedings
could negatively impact the Company's business, financial condition, and results
of operations.
The Company purchases 95% of its manufactured products from suppliers located in
China. China currently enjoys "normal trade relations" ("NTR") status under US
tariff laws, which provides a favorable category of US import duties. As a
result of continuing concerns in the US Congress regarding China's human rights
policies, and disputes regarding Chinese trade policies, including the country's
inadequate protection of US intellectual property rights, there has been, and
may be in the future, opposition to the annual extension of NTR status for
China. In 2000, however, there will be, for the first time, a major effort in
the US Congress to pass legislation that would make permanent China's NTR status
in return for the country's expected accession to the World Trade Organization.
The loss of NTR status for China would result in a substantial increase in the
import duty for the Company's products manufactured in China and imported into
the US and would result in increased costs for the Company. The impact of such
an event on the Company could be somewhat mitigated by the Company's ability to
source product for the US market from countries other than China. However, there
can be no assurance that the Company would be able to obtain manufactured
products under acceptable terms.
SUPPLEMENTAL CASH FLOW INFORMATION
During 1999, the Company sold a portion of its excess inventory to a customer in
exchange for credits toward future purchases of advertising media. The credits
were valued at $1,011 and can be used over a period of five years. During 1999,
the Company utilized $225 of these credits. Of the remaining balance of the
credits, $450 is recorded in prepaid expenses and other current assets and $336
is recorded in other assets in the accompanying consolidated balance sheet.
COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income." This statement establishes standards for reporting and
display of comprehensive income and its components in a full set of
general-purpose financial statements. There are no adjustments to net income
(loss) to arrive at comprehensive income (loss).
RECLASSIFICATIONS
Certain reclassifications have been made to the 1997 and 1998 financial
statements to conform them with the 1999 presentation.
29
<PAGE> 30
2. RESTRUCTURING CHARGE
On December 21, 1998, the Company announced its decision to exit the
event-based-license consumer products business along with its retail pin
business. In connection with this decision, the Company recorded a restructuring
charge of $4,121 in 1998. The restructuring charge includes a provision for
projected minimum royalty guarantee shortfalls associated with long-term
licenses which the Company has decided to discontinue, severance for workforce
reductions of 30 employees, of which 15 were terminated as of December 31, 1998
and the remainder in 1999, a provision for outstanding inventory purchase
commitments on purchase orders the Company has cancelled, and a provision for
costs associated with the planned closure of the Company's warehouse facility.
The workforce reductions include employees from the consumer products business,
retail pin business, warehouse and other support services. Excluding the
warehouse employees, the workforce reductions were completed by the end of the
first quarter of 1999. The warehouse closed in the second quarter of 1999. As of
December 31, 1998 and the remainder in 1999, the Company was in the process of
negotiating settlements on remaining minimum royalty guarantees with licensors.
During 1999, the Company reversed a portion of the restructuring reserves for
projected royalty guarantee shortfalls as a result of negotiated settlements
with certain licensors. These reversals totaled $641 and are reflected net of a
$37 additional charge as a restructuring gain in the accompanying statements of
operations. Details of the restructuring charge are as follows:
<TABLE>
<CAPTION>
Original Utilized Utilized Charged To Be
Charge 1998 1999 Reversed 1999 Utilized
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Provision for projected minimum royalty
Guarantee Shortfalls $2,187 $ -- $ (267) $(641) $-- $1,279
Employee severance and termination benefits 738 (127) (648) -- 37 --
Outstanding inventory purchase commitments 800 -- (716) -- -- 84
Lease commitment for warehouse facility 396 -- (31) -- -- 365
- ------------------------------------------------------------------------------------------------------------
$4,121 $(127) $(1,662) $(641) $37 $1,728
- ------------------------------------------------------------------------------------------------------------
</TABLE>
For the years ended December 31, 1997 and 1998, the revenues generated in the
consumer products segment from licenses which the Company has decided not to
continue totaled $28,807 and $30,046, respectively. For the years ended December
31, 1997 and 1998, cost of sales associated with these revenues totaled $20,412
and $26,323, respectively.
3. IMPAIRMENT OF ASSETS
During the fourth quarter of 1998, the Company's EPI subsidiary lost its primary
customer, Shell Oil Company, as a result of that company's merger with Texaco.
This loss triggered an impairment review of EPI's long-lived assets, which
consisted primarily of goodwill. Based on revised projections of EPI's ongoing
business, the Company calculated the present value of expected cash flows
(before interest) to determine the fair value of the assets. Accordingly, the
Company recorded an impairment charge of $5,520 for a write-down of the goodwill
and other intangibles associated with the EPI purchase. This charge is reflected
in impairment of assets in the accompanying consolidated statements of
operations and is reflected in the corporate segment (see Note 12). As of
December 31, 1998, the remaining balance of the EPI goodwill was $300 and is
being amortized on a straight line basis over a period of five years.
In addition to the write-down of EPI goodwill, during the fourth quarter of
1998, the Company realized an impairment loss on certain assets associated with
the activities which the Company has exited (see Note 2). Such impairment
totaled $1,192 and is also reflected in impairment of assets in the accompanying
consolidated statements of operations. Of this amount, approximately $1,095
represents an impairment of royalty advances paid on long-term license
agreements which the Company has decided to discontinue and which will not be
recouped against future sales. Such impairment is reflected in the consumer
products segment (see Note 12). The remaining $97 reflects an impairment of
capitalized costs associated with an internet site associated with the retail
pin business as well as an impairment of warehouse leasehold improvements. Such
impairments are reflected in the corporate segment (see Note 12).
