ITEM 1. BUSINESS
GENERAL
Prior to August 2001, the Company, incorporated in Delaware and founded in 1976, had been operating as a multi-national full-service promotional marketing company, specializing in the design and development of high-impact promotional products and sales promotions. The major client of the Company in recent years had been McDonald's Corporation ("McDonald's"), for whom the Company's Simon Marketing subsidiary designed and implemented marketing promotions, which included premiums, games, sweepstakes, events, contests, coupon offers, sports marketing, licensing and promotional retail items. Net sales to McDonald's and Philip Morris, another significant client, accounted for 78% and 8%, respectively, of total net sales in 2001.
On August 21, 2001, the Company was notified by McDonald's that they were terminating their approximately 25-year relationship with Simon Marketing as a result of the arrest of Jerome P. Jacobson ("Mr. Jacobson"), a former employee of Simon Marketing who subsequently pled guilty to embezzling winning game pieces from McDonald's promotional games administered by Simon Marketing. No other Company employee was found to have any knowledge of or complicity in his illegal scheme. Simon Marketing was identified in the criminal indictment of Mr. Jacobson, along with McDonald's, as an innocent victim of Mr. Jacobson's fraudulent scheme. Further, on August 23, 2001, the Company was notified that its second largest customer, Philip Morris, was also ending its approximately nine-year relationship with the Company. As a result of the above events, the Company no longer has an on-going promotions business.
Since August 2001, the Company has concentrated its efforts on reducing its costs and settling numerous claims, contractual obligations and pending litigation. By April 2002, the Company had effectively eliminated a majority of its on-going promotions business operations and was in the process of disposing of its assets and settling its liabilities related to the promotions business and defending and pursuing litigation with respect thereto. The process is on-going and will continue for some indefinite period primarily dependent upon on-going litigation. See Item 3. Legal Proceedings. As a result of these efforts, the Company has been able to resolve a significant number of outstanding liabilities that existed in August 2001 or arose subsequent to that date. As of December 31, 2005, the Company had reduced its workforce to 4 employees from 136 employees as of December 31, 2001.
During the second quarter of 2002, the discontinued activities of the Company, consisting of revenues, operating costs, certain general and administrative costs and certain assets and liabilities associated with the Company's promotions business, were classified as discontinued operations for financial reporting purposes. At December 31, 2005, the Company had a stockholders' deficit of $.8 million. For the year ended December 31, 2005, the Company had a net loss of $3.2 million. The Company incurred losses within its continuing operations in 2005 and continues to incur losses in 2006 for the general and administrative expenses incurred to manage the affairs of the Company and resolve outstanding legal matters. By utilizing cash which had been received pursuant to the settlement of the Company's litigation with McDonald's in 2004, management believes it has sufficient capital resources and liquidity to operate the Company for the foreseeable future. However, as a result of the stockholders' deficit at December 31, 2005, the Company's significant loss from operations and the pending legal matters, the Company's independent registered public accounting firm has expressed substantial doubt about the Company's ability to continue as a going concern. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.
At December 31, 2005, the Company held an investment in Yucaipa AEC Associates, LLC ("Yucaipa AEC Associates"), a limited liability company that is controlled by the Yucaipa Companies, a Los Angeles, California based investment firm, which also controls the holder of the Company's outstanding preferred stock. Yucaipa AEC Associates in turn principally holds an investment in the common stock of Source Interlink Companies. Prior to 2005, this investment was in Alliance Entertainment Corp. ("Alliance") which is a home entertainment product distribution, fulfillment, and infrastructure company providing both brick-and-mortar and e-commerce home entertainment retailers with complete business-to-business solutions. At December 31, 2001, the Company's investment in Yucaipa AEC Associates had a carrying value of $10.0 million which was accounted for under the cost method. In June 2002, certain events occurred which indicated an impairment and the Company recorded a pre-tax non-cash charge of $10.0 million to write down this investment in June 2002.
In March 2004, the Emerging Issues Task Force ("EITF") of the FASB, issued EITF 03-16, "Accounting for Investments in Limited Liability Companies," which required the Company to change its method of accounting for its investment in Yucaipa AEC Associates from the cost method to the equity method for periods ending after July 1, 2004.
On February 28, 2005, Alliance merged with Source Interlink Companies, Inc. ("Source"), a direct-to-retail magazine distribution and fulfillment company in North America and a provider of magazine information and front-end management services for retailers. Inasmuch as Source is a publicly traded company, the Company's pro-rata investment in Yucaipa AEC Associates, which holds the shares in Source, is equal to the number of Source shares indirectly held by the Company multiplied by the stock price of Source on the date of closing of the merger. Accordingly, on February 28, 2005, the date of closing of the merger, and to reflect its share of the gain upon receipt of the Source equity by Yucaipa AEC Associates, the Company recorded an unrealized gain to Other Comprehensive Income of $11.3 million ($10.8 million net of tax), which does not reflect any discount for illiquidity. As the Company's investment in Yucaipa AEC Associates is accounted for under the equity method, the Company will adjust its investment based on its pro rata share of the earnings and losses of Yucaipa AEC Associates. There were no such adjustments during 2005. The Company has no power to dispose of or liquidate its holding in Yucaipa AEC Associates or its indirect interest in Source which power is held by Yucaipa AEC Associates. Furthermore, in the event of a sale or liquidation of the Source shares by Yucaipa AEC Associates, the amount and timing of any distribution of the proceeds of such sale or liquidation to the Company is discretionary with Yucaipa AEC Associates.
The Company is currently managed by Messrs. George Golleher and J. Anthony Kouba, members of the Board of Directors who jointly act as Chief Executive Officers, in consultation with a principal financial officer and acting general counsel. In connection with such responsibilities, Messrs. Golleher and Kouba entered into Executive Services Agreements dated May 30, 2003, which were subsequently amended in May 2004. See Item 11. Executive Compensation.
The Board of Directors continues to consider various alternative courses of action for the Company, including possibly acquiring or combining with one or more operating businesses. The Board of Directors has reviewed and analyzed a number of proposed transactions and will continue to do so until it can determine a course of action going forward to best benefit all shareholders, including the holder of the Company's outstanding preferred stock described below. The Company cannot predict when the Directors will have developed a proposed course of action or whether any such course of action will be successful.
1999 EQUITY INVESTMENT
In November 1999, Overseas Toys L.P., an affiliate of Yucaipa, invested $25 million into the Company in exchange for 25,000 shares of a new series A convertible preferred stock (initially convertible into 3,030,303 shares of Company common stock) and a warrant, which expired in November 2004, to purchase an additional 15,000 shares of series A convertible preferred stock (initially convertible into 1,666,667 shares of Company common stock). The net proceeds of $20.6 million from this transaction, which was approved by the Company's stockholders, were used for general corporate purposes. Under its terms, the preferred stock has a preference upon liquidation and must be redeemed under certain circumstances, including a sale of the Company or change of control as defined therein. As of December 31, 2005, the amount of the liquidation preference, which is equal to the sum of the preferred stock outstanding plus accrued dividends, was $31.3 million, and the redemption value, which is equal to the sum of the preferred stock outstanding plus accrued dividends multiplied by 101%, was $31.6 million. As of December 31, 2005, assuming conversion of all of the convertible preferred stock and accrued dividends, Overseas Toys L.P. would own approximately 18.6% of the then outstanding common stock.
In connection with the investment, the Company's Board of Directors was increased to seven members and three designees of Yucaipa, including Yucaipa's managing partner, Ronald W. Burkle, were elected to the Board of Directors and Mr. Burkle was elected Chairman. Pursuant to a Voting Agreement, dated September 1, 1999, among Yucaipa, Patrick Brady, Allan Brown, Gregory Shlopak, the Shlopak Foundation, Cyrk International Foundation and the Eric Stanton Self-Declaration of Revocable Trust, each of Messrs. Brady, Brown, Shlopak and Stanton agreed to vote all of the shares beneficially held by them to elect the three members nominated by Yucaipa. Mr. Burkle and Erika Paulson, a Yucaipa representative on the Board of Directors, subsequently resigned from the Board of Directors in August 2001. On March 20, 2006, Yucaipa notified the Company that it was designating Ira Tochner and Erika Paulson to fill the vacancies which had been created by the August 2001 resignations and that it was further designating that Mr. Tochner be appointed Chairman of the Board, as it was entitled to do under the terms of its investment. As of March 31, 2006, the Company's Board had not yet effectuated the designated appointments but expects to do so in the very near future.
2001 SALE OF BUSINESS
In February 2001, the Company sold its Corporate Promotions Group ("CPG") business to Cyrk, Inc. ("Cyrk"), formerly known as Rockridge Partners, Inc., for approximately $14 million, which included the assumption of approximately $3.7 million of Company debt. Two million three hundred thousand dollars ($2,300,000) of the purchase price was paid with a 10% per annum five-year subordinated note from Cyrk, with the balance being paid in cash. CPG had been engaged in the corporate catalog and specialty advertising segment of the promotions industry. Cyrk assumed certain liabilities of the CPG business as specified in the Purchase Agreement, and the Company agreed to transfer its former name, Cyrk, to the buyer. There is no material relationship between Cyrk and the Company or any of its affiliates, directors or officers, or any associate thereof, other than the relationship created by the Purchase Agreement and related documents. Subsequently, in connection with the settlement of a controversy between the parties, Cyrk supplied a $500,000 letter of credit to secure partial performance of assumed liabilities and the balance due on the note was forgiven, subject to a reinstatement thereof in the event of default by Cyrk under such assumed liabilities.
One of the obligations assumed by Cyrk was to Winthrop Resources Corporation ("Winthrop"). As a condition to Cyrk assuming this obligation, however, the Company was required to provide a $4.2 million letter of credit as collateral for Winthrop in case Cyrk did not perform the assumed obligation. The available amount under this letter of credit reduced over time as the underlying obligation to Winthrop reduces. As of September 30, 2005, the available amount under the letter of credit was $2.1 million which was secured, in part, by $1.6 million of restricted cash of the Company. The Company's letter of credit was also secured, in part, by the aforesaid $500,000 letter of credit provided by Cyrk for the benefit of the Company. Cyrk agreed to indemnify the Company if Winthrop made any draw under the letter of credit.
In the fourth quarter of 2003, Cyrk informed the Company that it was continuing to suffer substantial financial difficulties and that it might not be able to continue to discharge its obligations to Winthrop which were secured by the Company's letter of credit. As a result of the foregoing, the Company recorded a charge in 2003 of $2.8 million with respect to the liability arising from the Winthrop lease. Such charge was revised downward to $2.5 million during 2004 and to $1.6 million during 2005 based on the reduction in the Winthrop liability.
During the fourth quarter of 2005, Winthrop drew down the $1.6 million balance of the Company's letter of credit due to Cyrk's default on its obligations to Winthrop. An equal amount of the Company's restricted cash was drawn down by the Company's bank which had issued the letter of credit. Due to this default, Cyrk's $2.3 million subordinated note payable to the Company, which forgiven by the Company in 2003, was reinstated.
On January 31, 2006, the Company and Cyrk entered into a Settlement Agreement and Mutual General Release pursuant to which: (1) Cyrk agreed to pay $1.6 million to the Company, of which $435,000 was paid on or before March 1, 2006 and the balance is payable, pursuant to a subordinated note (the "New Subordinated Note"), in forty-one (41) approximately equal consecutive monthly installments beginning April 1, 2006; (ii) Cyrk entered into a Confession of Judgment in Washington State Court for all amounts owing to the Company under the New Subordinated Note and the $2.3 million note (the "Old Subordinated Note"); (iii) Cyrk's parent company agreed to subordinate approximately $4.3 million of Cyrk debt to the debt owed to the Company by Cyrk; and (iv) Cyrk and the Company entered into mutual releases of all claims except those arising under the Settlement Agreement, the New Subordinated Note or the Confession Judgment. So long as Cyrk does not default on the New Subordinated Note, the Company has agreed not to enter the Confession of Judgment in court. Cyrk's obligations under the New Subordinated Note and the Old Subordinated Note are subordinated to Cyrk's obligations to the financial institution which is Cyrk's senior lender, which obligations are secured by, among other things, substantially all of Cyrk's assets. In the event of a default by Cyrk of its obligations under the New Subordinated Note, there is no assurance that the Company will be successful in enforcing the Confession of Judgment.