4. ACQUISITIONS
On April 24, 1998, the Company acquired 100% of the common stock of Corinthian
and certain trademarks related to its business, including the "Headliners"
trademark (the "Trademark"), from Corinthian Marketing PLC, for total cash
consideration of $7,892 plus related transaction costs of $544 at the closing.
The total consideration was net of a holdback amount for which the Company
accrued approximately $600 as of the acquisition date. In September 1999, this
holdback was settled and the accrual was reversed as a reduction to goodwill.
Corinthian is engaged principally in the design, manufacture, marketing and
distribution of the Headliners(R) brand of collectible sports figurines.
The Corinthian acquisition has been accounted for under the purchase method of
accounting. The 1998 financial statements reflect the preliminary allocations of
the purchase price and the assumption of liabilities and include the operating
results of Corinthian from the date of acquisition. The purchase price has been
allocated to the assets acquired and liabilities assumed based on their
estimated fair values as of the acquisition date. As of December 31, 1999, the
excess of the purchase price over the estimated fair values of the net assets
acquired was $7,021 which has been recorded as goodwill and is being amortized
on a straight-line basis over 20 years. The Trademark has been valued at $2,830
and is being amortized on a straight-line basis over 20 years.
30
<PAGE> 31
On July 23, 1998 the Company acquired substantially all of the assets of CMI and
USI, in exchange for $14,659 plus related transaction costs of $429. Potential
additional cash consideration may be paid based upon the results of operations
of USI during each calendar year through December 31, 2002 as set forth in the
respective Asset Purchase Agreements, dated July 23, 1998, by and among the
Company and each of CMI and USI. In August 1999, an additional $149 was paid to
the stockholders of CMI and USI and allocated to Goodwill.
The USI acquisition has been accounted for under the purchase method of
accounting. The 1998 financial statements reflect the preliminary allocations of
the purchase price to the acquired net assets based on their estimated fair
value as of the acquisition date. As of December 31, 1999, the excess of the
purchase price over the estimated fair value of the net assets acquired was
$13,567 which has been recorded as goodwill and is being amortized on a straight
line basis over 20 years.
During 1999, the preliminary allocation of the acquisition costs was adjusted to
revise the estimated value of the deferred tax assets and certain accrued
liabilities. These adjustments, along with the reversal of the amounts accrued
for the holdback discussed above, resulted in a net reduction to goodwill of
$492.
The allocation of the acquisition costs (based upon estimated fair values) of
Corinthian and USI was as follows:
<TABLE>
<CAPTION>
<S> <C>
Cash and cash equivalents $ 1,183
Accounts receivable 2,163
Inventory 1,645
Deferred taxes 402
Other current assets 398
Fixed assets 184
Trademark 2,830
Goodwill 20,588
Accounts payable (2,318)
Accrued liabilities (3,402)
----------------------------------------------------------
$23,673
==========================================================
</TABLE>
Deferred income taxes have been recorded for the basis differential of the
assets acquired between financial reporting purposes and tax reporting purposes.
The following unaudited pro forma information presents a summary of the
consolidated results of operations of the Company as if the acquisitions of
Corinthian and USI had occurred at the beginning of each period presented and
includes pro-forma adjustments to give effect to the amortization of goodwill,
decreased interest income, increased interest expense associated with funding
the acquisitions, and certain other adjustments, together with the related
income tax effects. The pro forma financial information is presented for
informational purposes only and may not be indicative of the results of
operations as they would have been if the Company, Corinthian and USI had been a
single entity during 1997 and 1998, nor is it necessarily indicative of the
results of operations that may occur in the future.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------
1997 1998
-----------------------------------------------------------------------
(UNAUDITED)
<S> <C> <C>
Pro forma revenues $ 177,004 $ 166,752
Pro forma net income (loss) $ 9,271 $ (6,719)
Pro forma basic income (loss) per share $ 1.57 $ (1.10)
Pro forma diluted income (loss) per share $ 1.49 $ (1.10)
Pro forma basic weighted average
shares outstanding 5,913,313 6,089,618
Pro forma diluted weighted average
shares outstanding 6,216,794 6,089,618
</TABLE>
31
<PAGE> 32
5. FIXED ASSETS, NET
Fixed assets, net is summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1998 1999
-------------------------------------------------------------
<S> <C> <C>
Furniture, fixtures and equipment $ 2,289 $ 2,389
Computer software 2,396 2,562
Computer hardware 2,249 2,538
Leasehold improvements 1,801 1,369
-----------------------------------------------------------
Fixed assets, at cost 8,735 8,858
Accumulated depreciation and
amortization (2,843) (3,951)
-----------------------------------------------------------
Fixed assets, net $ 5,892 $ 4,907
===========================================================
</TABLE>
For the years ended December 31, 1997, 1998 and 1999, depreciation and
amortization expense related to fixed assets was $825, $1,090 and $1,456
respectively.
6. INFORMATION SYSTEMS
Based on strategic and operational assessments, the Company decided to replace
its existing information systems. The new enterprise system is designed to
enhance management information, financial reporting, inventory management, order
entry and cost evaluation and control. The new enterprise system went into
operation in January 1999. The Company spent a total of $4,302, of which $2,220
was spent on business process reengineering in 1998. In accordance with Emerging
Issues Task Force Issue No. 97-13, such business process reengineering costs
were expensed as incurred. These expenses are presented as business process
reengineering expenses in the accompanying consolidated statements of operations
for the year ended December 31, 1998. The expenditures for hardware, software,
and software implementation of $2,082 associated with the conversion to the new
system are capitalizable and are reflected in fixed assets in the accompanying
consolidated balance sheets.