ITEM 1A.
ITEM 1A. RISK FACTORS
The following important factors, among others, in some cases have affected, and in the future could affect, the Company's actual results and could cause the Company's actual consolidated results for the Company's current year and beyond to differ materially from those expressed in any forward-looking statements made by or on behalf of the Company.
UNCERTAIN OUTLOOK
The Company no longer has any operating business. As a result of this fact, together with the stockholders' deficit, the Company's significant loss from operations and the pending legal matters, the Company's independent registered public accounting firm has expressed substantial doubt about the Company's ability to continue as a going concern. The Board of Directors continues to consider various alternative courses of action for the Company, including possibly acquiring or combining with one or more operating businesses. The Board of Directors has reviewed and analyzed a number of proposed transactions and will continue to do so until it can determine a course of action going forward to best benefit all shareholders, including the holder of the Company's outstanding preferred stock described below. The Company cannot predict when the Directors will have developed a proposed course of action or whether any such course of action will be successful.
No assurances can be made that the holders of our capital stock will receive any distributions if the Company is wound up and liquidated or sold. The outstanding preferred stock has a liquidation preference over the common stock of approximately $31.3 million, which includes accrued dividends. Also, upon a change of control of the Company, the holder of the outstanding preferred stock can cause the Company to redeem the preferred stock for 101% of the liquidation preference.
PENDING LITIGATION
Although significant litigation, including the litigation with McDonald's and related entities, was settled during the third quarter of 2004, other material litigation against the Company is still pending, specifically, a case in Canada which arose out of the same events which resulted in the McDonald's litigation. In addition to the on-going legal costs associated with the defense of this case and any future cases which may be brought against the Company by persons who opted out of the McDonald's settlement or others, any significant adverse judgment would have a material adverse effect on the Company.
DEPENDENCE ON KEY PERSONNEL
We are dependent on several key personnel, including our Directors. In light of our uncertain outlook, there is no assurance that our key personnel can be retained. The loss of the services of our key personnel would harm the Company. In addition, the Company has a limited number personnel. As such, this presents a challenge in implementing Section 404 of the Sarbanes-Oxley Act of 2002 with which the Company must comply in fiscal 2007. If Section 404 is not properly implemented, the Company's internal control over financial reporting may be adversely affected.
INVESTMENTS
The Company has made strategic and venture investments in a portfolio of privately held companies. These investments were in technology and internet related companies that were at varying stages of development, and were intended to provide the Company with an expanded technology and internet presence, to enhance the Company's position at the leading edge of e-business and to provide venture investment returns. These companies in which the Company has invested are subject to all the risks inherent in technology and the internet. In addition, these companies are subject to the valuation volatility associated with the investment community and capital markets. The carrying value of the Company's investments in these companies is subject to the aforementioned risks. Periodically, the Company performs a review of the carrying value of all its investments in these companies, and considers such factors as current results, trends and future prospects, capital market conditions and other economic factors. The carrying value of the Company's investment portfolio totaled $11.5 million as of December 31, 2005.
From time to time, the Company may provide forward looking information such as forecasts of expected future performance or statements about the Company's plans and objectives. This information may be contained in filings with the Securities and Exchange Commission, press releases or oral statements by the officers of the Company. The Company desires to take advantage of the "Safe Harbor" provisions of the Private Securities Litigation Reform Act of 1995 and these risk factors are intended to do so.
1B. UNRESOLVED STAFF COMMENTS
Inapplicable.
ITEM 2.
ITEM 2. PROPERTIES
As a result of the loss of its two major customers in 2001, the Company took actions to significantly reduce its infrastructure and its global property commitments. During 2002, the Company negotiated early terminations of all its domestic, Asian and European office, warehouse and distribution facility leases and settled its outstanding remaining real estate lease obligations. During 2002, the Company made aggregate payments totaling approximately $2.9 million related to the early termination of these leases.
In September 2005, the Company renewed a 12-month lease agreement for 2,600 square feet of office space in Los Angeles, California, with a monthly rent of approximately $3,600, into which it has located its remaining scaled-down operations. For a summary of the Company's minimum rental commitments under all non-cancelable operating leases as of December 31, 2005, see Notes to Consolidated Financial Statements.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
As a result of the Jacobson embezzlement described above in Item 1, numerous consumer class action and representative action lawsuits were filed in Illinois and multiple other jurisdictions nationwide and in Canada. All actions brought in the United States were eventually consolidated and settled (the "Boland Settlement"), except for any plaintiff who opted out of such settlement.
On or about September 13, 2002, an action was filed against Simon Marketing and McDonald's in Canada in Ontario Provincial Court alleging substantially the same facts as in the United States class action lawsuits and adding an allegation that Simon Marketing and McDonald's deliberately diverted from seeding in Canada game pieces with high-level winning prizes in certain McDonald's promotional games. The plaintiffs were Canadian citizens seeking restitution and damages on a class-wide basis. On October 28, 2002, a second action was filed against Simon Marketing and McDonald's in Ontario Provincial Court containing similar allegations. The plaintiffs in the aforesaid actions seek an aggregate of $110 million in damages. Simon Marketing has retained Canadian local counsel to represent it in these actions. The Company believes that the plaintiffs in these actions did not opt out of the Boland Settlement. The Company and McDonald's have filed motions to dismiss or stay these cases on the basis of the Boland Settlement. The Canadian Court has dismissed the case filed in September 2002, but has allowed the October 2002 case to move forward. An appeal of that decision by McDonald's and the Company has been denied by the Court of Appeal. During the third quarter of 2005, the Company entered into a settlement agreement with plaintiff in the case on behalf of the class pursuant to which the Company agreed to pay $650,000 Canadian ($554,512 US) to be used for costs, fees and expenses relating to the settlement with excess proceeds to be distributed to two charities. The settlement is subject to certification of the class with respect to the Company and approval of the terms of settlement by the Canadian court.
On March 29, 2002, Simon Marketing filed a lawsuit against PricewaterhouseCoopers LLP ("PWC") and two other accounting firms, citing the accountants' failure to oversee, on behalf of Simon Marketing, various steps in the distribution of high-value game pieces for certain McDonald's promotional games. The complaint alleged that this failure allowed the misappropriation of certain of these high-value game pieces by Mr. Jacobson. The lawsuit, filed in Los Angeles Superior Court, sought unspecified actual and punitive damages resulting from economic injury, loss of income and profit, loss of goodwill, loss of reputation, lost interest, and other general and special damages. Defendants' demurrers to the first and a second amended complaint were sustained in part, including the dismissal of all claims for punitive damages with no leave to amend. A third amended complaint was filed, and defendants' demurrer to all causes of action was sustained without leave to amend. The Company appealed this ruling with respect to PWC only, and the California Court of Appeal subsequently reversed the lower court and reinstated the case against PWC. The case is now proceeding in the discovery stage.
On October 19, 2005, the Company received notice of a lawsuit against it in the Bankruptcy Court for the Northern District of Illinois by the Committee representing the unsecured creditors of H A 2003 Inc., formerly known as HA-LO Industries, Inc. ("HA-LO"), seeking to recover as a voidable preference a certain payment made in May 2001 by HA-LO to the Company in the amount of $459,852 plus interest. The Company has retained bankruptcy counsel to represent it in the matter and is investigating facts surrounding the alleged payment. It has recorded a contingent loss liability of $.5 million related to this matter.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Until May 3, 2002, the Company's stock traded on The Nasdaq Stock Market under the symbol SWWI. On May 3, 2002, the Company's stock was delisted by Nasdaq due to the fact that the Company's stock was trading at a price below the minimum Nasdaq requirement. The following table presents, for the periods indicated, the high and low sales prices of the Company's common stock as reported on the over-the-counter market as reported in the Pink Sheets. Such over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
As of February 28, 2006, the Company had approximately 416 holders of record of its common stock. The last reported sale price of the Company's common stock on February 28, 2006, was $.25.
The Company has never paid cash dividends, other than series A preferred stock distributions in 2000 and stockholder distributions of Subchapter S earnings during 1993 and 1992.
During 2005, the Company did not repurchase any of its common stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
By April 2002, the Company had effectively eliminated a majority of its on-going promotions business operations. Accordingly, the discontinued activities of the Company have been classified as discontinued operations. The selected financial data for prior periods has been reclassified to conform to current period presentation. The following selected financial data had been derived from our audited financial statements and should be read in conjunction with Item 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
From time to time, the Company may provide forward-looking information such as forecasts of expected future performance or statements about the Company's plans and objectives, including certain information provided below. These forward-looking statements are based largely on the Company's expectations and are subject to a number of risks and uncertainties, certain of which are beyond the Company's control. The Company wishes to caution readers that actual results may differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company including, without limitation, as a result of factors described in Item 1A. Risk Factors.
BUSINESS CONDITIONS
Prior to August 2001, the Company, incorporated in Delaware and founded in 1976, had been operating as a multi-national full-service promotional marketing company, specializing in the design and development of high-impact promotional products and sales promotions. The majority of the Company's revenue was derived from the sale of products to consumer products and services companies seeking to promote their brand names and corporate identities and build brand loyalty. The major client of the Company was McDonald's Corporation ("McDonald's"), for whom the Company's Simon Marketing subsidiary designed and implemented marketing promotions, which included premiums, games, sweepstakes, events, contests, coupon offers, sports marketing, licensing and promotional retail items. Net sales to McDonald's and Philip Morris, another significant client, accounted for 78% and 8%, respectively, of total net sales in 2001.
On August 21, 2001, the Company was notified by McDonald's that it was terminating its approximately 25-year relationship with Simon Marketing as a result of the arrest of Jerome P. Jacobson ("Mr. Jacobson"), a former employee of Simon Marketing who subsequently pled guilty to embezzling winning game pieces from McDonald's promotional games administered by Simon Marketing. No other Company employee was found to have any knowledge of or complicity in his illegal scheme. Simon Marketing was identified in the criminal indictment of Mr. Jacobson, along with McDonald's, as an innocent victim of Mr. Jacobson's fraudulent scheme. Further, on August 23, 2001, the Company was notified that its second largest customer, Philip Morris, was also ending its approximately nine-year relationship with the Company. As a result of the above events, the Company no longer has an on-going promotions business.
Since August 2001, the Company has concentrated its efforts on reducing its costs and settling numerous claims, contractual obligations and pending litigation. By April 2002, the Company had effectively eliminated a majority of its on-going promotions business operations and was in the process of disposing of its assets and settling its liabilities related to the promotions business and defending and pursuing litigation with respect thereto. The process is on-going and will continue for some indefinite period primarily dependent upon on-going litigation. See Item 3. Legal Proceedings. As a result of these efforts, the Company has been able to resolve a significant number of outstanding liabilities that existed in August 2001 or arose subsequent to that date. As of December 31, 2005, the Company had reduced its workforce to 4 employees from 136 employees as of December 31, 2001.
During the second quarter of 2002, the discontinued activities of the Company, consisting of revenues, operating costs, certain general and administrative costs and certain assets and liabilities associated with the Company's promotions business, were classified as discontinued operations for financial reporting purposes. At December 31, 2005, the Company had a stockholders' deficit of $.8 million. For the year ended December 31, 2005, the Company had a net loss of $3.2 million. The Company incurred losses within its continuing operations in 2005 and continues to incur losses in 2006 for the general and administrative expenses incurred to manage the affairs of the Company and resolve outstanding legal matters. By utilizing cash which had been received pursuant to the settlement of the Company's litigation with McDonald's in 2004, management believes it has sufficient capital resources and liquidity to operate the Company for the foreseeable future. However, as a result of the stockholders' deficit at December 31, 2005, the Company's significant loss from operations and the pending legal matters, the Company's independent registered public accounting firm has expressed substantial doubt about the Company's ability to continue as a going concern. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.
The Company is currently managed by Messrs. George Golleher and J. Anthony Kouba, members of the Board of Directors who jointly act as Chief Executive Officers, in consultation with a principal financial officer and acting general counsel. In connection with such responsibilities, Messrs. Golleher and Kouba entered into Executive Services Agreements dated May 30, 2003, which were subsequently amended in May 2004. See Item 11. Executive Compensation.