7. LINE OF CREDIT
At December 31, 1998 and 1999, the Company was party to a revolving credit
agreement ("Credit Agreement") with two commercial banks. The agreement, as
amended on March 13, 2000 provides for a line of credit of $25,000 through June
30, 2001 with borrowing availability determined by a formula based on qualified
assets. Interest on outstanding borrowings is based on either a fixed rate
equivalent to LIBOR plus 3.00 percent or a variable rate equivalent to the lead
bank's reference rate plus .50 percent. The Company is also required to pay an
unused line fee of .50 percent per annum and certain letter of credit fees. The
Credit Agreement is secured by substantially all of the Company's assets. The
Credit Agreement requires the Company to comply with certain restrictions and
financial covenants as defined in the agreement. As of December 31, 1999, the
Company was in compliance with these covenants.
As of December 31, 1998 and 1999 there were $30,000 and $12,500, respectively,
outstanding under the Credit Agreement. As of December 31, 1999, the interest
rate on borrowings was 9.0%. Letters of credit amounts outstanding as of
December 31, 1998 and 1999 were $995 and $401, respectively.
8. DEFINED CONTRIBUTION PLAN
The Company has a 401(k) Tax Deferred Savings Plan (the "401(k) Plan"), which
became effective on January 1, 1992. The 401(k) Plan covers substantially all of
its eligible employees, as defined under the 401(k) Plan. The Company makes
annual contributions to the 401(k) Plan consisting of a discretionary matching
contribution equal to a determined percentage of the employee's contribution and
a discretionary amount determined each year by the Company and paid out of the
Company's current or accumulated net profit. Costs related to contributions to
the 401(k) Plan for the years ended December 31, 1997, 1998, and 1999 were $137,
$154 and $235, respectively.
9. STOCKHOLDERS' EQUITY
STOCK OPTIONS
The Company has two stock option plans, the Employee Stock Option Plan (the
"Employee Plan") and the Non-Employee Director Stock Option Plan (the "Director
Plan"), together referred to as the "Option Plans". A total of 2,740,000 shares
of common stock are reserved for issuance, pursuant to options granted and to be
granted under these stock option plans. 730,189 shares are available for grant
as of December 31, 1999. Options pursuant to the Employee Plan vest over three
to five years and expire ten years from the date of grant. The Employee Plan
expires in 2001. Options pursuant to the Director Plan vest over six months to
three years and expire ten years from the date of grant. The Director Plan
expires in 2003.
32
<PAGE> 33
The Option Plans provide for option grants at exercise prices not less than the
fair market value on the date of grant in the case of qualified incentive stock
options, and not less than par value in the case of non-qualified options.
Transactions involving the Option Plans are summarized as follows:
<TABLE>
<CAPTION>
EXERCISABLE AT END OF YEAR
WEIGHTED AVERAGE ------------------------------
NUMBER EXERCISE PRICE WEIGHTED AVERAGE
OF SHARES PER SHARE SHARES EXERCISE PRICE
------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Outstanding at December 31, 1996 871,350 $ 9.08 322,350 $ 4.26
Granted 438,000 24.09 =============================
Exercised (88,428) 5.20
Canceled (18,572) 9.13
-------------------------------------------------------------- ------------------------------
Outstanding at December 31, 1997 1,202,350 14.84 429,778 $ 6.89
==============================
Granted 1,111,917 15.58
Exercised (175,000) 6.81
Canceled (1,024,166) 19.84
-------------------------------------------------------------- ------------------------------
Outstanding at December 31, 1998 1,115,101 12.23 421,114 $11.52
==============================
Granted 548,000 9.20
Exercised (54,290) 4.84
Canceled (206,500) 14.86
-------------------------------------------------------------- ------------------------------
Outstanding at December 31, 1999 1,402,311 $10.65 660,506 $10.29
============================================================== ==============================
</TABLE>
The following table summarizes information about the Company's stock options
outstanding and exercisable as of December 31, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------------------------------------------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$0.32 - $ 7.50 659,311 6.84 $ 6.05 452,172 $ 5.57
$ 8.44 - $11.00 348,000 9.28 $ 9.48 -- $ --
$12.25 - $20.75 310,000 7.94 $17.22 145,000 $17.76
$22.25 - $28.13 85,000 7.99 $27.19 63,334 $26.87
---------------------------------------------------------------------------------------------------
1,402,311 7.76 $10.65 660,506 $10.29
===================================================================================================
</TABLE>
On December 14, 1998, the Company permitted option holders to exchange their
outstanding stock options for a lesser number of options priced at fair market
value on that date, $7.50. Options with an exercise price greater than $20.00 a
share were eligible to be exchanged for options priced at $7.50 with a 50%
reduction in the number of options, and options with an exercise price less than
or equal to $20.00 a share were eligible to be exchanged for options priced at
$7.50 with a 33% reduction in the number of options. Each replacement grant
retained the original grant's vesting schedule but imposed a one year moratorium
on exercise. Twenty-one employees and consultants of the Company elected to
participate, exchanging an aggregate of options to purchase 817,500 shares of
Common Stock at exercise prices ranging from $12.25 to $28.13 a share in return
for an aggregate of options to purchase 422,417 shares of Common Stock at an
exercise price of $7.50 per share. Donald A. Kurz and Stephen P. Robeck, the
Company's co-chief executive officers, were not eligible to participate in the
exchange.