The Board of Directors continues to consider various alternative courses of action for the Company, including possibly acquiring or combining with one or more operating businesses. The Board of Directors has reviewed and analyzed a number of proposed transactions and will continue to do so until it can determine a course of action going forward to best benefit all shareholders, including the holder of the Company's outstanding preferred stock. The Company cannot predict when the Directors will have developed a proposed course of action or whether any such course of action will be successful. Management believes it has sufficient capital resources and liquidity to operate the Company for the foreseeable future.
CRITICAL ACCOUNTING POLICIES
Management's discussion and analysis of financial condition and results of operations is based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, management evaluates its estimates and bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
Management applies the following critical accounting policies in the preparation of the Company's consolidated financial statements:
LONG-TERM INVESTMENTS
In the past, with its excess cash, the Company had made strategic and venture investments in a portfolio of privately held companies. These investments were in technology and internet related companies that were at varying stages of development, and were intended to provide the Company with an expanded technology and internet presence, to enhance the Company's position at the leading edge of e-business and to provide venture investment returns. These companies in which the Company has invested are subject to all the risks inherent in technology and the internet. In addition, these companies are subject to the valuation volatility associated with the investment community and capital markets. The carrying value of the
Company's investments in these companies is subject to the aforementioned risks. Periodically, the Company performs a review of the carrying value of all its investments in these companies, and considers such factors as current results, trends and future prospects, capital market conditions and other economic factors. The carrying value of the Company's investment portfolio totaled $11.5 million as of December 31, 2005.
At December 31, 2005, the Company held an investment in Yucaipa AEC Associates, LLC ("Yucaipa AEC Associates"), a limited liability company that is controlled by Yucaipa, which also controls the holder of the Company's outstanding preferred stock. Yucaipa AEC Associates in turn principally holds an investment in the common stock of Source Interlink Companies. Prior to 2005, this investment was in Alliance Entertainment Corp. ("Alliance") which is a home entertainment product distribution, fulfillment, and infrastructure company providing both brick-and-mortar and e-commerce home entertainment retailers with complete business-to-business solutions. At December 31, 2001, the Company's investment in Yucaipa AEC Associates had a carrying value of $10.0 million which was accounted for under the cost method. In June 2002, certain events occurred which indicated an impairment and the Company recorded a pre-tax non-cash charge of $10.0 million to write down this investment in June 2002.
In March 2004, the Emerging Issues Task Force ("EITF") of the FASB, issued EITF 03-16, "Accounting for Investments in Limited Liability Companies," which required the Company to change its method of accounting for its investment in Yucaipa AEC Associates from the cost method to the equity method for periods ending after July 1, 2004.
On February 28, 2005, Alliance merged with Source Interlink Companies, Inc. ("Source"), a direct-to-retail magazine distribution and fulfillment company in North America and a provider of magazine information and front-end management services for retailers. As such, the primary asset of Yucaipa AEC is its investment in Source. Inasmuch as Source is a publicly traded company, the Company's pro-rata investment in Yucaipa AEC Associates, which holds the shares in Source, is equal to the number of Source shares indirectly held by the Company multiplied by the stock price of Source on the date of closing of the merger. Accordingly, on February 28, 2005, the date of closing of the merger, and to reflect the change in its underlying investment within Yucaipa AEC Associates, the Company recorded an unrealized gain to Other Comprehensive Income of $11.3 million ($10.8 million net of tax), which does not reflect any discount for illiquidity. As the Company's investment in Yucaipa AEC Associates is accounted for under the equity method, the Company will adjust its investment based in its pro rata share of the earnings and losses of Yucaipa AEC Associates. Other than the merger of Alliance with Source, there were no such adjustments during 2005. The Company has no power to dispose of or liquidate its holding in Yucaipa AEC Associates or its indirect interest in Source which power is held by Yucaipa AEC Associates. Furthermore, in the event of a sale or liquidation of the Source shares by Yucaipa AEC Associates, the amount and timing of any distribution of the proceeds of such sale or liquidation to the Company is discretionary with Yucaipa AEC Associates.
While the Company will continue to periodically evaluate its investments, there can be no assurance that its investment strategy will be successful, and thus the Company might not ever realize any benefits from its portfolio of investments. During 2005, the Company recorded an investment impairment of $.2 million, net of related amounts recorded in unrealized gain on the balance sheet, to adjust the recorded value of its other investments that are accounted for under the cost method to the estimated future undiscounted cash flows the Company expects from such investments.
CONTINGENCIES
The Company records an accrued liability and related charge for an estimated loss from a loss contingency if two conditions are met: (i) information is available prior to the issuance of the financial statements that indicates it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements and (ii) the amount of loss can be reasonably estimated. Accruals for general or unspecified business risks are not recorded. Gain contingencies are recognized when realized.
On October 19, 2005, the Company received notice of a lawsuit against it in the Bankruptcy Court for the Northern District of Illinois by the Committee representing the unsecured creditors of H A 2003 Inc., formerly known as HA-LO Industries, Inc. ("HA-LO"), seeking to recover as a voidable preference a certain payment made in May 2001 by HA-LO to the Company in the amount of $459,852 plus interest. Based on an assessment by management, during the three months ended September 30, 2005, the Company recorded a contingent loss liability of $.5 million related to this matter.
In the fourth quarter of 2003, Cyrk informed the Company that it was continuing to suffer substantial financial difficulties and that it might not be able to continue to discharge its obligations to Winthrop which was secured by a letter of credit of the Company. As a result of the foregoing, the Company recorded a charge in 2003 of $2.8 million with respect to the liability
arising from the Winthrop lease. Such charge was revised downward to $2.5 million during 2004 and to $1.6 million during 2005 based on the reduction in the Winthrop liability.
During the fourth quarter of 2005, Winthrop drew down the $1.6 million balance of the Company's letter of credit due to Cyrk's default on its obligations to Winthrop. An equal amount of the Company's restricted cash was drawn down by the Company's bank which had issued the letter of credit. Due to this default, Cyrk's $2.3 million subordinated note payable to the Company, which forgiven by the Company in 2003, was reinstated.
On January 31, 2006, the Company and Cyrk entered into a Settlement Agreement and Mutual General Release pursuant to which: (1) Cyrk agreed to pay $1.6 million to the Company, of which $435,000 was paid on or before March 1, 2006 and the balance is payable, pursuant to a subordinated note (the "New Subordinated Note"), in forty-one (41) approximately equal consecutive monthly installments beginning April 1, 2006; (ii) Cyrk entered into a Confession of Judgment in Washington State Court for all amounts owing to the Company under the New Subordinated Note and the $2.3 million note (the "Old Subordinated Note"); (iii) Cyrk's parent company agreed to subordinate approximately $4.3 million of Cyrk debt to the debt owed to the Company by Cyrk; and (iv) Cyrk and the Company entered into mutual releases of all claims except those arising under the Settlement Agreement, the New Subordinated Note or the Confession Judgment. So long as Cyrk does not default on the New Subordinated Note, the Company has agreed not to enter the Confession of Judgment in court. Cyrk's obligations under the New Subordinated Note and the Old Subordinated Note are subordinated to Cyrk's obligations to the financial institution which is Cyrk's senior lender, which obligations are secured by, among other things, substantially all of Cyrk's assets. In the event of a default by Cyrk of its obligations under the New Subordinated Note, there is no assurance that the Company will be successful in enforcing the Confession of Judgment.
RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board ("FASB") issued a revision entitled, "Share Based Payment," to Statement of Financial Accounting Standard ("SFAS") No. 123, "Accounting for Stock Based Compensation." This revision supersedes Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and its related implementation guidance. As such, this revision eliminates the alternative to use the intrinsic value method of accounting under APB Opinion No. 25 that was available under SFAS No. 123 as originally issued. Under APB Opinion No. 25, issuing stock options to employees generally resulted in recognition of no compensation cost. This revision requires entities to recognize the cost of employee services received in exchange for awards of equity instruments based on the fair value at grant-date of those awards (with limited exceptions). The Company currently applies APB Opinion No. 25 and related interpretations in accounting for its stock-based compensation plan. In March 2005, the Securities and Exchange Commission (the "SEC") issued Staff Accounting Bulletin No. 107, "Share-Based Payment", which summarizes the views of the SEC staff regarding the interaction between Statement No. 123(R) and certain SEC rules and regulations, and is intended to assist in the initial implementation. Statement No. 123(R) is effective for the annual reporting period beginning January 1, 2006. The Company does not expect the adoption of Statement No. 123(R) to have a material effect on its consolidated statements of financial position or results of operations, due to the small number of outstanding options.
In May 2005, the FASB issued Statement No. 154, "Accounting Changes and Error Corrections--a replacement of APB Opinion No. 20 and FASB Statement No. 3." APB Opinion No. 20 relates to accounting changes and FASB Statement No. 3 relates to reporting accounting changes in interim financial statements and establishes retrospective application as the required method for reporting a change in accounting principle. Statement No. 154 provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable. The reporting of a correction of an error by restating previously issued financial statements is also addressed. Statement No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not expect the adoption of Statement No. 154 to have a material effect on its consolidated statements of financial position or results of operations.
SIGNIFICANT CONTRACTUAL OBLIGATIONS
The following table includes certain significant contractual obligations of the Company at December 31, 2005. See Notes to Consolidated Financial Statements for additional information related to these and other obligations.
(1) Payments for operating leases are recognized as an expense in the Consolidated Statement of Operations on a straight-line basis over the term of the lease.
(2) Relates to life insurance premiums for the benefit of a former Company executive and for which the Company is obligated.
OTHER COMMERCIAL COMMITMENTS
The following table includes certain commercial commitments of the Company at December 31, 2005. See Notes to Consolidated Financial Statements for additional information related to these and other commitments.
The amount committed at December 31, 2005, relates to a letter of credit provided by the Company to support the Company's obligation to Winthrop Resources Corporation.
RESULTS OF CONTINUING AND DISCONTINUED OPERATIONS
By April 2002, the Company had effectively eliminated a majority of its on-going promotions business operations and was in the process of disposing of its assets and settling its liabilities related to the promotions business. Accordingly, the discontinued activities of the Company have been classified as discontinued operations in the accompanying consolidated financial statements. Continuing operations represent the direct costs required to maintain the Company's current corporate infrastructure that will enable the Board of Directors to pursue various alternative courses of action going forward. These costs primarily consist of the salaries and benefits of executive management and corporate finance staff, professional fees, Board of Director fees, and space and facility costs. The Company's continuing operations and discontinued operations will be discussed separately, based on the respective financial results contained in the accompanying consolidated financial statements and related notes.
CONTINUING OPERATIONS
2005 COMPARED TO 2004
There were no net sales during 2005 or 2004.
General and administrative expenses totaled $3.1 million in 2005 compared to $3.6 million in 2004. The decrease was primarily due to reductions in insurance expense ($.3 million), labor costs ($.1 million) and facilities costs ($.1 million) with no material offsetting increases. Changes in general and administrative expenses going forward are dependent on the outcome of the various alternative courses of action for the Company being considered by the Board of Directors, which include possibly acquiring or combining with one or more operating businesses. The Board has reviewed and analyzed a number of proposed transactions and will continue to do so until it can determine a course of action going forward to best benefit all shareholders, including the holder of the Company's outstanding preferred stock. The Company cannot predict when the Directors will have developed a proposed course of action or whether any such course of action will be successful. Accordingly, the Company cannot predict changes in general and administrative expenses going forward.
The Company recorded an investment impairment during 2005 of $.2 million, net of related amounts recorded in unrealized gain on the balance sheet, to adjust the recorded value of its investments accounted for under the cost method to the estimated future undiscounted cash flows the Company expects from such investments.
2004 COMPARED TO 2003
There were no net sales during 2004 or 2003.
General and administrative expenses totaled $3.6 million in 2004 compared to $5.3 million in 2003. The decrease was primarily due to reductions in professional fees ($.7 million), insurance expense ($.5 million), labor costs ($.4 million) and facilities costs ($.1 million).
DISCONTINUED OPERATIONS
2005 COMPARED TO 2004
There were no net sales or gross profit during 2005 or 2004.
General and administrative expenses totaled $.2 million in 2005 compared to $2.0 million in 2004. The decrease was primarily due to a charge in 2004 against an asset related to an insurance policy for the benefit of a former Company executive and on which the Company was the beneficiary of the cash surrender value ($1.0 million) and a reduction in expenses and other items related to the wind-down of the Company's Europe and Hong Kong entities ($.8 million).