The Company has adopted SFAS No. 123, "Accounting for Stock-Based Compensation,
"issued in October 1995. In accordance with provisions of SFAS No. 123, the
Company applies APB Opinion 25 and related interpretations in accounting for its
stock option plans and, accordingly, does not recognize compensation cost. If
the Company had elected to recognize compensation cost based on the fair value
of the options granted at grant date as prescribed by SFAS No. 123, net income
and earnings per share would have been reduced to the pro forma amounts
indicated in the table below (in thousands, except per share amounts):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------
1997 1998 1999
------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income (loss) - as reported $9,623 $(5,993) $9,414
Net income (loss) - pro forma $8,138 $(9,672) $5,572
Basic earnings (loss) per share-as reported $ 1.63 $ (.98) $ 1.51
Basic earnings (loss) per share-pro forma $ 1.38 $ (1.59) $ 0.89
Diluted earnings (loss) per share-as reported $ 1.55 $ (.98) $ 1.46
Diluted earnings (loss) per share-pro forma $ 1.31 $ (1.59) $ 0.87
</TABLE>
33
<PAGE> 34
Because the SFAS No. 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting pro-forma compensation cost may
not be representative of the cost to be expected in future years.
The fair value of each option is estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1997 1998 1999
------------------------------------------------------------------------
<S> <C> <C> <C>
Expected dividend yield 0.00% 0.00% 0.00%
Expected stock price volatility 65.73% 69.97% 70.39%
Risk free interest rate 5.53% 4.41% 5.09%
Expected life of options 3 years 3 years 3 years
</TABLE>
The weighted average fair value of options granted during 1998 and 1999 is $7.28
and $4.55, respectively.
During 1998, the Company granted options to purchase 60,000 shares of common
stock to a member of the Board of Directors in exchange for consulting services
rendered. The securities are to vest through March 2001. None of these options
have been exercised. On December 14, 1998 these options were exchanged for
options to purchase 40,000 shares of common stock at an exercise price of $7.50.
Options to purchase approximately 20,001 shares of common stock have vested as
of December 31, 1999. The fair value of these options was estimated at the date
of grant and repricing using the Black-Scholes option pricing model with
assumptions consistent with those shown above. For the years ended December 31,
1998 and 1999, the Company has recorded compensation expense of approximately
$211 and $172, respectively, related to these options.
WARRANTS
At December 31, 1998, there were 4,131 "underwriters" warrants outstanding
relating to the Company's initial public offering, which were exercisable at
$8.02 per share. The warrants expired on January 31, 1999.
PREFERRED STOCK
The Company has authorized 1,000,000 shares of preferred stock, par value $.001
per share ("Preferred Stock"). The Board of Directors is empowered to issue
Preferred Stock from time to time in one or more series, without stockholder
approval, and to determine the rights, preferences and restrictions, including
dividend, conversion, voting, redemption (including sinking fund provisions),
and other rights, liquidation preferences and the number of shares constituting
any series and the designations of such series. To date, no series of Preferred
Stock has been issued.
STOCK SUBSCRIPTION RECEIVABLE
On September 27, 1991, a minority stockholder of the Company purchased 1,850,000
shares of the Company's treasury stock for an aggregate purchase price of $107.
Since the stock was sold below cost, the loss on the issuance of the treasury
stock was charged to retained earnings. The purchase price for these shares was
paid with promissory notes, payable in ten years, together with interest at an
annual rate of 8.41% per year on the unpaid principal balance. The notes are
subject to the terms of the Loan Forgiveness Agreements dated September 27,
1991, pursuant to which the principal amount of the notes will be forgiven at
10% per year, provided that the stockholder remains employed by the Company at
such time. The stock subscription receivable is included in the accompanying
consolidated balance sheets as a reduction of stockholders' equity. The Company
records the annual reduction as compensation expense.
RESTRICTED STOCK
The Company has reserved 100,000 shares of common stock for issuance under the
1995 Stock Award Plan, (the "Plan"), which covers certain key salaried employees
who are not officers or directors of the Company. For the year ended December
31, 1999, 33,450 shares with an aggregate market value on the date of grant of
$202 were canceled under the Plan. No shares were issued under the plan for the
year ended December 31, 1999. The shares are subject to restrictions, which
lapse over a three to five year period, and continued employment with the
Company.
Unearned compensation was charged for the market value of the restricted shares
as these shares were issued in accordance with the Plan. The unearned
compensation is shown as a reduction of shareholders' equity in the accompanying
consolidated balance sheets and is being amortized ratably over the restricted
period. Compensation charged to expense was $58, $248 and $242 in 1997, 1998 and
1999, respectively. At December 31, 1999, 66,785 shares were available for
issuance under the Plan.
34
<PAGE> 35
10. INCOME TAXES
In accordance with SFAS 109, deferred income taxes reflect the impact of
temporary differences between values recorded for assets and liabilities for
financial reporting purposes and the values utilized for measurement in
accordance with current tax laws.
The provisions for income taxes consist of:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------
1997 1998 1999
-------------------------------------------------------------------------------
<S> <C> <C> <C>
CURRENT:
Federal $ 4,713 $ 1,266 $ 4,970
State and local 728 175 779
-------------------------------------------------------------------------------
5,441 1,441 5,749
-------------------------------------------------------------------------------
DEFERRED:
Federal 84 (1,673) 175
State and local 9 (232) 27
-------------------------------------------------------------------------------
93 (1,905) 202
-------------------------------------------------------------------------------
Additional paid-in capital from
benefit of stock options exercised 490 533 183
-------------------------------------------------------------------------------
$ 6,024 $ 69 $ 6,134
===============================================================================
</TABLE>
Income taxes recorded by the Company differ from the amounts computed by
applying the statutory United States Federal income tax rate to income before
income taxes. The following schedule reconciles income tax expense at the
statutory rate and the actual income tax expense as reflected in the
accompanying consolidated statements of operations.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------
1997 1998 1999
--------------------------------------------------------------------------------------
<S> <C> <C> <C>
Tax at the Federal statutory rate $ 5,476 $ (2,014) $ 5,341
State income taxes, net of the Federal
tax benefit 597 (170) 541
Other (49) 2,253 252
--------------------------------------------------------------------------------------
$ 6,024 $ 69 $ 6,134
======================================================================================
</TABLE>
Other reflects the effects of permanent differences such as amortization of
goodwill and the write-off of the EPI goodwill in 1998.