During 2004, and in connection with the Company's settlement of its litigation with McDonald's and related entities, the Company received net cash proceeds, after attorney's fees, of approximately $13 million and due to the elimination of liabilities associated with the settlement of $12 million, the Company recorded a gain of $25 million. This gain was partially offset by a settlement loss of $.5 million resulting in a net gain on settlement of obligations of $24.5 million
2004 COMPARED TO 2003
There were no net sales or gross profit during 2004 or 2003.
General and administrative expenses totaled $2.0 million in 2004 compared to $1.4 million in 2003. The increase was primarily due to a charge of $1.0 million against an asset related to an insurance policy for the benefit of a former Company executive and on which the Company was the beneficiary of the cash surrender value partially offset by reductions in professional fees, labor costs, facilities costs, and other items related to the wind-down of the Company's Europe, Hong Kong and United States entities.
Gain on settlement of obligations totaled $24.5 million in 2004 compared to $.02 million during 2003. During 2004, and in connection with the Company's settlement of its litigation with McDonald's and related entities, the Company received net
cash proceeds, after attorney's fees, of approximately $13 million and due to the elimination of liabilities associated with the settlement of $12 million, the Company recorded a gain of $25 million. This gain was partially offset by a settlement loss of $.5 million. During 2003, the Company's gains related to the settlement of outstanding liabilities with some of its vendors on terms more favorable to the Company than required by the existing terms of the liabilities.
LIQUIDITY AND CAPITAL RESOURCES
The lack of any operating revenue has had and will continue to have a substantial adverse impact on the Company's cash position. As a result of the stockholders' deficit at December 31, 2005, the Company's significant loss from operations and the pending legal matters, the Company's independent registered public accounting firm has expressed substantial doubt about the Company's ability to continue as a going concern. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Since inception, the Company had financed its working capital and capital expenditure requirements through cash generated from operations, and investing and financing activities such as public and private sales of common and preferred stock, bank borrowings, asset sales and capital equipment leases. The Company incurred losses within its continuing operations in 2005 and continues to incur losses in 2006 for the general and administrative expenses incurred to manage the affairs of the Company and resolve outstanding legal matters. Inasmuch as the Company no longer generates operating income within its continuing operations, the source of current and future working capital is expected to be cash on hand, the recovery of certain long-term investments and any future proceeds from litigation. Management believes it has sufficient capital resources and liquidity to operate the Company for the foreseeable future.
The Board of Directors continues to consider various alternative courses of action for the Company, including possibly acquiring or combining with one or more operating businesses. The Board of Directors has reviewed and analyzed a number of proposed transactions and will continue to do so until it can determine a course of action going forward to best benefit all shareholders, including the holder of the Company's outstanding preferred stock.
CONTINUING OPERATIONS
Working capital attributable to continuing operations at December 31, 2005, was $18.7 million compared to $21.4 million at December 31, 2004.
Net cash used in operating activities from continuing operations during 2005 totaled $2.5 million, primarily due to a loss from continuing operations of $2.7 million, resulting from the general and administrative expenses incurred to manage the affairs of the Company and resolve outstanding legal matters, partially offset by a investment impairment charge of $.2 million. By utilizing cash which had been received pursuant to the settlement of the Company's litigation with McDonald's in 2004 of $13 million, after attorney's fees, management believes it has sufficient capital resources and liquidity to operate the Company for the foreseeable future. In addition, the Company does not expect any significant capital expenditures in the foreseeable future.
Net cash used in operating activities from continuing operations during 2004 totaled $2.8 million, primarily due to a loss from continuing operations of $3.6 million, resulting from the general and administrative expenses incurred to manage the affairs of the Company and resolve outstanding legal matters, partially offset by changes in working capital items of $.8 million.
Net cash used in operating activities from continuing operations during 2003 totaled $4.9 million, primarily due to a loss from continuing operations of $5.3 million, resulting from the general and administrative expenses incurred to manage the affairs of the Company and resolve outstanding legal matters, partially offset by a net increase in working capital items of $.4 million.
Net cash provided by investing activities during 2005 totaled $.2 million, primarily due to a decrease in restricted cash.
Net cash used in investing activities during 2004 totaled $2.6 million, primarily due to an increase in restricted cash as such restricted cash was transferred from discontinued operations on the basis that discontinued operations already had sufficient assets from discontinued operations to be disposed of to cover liabilities from discontinued operations.
Net cash provided by investing activities during 2003 totaled $7.3 million, primarily due to a decrease in restricted cash as such restricted cash was transferred to discontinued operations on the basis that discontinued operations required additional assets from discontinued operations to be disposed of to cover liabilities from discontinued operations.
There were no financing cash flows from continuing operations during 2005, 2004 or 2003.
In March 2002, the Company, Simon Marketing and a Trustee entered into an Indemnification Trust Agreement (the "Trust"), which requires the Company and Simon Marketing to fund an irrevocable trust in the amount of $2.7 million. The Trust was set up and will be used to augment the Company's existing insurance coverage for indemnifying directors, officers and certain described consultants, who are entitled to indemnification against liabilities arising out of their status as directors, officers and/or consultants. As of December 31, 2005, there have not been any claims made against the trust. On March 1, 2006, the trust expired by its own terms without any claims having been made and all funds held by the trust plus accrued interest, less trustee fees, totaling approximately $2.8 million were returned to the Company.
In addition to the legal matters discussed in Item 3. Legal Proceedings, the Company is also involved in other litigation and legal matters which have arisen in the ordinary course of business. The Company does not believe that the ultimate resolution of these other litigation and legal matters will have a material adverse effect on its financial condition, results of operations or net cash flows.
Restricted cash included within continuing operations at December 31, 2005 and 2004, totaled $2.8 million and $3.0 million, respectively, and primarily consisted of amounts deposited into an irrevocable trust, totaling $2.7 million and, at December 31, 2004, amounts deposited with lenders to satisfy the Company's obligations pursuant to its standby letter of credit.
DISCONTINUED OPERATIONS
Working capital (deficit) attributable to discontinued operations at December 31, 2005, was $(.3) million compared to $(.2) million at December 31, 2004.