The tax effects of the significant temporary differences giving rise to the
Company's deferred tax assets (liabilities) for the years ended December 31,
1998 and 1999 are as follows:
<TABLE>
<CAPTION>
1998 1999
-------------------------------------------------------------
<S> <C> <C>
Allowance for doubtful accounts $ 1,411 $ 2,031
Inventory Reserve 895 654
Accrued expenses 1,889 1,625
Other 136 147
-----------------------------------------------------------
Total current 4,331 4,457
-----------------------------------------------------------
Trademark (1,035) (1,016)
Depreciation 289 54
Other -- (50)
------------------------------------------------------------
Total non-current (746) (1,012)
-------------------------------------------------------------
Total $ 3,585 $ 3,445
=============================================================
</TABLE>
35
<PAGE> 36
11. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
The Company has operating leases for its properties, which expire at various
dates through 2005.
Future minimum lease payments under non-cancelable operating are as follows:
<TABLE>
<CAPTION>
YEAR
--------------------------------------------------
<S> <C>
2000 $ 2,107
2001 1,668
2002 1,486
2003 1,480
2004 1,629
Thereafter 1,315
---------------------------------------------------
Total $ 9,685
===================================================
</TABLE>
Aggregate rental expenses for operating leases was $1,069, $1,235 and $1,783 for
the years ended December 31, 1997, 1998 and 1999, respectively.
GUARANTEED ROYALTIES
For the years ended December 31, 1997, 1998, and 1999, the Company incurred
$3,761, $6,149 and $5,295, 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 December 31, 1999, the
Company was committed to pay total minimum guaranteed royalties as follows:
<TABLE>
<CAPTION>
YEAR
---------------------------------------------------
<S> <C>
2000 $ 1,275
2001 20
---------------------------------------------------
Total $ 1,295
===================================================
</TABLE>
Included in the above commitments are projected minimum guarantee shortfalls of
$1,279 which have been accrued as of December 31, 1999 (see note 2).
EMPLOYMENT AGREEMENTS
The Company has employment agreements with several key executives. Guaranteed
compensation under these agreements is as follows:
<TABLE>
<CAPTION>
YEAR
---------------------------------------------------
<S> <C>
2000 $ 1,668
2001 1,035
2002 375
---------------------------------------------------
Total $ 3,078
===================================================
</TABLE>
LEGAL PROCEEDINGS
On December 27, 1999, Burger King announced that in cooperation with the
Consumer Product Safety Commission ("CPSC") it would conduct a voluntary recall
of Pokemon(TM) balls included with Burger King kids meals. The recall resulted
primarily from the death of a 13 month old child in Sonora, California on
December 11, 1999. The child reportedly suffocated when one half of a
Pokemon(TM) ball covered her nose and mouth. In announcing the recall, Burger
King stated that the balls may pose a suffocation hazard to children under three
years of age. Burger King further stated that consumers should immediately take
the balls away from children under the age of three and either discard the balls
or return them to a Burger King restaurant in exchange for a free small order of
french fries. Subsequent to the announcement of the recall, on January 25, 2000,
a 4 month old child in Indianapolis, Indiana also reportedly suffocated when one
half of a Pokemon(TM) ball covered his nose and mouth.
The Company designed and manufactured 151 trading cards and 57 gift-with-
purchase products based on Pokemon(TM) for Burger King. The Company
believes that these products met or exceeded federal safety guidelines and
underwent rigorous safety testing by an independent, third party laboratory
during and after production.
36
<PAGE> 37
Burger King and its franchisees incurred substantial costs in the conduct of the
Pokemon(TM) ball recall, including costs for legal expenses, advertising,
collection and destruction of Pokemon(TM) balls, and free goods. Although the
Company strongly believes it met all of its contractual obligations with respect
to the Pokemon(TM) ball, Burger King and its franchisees may request
indemnification for some or all of these costs. While the Company cannot
currently estimate the amount of such costs, management believes that the
payment by the Company of the costs incurred in the conduct of the Pokemon(TM)
ball recall could have a material adverse effect on the Company's business,
financial condition and results of operations. As of the date hereof, Burger
King has not requested indemnification for such costs.
On January 21, 2000, a purported class action lawsuit entitled Domingo
Quintinilla v. Tex-Best Travel Centers, Inc., Burger King Corporation, and
Equity Marketing, Inc. was filed in the District Court of Hidalgo County, Texas.
The lawsuit was filed by an individual purporting to represent all individuals
in the United States that received a Pokemon(TM) ball from a Burger King(R)
restaurant. The lawsuit alleges that the Pokemon(TM) ball is unsafe and asserts
causes of action for breach of contract, breach of warranty, negligence,
negligent misrepresentation and gross negligence and seeks an unspecified amount
of damages and attorneys fees. Equity Marketing filed its answer on February 23,
2000. The lawsuit is in the early discovery phase.
On February 28, 2000, a class action lawsuit entitled Scott Pace and Diane
Mitchell Bubonic v. Burger King Corporation, Case No. 310285, was filed in the
Superior Court of the State of California for the City and County of San
Francisco. The lawsuit was filed by individuals purporting to represent all
individuals in the State of California that received a Pokemon(TM) ball from a
Burger King(R) restaurant. The lawsuit alleges that the Pokemon(TM) ball is
unsafe and asserts causes of action for breach of implied warranty and fraud in
the sale of consumer goods, and seeks an unspecified amount of damages and
attorneys fees.
The Company may be contractually required to indemnify Burger King and its
franchisees for the expenses and damages, if any, incurred in connection with
these lawsuits. Burger King has requested indemnification for such expenses and
damages, if any. While the Company believes these lawsuits are without merit and
intends to defend them vigorously, they may, regardless of the outcome, result
in substantial expenses and damages to the Company and may significantly divert
the attention of the Company's management. There can be no assurance that the
Company will be able to achieve a favorable settlement of these lawsuits or
obtain a favorable resolution of such lawsuits if they are not settled. An
unfavorable resolution of these lawsuits or prolonged litigation, the costs of
which may be substantial, could have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company is involved in various other legal proceedings generally incidental
to its business. While the result of any litigation contains an element of
uncertainty, management presently believes that the outcome of any other known,
pending or threatened legal proceeding or claim, individually or combined, will
not have a material adverse effect on the Company's financial position or
results of operations.
12. INDUSTRY SEGMENTS, GEOGRAPHICAL INFORMATION AND MAJOR CUSTOMERS
The Company's revenues are highly dependent on obtaining major contracts from a
limited number of customers. Approximately 67%, 63% and 80% of the Company's
revenues for the years ended December 31, 1997, 1998 and 1999, respectively,
were from one customer in the promotional segment.
Effective January 1, 1998, the Company adopted the provisions of SFAS No.
131--"Disclosures about Segments of an Enterprise and Related Information." The
Company has identified two reportable segments through which it conducts its
continuing operations: promotions 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 promotions
segment produces promotional products used as free premiums or sold in
conjunction with the purchase of other items at a retailer or quick service
restaurant. Promotional products are used for marketing purposes by both the
companies sponsoring the promotions and the licensors of the entertainment
properties on which the promotional products are based. The consumer products
segment designs and contracts for the manufacture of toys and other consumer
products for sale to major mass market retailers, who in turn sell the products
to consumers.
Earnings of industry segments and geographic areas exclude interest income,
interest expense, and depreciation expense, 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 the Headliners(R)
trademark. Corporate assets consist of cash, certain corporate receivables,
fixed assets, and certain trademarks.
37
<PAGE> 38
INDUSTRY SEGMENTS
<TABLE>
<CAPTION>
AS OF AND FOR THE YEAR ENDED DECEMBER 31, 1997
--------------------------------------------------
CONSUMER
PROMOTIONS PRODUCTS CORPORATE TOTAL
----------------------------------------------------
<S> <C> <C> <C> <C>
Total revenues $ 116,022 $ 30,306 $ - $146,328
==========================================================================================================
Income (loss) before provision (benefit)
for income taxes $ 20,878 $ 3,733 $ (8,964) $ 15,647
Provision (benefit) for income taxes 8,038 1,437 (3,451) 6,024
- ---------------------------------------------------------------------------------------------------------
Net income (loss) $ 12,840 $ 2,296 $ (5,513) 9,623
=========================================================================================================
Fixed asset additions, net $ - $ - $ 1,097 $ 1,097
=========================================================================================================
Depreciation and amortization $ 422 $ - $ 825 $ 1,247
=========================================================================================================
Total assets $ 21,068 $ 7,811 $ 28,274 $57,153
=========================================================================================================
</TABLE>
<TABLE>
<CAPTION>
AS OF AND FOR THE YEAR ENDED DECEMBER 31, 1998
----------------------------------------------------
CONSUMER
PROMOTIONS PRODUCTS CORPORATE TOTAL
----------------------------------------------------
<S> <C> <C> <C> <C>
Total revenues $ 116,280 $ 42,856 $ - $159,136
==========================================================================================================
Income (loss) before provision (benefit)
for income taxes $ 22,201 $ (7,092) $ (21,033) $ (5,924)
Provision (benefit) for income taxes 8,501 (2,716) (5,716) 69
- ----------------------------------------------------------------------------------------------------------
Net income (loss) $ 13,700 $ (4,376) $ (15,317) $ (5,993)
==========================================================================================================
Fixed asset additions, net $ - $ - $ 4,366 $ 4,366
==========================================================================================================
Depreciation and amortization $ 565 $ 367 $ 1,090 $ 2,022
==========================================================================================================
Total assets $ 69,185 $ 23,508 $ 22,787 $115,480
==========================================================================================================
</TABLE>
<TABLE>
<CAPTION>
AS OF AND FOR THE YEAR ENDED DECEMBER 31, 1999
-----------------------------------------------------
CONSUMER
PROMOTIONS PRODUCTS CORPORATE TOTAL
-----------------------------------------------------
Total revenues $ 202,195 $ 24,868 $ - $227,063
===========================================================================================================
<S> <C> <C> <C> <C>
Income (loss) before provision (benefit)
for income taxes $ 36,332 $ 181 $ (20,965) $ 15,548
Provision (benefit) for income taxes 14,333 72 (8,271) 6,134
- -----------------------------------------------------------------------------------------------------------
Net income (loss) $ 21,999 $ 109 $ (12,694) $ 9,414
===========================================================================================================
Fixed asset additions, net $ - $ -- $ 847 $ 847
===========================================================================================================
Depreciation and amortization $ 743 $ 504 $ 1,461 $ 2,708
===========================================================================================================
Total assets $ 62,910 $ 19,588 $ 14,746 $ 97,244
===========================================================================================================
</TABLE>
Information about the Company's operations by geographical area is as
follows:
<TABLE>
<CAPTION>
AS OF AND FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------
1997 1998 1999
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
United States $ 117,521 $ 138,571 $ 205,182
International 28,807 20,565 21,881
- ------------------------------------------------------------------------------------------------
Total revenues $ 146,328 $ 159,136 $ 227,063
================================================================================================
Income (loss) from operations:
United States $ 12,316 $ (10,669) $ 14,516
International 2,809 5,256 1,542
- ------------------------------------------------------------------------------------------------
Total income (loss) from operations $ 15,125 $ (5,413) $ 16,058
================================================================================================
Fixed assets, net:
United States $ 2,432 $ 5,736 $ 4,586
International 118 156 321
- ------------------------------------------------------------------------------------------------
Total fixed assets $ 2,550 $ 5,892 $ 4,907
================================================================================================
</TABLE>
38
<PAGE> 39
13. SUMMARIZED QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
------------------------------------------------------------
<S> <C> <C> <C> <C>
1998
Revenues $ 23,796 $ 30,593 $ 29,987 $ 74,760
Income (loss) from operations $ 862 $ 2,456 $ (821) $ (7,910)
Net income (loss) $ 616 $ 1,565 $ (700) $ (7,474)
Basic Income (Loss) Per Share:
Earnings (loss) per share $ 0.10 $ 0.26 $ (0.12) $ (1.20)
Weighted average shares
outstanding 6,010,103 6,035,066 6,085,585 6,227,718
Diluted Income (Loss) Per Share:
Earnings (loss) per share $ 0.10 $ 0.25 $ (0.12) $ (1.20)
Weighted average shares
outstanding 6,314,902 6,315,415 6,085,585 6,227,718
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
------------------------------------------------------------
<S> <C> <C> <C> <C>
1999
Revenues $ 27,457 $ 56,011 $ 53,334 $ 90,261
Income (loss) from operations $ (219) $ 4,990 $ 4,771 $ 6,516
Net income (loss) $ (265) $ 2,864 $ 2,772 $ 4,043
Basic Income (Loss) Per Share:
Earnings (loss) per share $ (0.04) $ 0.46 $ 0.44 $ 0.65
Weighted average shares
outstanding 6,210,497 6,223,099 6,230,906 6,247,248
Diluted Income (Loss) Per Share:
Earnings (loss) per share $ (0.04) $ 0.45 $ 0.42 $ 0.61
Weighted average shares
outstanding 6,210,497 6,340,969 6,533,737 6,600,100
</TABLE>
39
<PAGE> 40
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF LOS
ANGELES AND STATE OF CALIFORNIA ON THE 27TH DAY OF MARCH, 2000.
EQUITY MARKETING, INC.
By: /s/ Donald A. Kurz
---------------------------------
Donald A. Kurz
Chairman of the Board and Chief
Executive Officer
POWER OF ATTORNEY
We, the undersigned directors and officers of Equity Marketing, Inc. do hereby
severally constitute and appoint Donald A. Kurz, Leland P. Smith and Teresa P.
Covington, and each of them, our true and lawful attorneys and agents, to do any
and all acts and things in our name and behalf in our capacities as directors
and officers and to execute any and all instruments for us and in our names in
the capacities indicated below, which said attorneys and agents, or any of them,
may deem necessary or advisable to enable said corporation to comply with the
Securities Exchange Act of 1934, as amended, and any rules, regulations and
requirements of the Securities and Exchange Commission, in connection with this
Annual Report on Form 10-K, including specifically, but without limitation,
power and authority to sign for us or any of us, in our names in the capacities
indicated below, any and all amendments hereto; and we do each hereby ratify and
confirm all said attorneys and agents, or any one of them, shall do or cause to
be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
<S> <C> <C>
/s/ Donald A. Kurz Chairman of the Board and Chief March 27, 2000
- ----------------------------- Executive Officer
Donald A. Kurz (Principal Executive Officer)
/s/ Teresa P. Covington Vice President, Finance March 27, 2000
- ----------------------------- (Principal Financial and
Teresa P. Covington Accounting Officer)
/s/ Sanford R. Climan Director March 27, 2000
- -----------------------------
Sanford R. Climan
/s/ Lawrence Elins Director March 27, 2000
- -----------------------------
Lawrence Elins
/s/ Bruce Raben Director March 27, 2000
- -----------------------------
Bruce Raben
/s/ Stephen P. Robeck Director March 27, 2000
- -----------------------------
Stephen P. Robeck
/s/ Mitchell H. Kurz Director March 27, 2000
- -----------------------------
Mitchell H. Kurz
</TABLE>
40
<PAGE> 41
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Equity Marketing, Inc.:
We have audited in accordance with auditing standards generally accepted in the
United States, the consolidated financial statements of Equity Marketing, Inc.
and subsidiaries included in this Form 10-K and have issued our report thereon
dated March 23, 2000. Our audits were made for the purpose of forming an opinion
on the basic consolidated financial statements taken as a whole. The schedule
listed in the index in Item 14 is the responsibility of the Company's management
and is presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in the audits of
the basic consolidated financial statements and, in our opinion, fairly states
in all material respects the financial data required to be set forth therein in
relation to the basic consolidated financial statements taken as a whole.
/s/ ARTHUR ANDERSEN LLP
Arthur Andersen LLP
Los Angeles, California
March 23, 2000
41
<PAGE> 42
SCHEDULE II
EQUITY MARKETING, INC.
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Balance at Additions Additions
Beginning of Charged to Charged to Balance at
CLASSIFICATION of Year Operating Expenses Revenues Deductions, net End of Year
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1997
Allowances for doubtful
accounts receivable
and sales returns $ 555 $ 92 $ 807 $ (854)(A) $ 600
Year Ended December 31, 1998
Allowances for doubtful
accounts receivable
and sales returns $ 600 $1,435 $3,734 $(2,085)(A) $3,684
Restructuring reserves -- 4,121 -- (127) 3,994
Year Ended December 31, 1999
Allowances for doubtful
accounts receivable
and sales returns $3,684 $1,585 $4,031 $(3,930)(A) $5,370
Restructuring reserves 3,994 (604) -- (1,662) 1,728
</TABLE>
- ------------
(A) Represents product returns, credits applied and accounts receivable written
off, net of recoveries.
42
<PAGE> 43
<TABLE>
<CAPTION>
Exhibit Description Page
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
3.1 Certificate of Incorporation.(2)
3.2 Amended and Restated Bylaws.(4)
3.3 First Amendment to Amended and Restated Bylaws(5)
10.1 Amended and Restated Credit Agreement dated December 10, 1998 between Equity Marketing, Inc.,
Sanwa Bank California, and Imperial Bank.(5)
10.2 First Amendment and Waiver to Amended and Restated Credit Agreement dated March 30, 1999 between
Equity Marketing, Inc., Sanwa Bank California, and Imperial Bank.(5)
10.3 Second Amendment to Amended and Restated Credit Agreement dated June 18, 1999 between Equity
Marketing, Inc., Sanwa Bank California, and Imperial Bank.(6)
10.4 Third Amendment to Amended and Restated Credit Agreement dated October 28, 1999 between Equity
Marketing, Inc., Sanwa Bank California, and Imperial Bank.(7)
10.5 Fourth Amendment to Amended and Restated Credit Agreement dated January 25, 2000 between Equity
Marketing, Inc., Sanwa Bank California, and Imperial Bank.(*)
10.6 Fifth Amendment to Amended and Restated Credit Agreement dated March 13, 2000 between Equity
Marketing, Inc., Sanwa Bank California, and Imperial Bank.(*)
10.7 Sixth Amendment to Amended and Restated Credit Agreement dated March 24, 2000 between Equity
Marketing, Inc., Sanwa Bank California, and Imperial Bank.(*)
10.8 Agreement of lease dated February 9, 1999 between Miracle Mile, L.L.C. and Equity Marketing,
Inc.(*)
10.9 Agreement of Lease, dated September 1, 1999, between Wide Harvest Investment Ltd. and Equity
Marketing Hong Kong, Ltd.(*)
10.10 Promissory Notes, dated September 27, 1991, issued by Donald A. Kurz to
Equity Marketing, Inc.(1)
10.11 Loan Forgiveness Agreements, dated September 27, 1991, between Equity Marketing, Inc. and Donald
A. Kurz.(1)
10.12 Tax indemnification Agreement, dated October 1, 1993, among Stephen P. Robeck, Donald A. Kurz
and Equity Marketing, Inc.(1)
10.13 Reimbursement Agreement, dated October 1, 1993, among Donald A. Kurz, Stephen P. Robeck and
Equity Marketing, Inc.(1)
</TABLE>
EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS OF THE COMPANY
<TABLE>
<S> <C>
10.14 Form of Director's and Officer's Indemnification Agreement.(4)
10.15 Equity Marketing, Inc. Deferred Compensation Plan.(2)
10.16 Equity Marketing, Inc. Amended and Restated Stock Option Plan.(4)
10.17 Equity Marketing Inc. Non-Employee Director Stock Option Plan.(3)
10.18 Employment agreement dated January 1, 1999 between Equity Marketing, Inc. and Donald A. Kurz.(5)
10.19 Consulting agreement dated January 1, 1999 between Equity Marketing, Inc. and Stephen P. Robeck.(5)
10.20 Amended and Restated Employment agreement dated September 1, 1998 between Equity Marketing, Inc.
and Joseph F. Morrison.(5)
10.21 Employment Agreement dated April 13, 1998 between Equity Marketing, Inc. and Edward T. Boyd.(5)
21. Subsidiaries of the Registrant.
23. Consent of Arthur Andersen LLP.
27. Financial Data Schedule.
</TABLE>
- ------------------------
(1) Previously filed as an exhibit to the Registrant's Registration Statement on
Form S-1 (Registration Statement No. 33-67778), which is incorporated herein by
reference.
(2) Previously filed as an exhibit to the Registrant's Statement on Form 10-K
for the year ended December 31, 1995, which is incorporated herein by reference.
(3) Previously filed as an exhibit to the Registrant's Statement on Form 10-K
for the year ended December 31, 1997, which is incorporated herein by reference.
(4) Previously filed as an exhibit to the Registrant's Statement on Form 10-Q
for the quarter ended September 30, 1998, which is incorporated herein by
reference.
(5) Previously filed as an exhibit to the Registrant's Current Report on Form
8-K dated April 16, 1999, which is incorporated herein by reference.
(6) Previously filed as an exhibit to the Registrant's Statement on Form 10-Q
for the quarter ended June 30, 1999, which is incorporated herein by reference.
43
<PAGE> 44
(7) Previously filed as an exhibit to the Registrant's Statement on Form 10-Q
for the quarter ended September 30, 1999, which is incorporated herein by
reference.
(*) To be filed on a Current Report on Form 8-K
44
<PAGE> 1
EXHIBIT 21
Subsidiaries of the Registrant
1. Equity Marketing Hong Kong, Ltd., a Delaware corporation.
2. Synergy Promotions, S.A. de C.V., a Mexico corporation.
3. Corinthian Marketing, Inc., a Delaware corporation.
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
reports included in this Form 10-K, into the Company's previously filed Form S-8
registration statements File Nos. 33-84592, 33-84594, 33-15493, 33-15499,
33-48539, 333-48541, 333-58773, 333-58777.
/s/ ARTHUR ANDERSEN LLP
- -----------------------------------
Arthur Andersen LLP
Los Angeles, California
March 23, 2000
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<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
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