Net cash used in discontinued operations during 2005 totaled $.4 million primarily due to cash used in operating activities of discontinued operations of $2.7 million, cash transferred from continuing operations of $.1 million, partially offset by cash provided by investing activities of discontinued operations of $2.4 million. The $2.7 million cash used in operating activities of discontinued operations is primarily due to a net loss of $.5 million, a reduction in working capital items of $1.9 million, and other items of $.3 million. The $2.4 million cash provided by investing activities of discontinued operations was primarily due to a decrease in restricted cash with $1.6 million of such reduction due to the default by Cyrk on the Winthrop lease. See "2001 Sale of Business" in Item 1. Business.
Net cash provided by discontinued operations during 2004 totaled $24.3 million, primarily due to cash received and the elimination of liabilities related to the McDonald's settlement totaling $25.0 million and cash provided by investing activities of $3.6 million primarily related to a reduction in restricted cash, partially offset by a settlement loss of $.5 million, a net change in working capital items of $2.8 million and other charges of $1.0 million.
Net cash used in discontinued operations during 2003 totaled $3.6 million, primarily due to net cash used in operating activities of $.2 million, net cash used in investing activities of $6.6 million and a reallocation of funds, totaling approximately $3.2 million, from continuing to discontinued operations on the basis that discontinued operations required additional assets from discontinued operations to be disposed of to cover liabilities from discontinued operations.
Net cash used in operating activities of discontinued operations during 2003 of $.2 million primarily consisted of a net loss of $3.6 million partially offset by a non-cash charge for a contingent loss of $2.8 million and a provision for doubtful accounts and other items of $.6 million.
Net cash used in investing activities of discontinued operations during 2003 of $6.6 million primarily consisted of an increase in restricted cash.
There were no financing activities of discontinued operations during 2005, 2004 and 2003.
In 2004, the Company recorded a net settlement gain of $24.5 million primarily due to cash received and the elimination of liabilities related to the McDonald's settlement totaling $25.0 million partially offset by a settlement loss of $.5 million related to a life insurance policy for a former Company executive and on which the Company was obligated to make premium payments. The Company recorded nominal settlement gains during 2003.
At December 31, 2004, the Company had various pre-existing letters of credit outstanding, which were cash collateralized and had various expiration dates through August 2007. As of December 31, 2004, the Company had approximately $3.0 million in outstanding letters of credit, which primarily consisted of letters of credit provided by the Company to support Cyrk's and the Company's obligations to Winthrop Resources Corporation. These letters of credit were secured, in part, by $2.5 million of restricted cash of the Company. The Company's letter of credit which supported Cyrk's obligations to Winthrop was also secured, in part, by a $500,000 letter of credit provided by Cyrk for the benefit of the Company. Cyrk has agreed to indemnify the Company if Winthrop makes any draw under the letter of credit which supported Cyrk's obligations to Winthrop. In the fourth quarter of 2003, Cyrk informed the Company that it was continuing to suffer substantial financial difficulties, and that it could not continue to discharge its obligations to Winthrop which were secured by the Company's letter of credit. In the event of default, Winthrop had the right to draw upon the Company's letter of credit. As a result of the foregoing facts, the Company recorded a charge in 2003 of $2.8 million with respect to the liability arising from the Winthrop lease. Such charge was revised downward to $2.5 million during 2004 and to $1.6 million during 2005 based on the reduction in the Winthrop liability. During the fourth quarter of 2005, Winthrop drew down the $1.6 million balance of the Company's letter of credit due to Cyrk's default on its obligations to Winthrop. See "2001 Sale of Business" in Item 1. Business.
On October 19, 2005, the Company received notice of a lawsuit against it in the Bankruptcy Court for the Northern District of Illinois by the Committee representing the unsecured creditors of H A 2003 Inc., formerly known as HA-LO Industries, Inc. ("HA-LO"), seeking to recover as a voidable preference a certain payment made in May 2001 by HA-LO to the Company in the amount of $459,852 plus interest. The Company has retained bankruptcy counsel to represent it in the matter and is investigating facts surrounding the alleged payment. It has recorded a contingent loss liability of $.5 million related to this matter.
Restricted cash included within discontinued operations at December 31, 2005 and 2004 totaled $.4 million and $2.8 million, respectively, and primarily consisted of amounts deposited with lenders to satisfy the Company's obligations pursuant to its outstanding standby letters of credit. These amounts are in addition to the restricted cash amounts included within continuing operations at December 31, 2005 and 2004, totaling $2.8 million and $3.0 million, respectively, which primarily consisted of amounts deposited into an irrevocable trust, totaling $2.7 million and, at December 31, 2004, amounts deposited with lenders to satisfy the Company's obligations pursuant to its standby letter of credit.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The disclosure required by this Item is not material to the Company because the Company does not currently have any exposure to market rate sensitive instruments, as defined in this Item.
Part of the Company's discontinued operations consists of certain consolidated subsidiaries that are denominated in foreign currencies. However, because the close down of these subsidiaries is substantially complete, there are no material assets or liabilities remaining at these subsidiaries. As such, the Company is not materially exposed to foreign currency exchange risk.
All of the Company's cash equivalents consist of short-term, highly liquid investments, with original maturities at the date of purchase of three-months or less.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES: As of December 31, 2005, the Company evaluated the effectiveness and design and operation of its disclosure controls and procedures. The Company's disclosure controls and procedures are the controls and other procedures that the Company designed to ensure that it records, processes, summarizes and reports in a timely manner the information that it must disclose in reports that the Company files with or submits to the Securities and Exchange Commission. Anthony Kouba and George Golleher, the members of the Board of Directors, who have responsibility for the role of Chief Executive Officer of the Company, and Greg Mays, the Principal Financial Officer, reviewed and participated in this evaluation. Based on this evaluation, the Company's disclosure controls were effective.
INTERNAL CONTROLS: Since the date of the evaluation described above, there have not been any significant changes in the Company's internal controls or in other factors that could significantly affect those controls.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Company's certificate of incorporation provides that the number of directors shall be determined from time to time by the Board of Directors (but shall be no less than three and no more than fifteen) and that the Board of Directors shall be divided into three classes. On September 1, 1999, the Company entered into a Securities Purchase Agreement with Overseas Toys, L.P., an affiliate of Yucaipa, the holder of all of the Company's outstanding series A senior cumulative participating convertible preferred stock, pursuant to which the Company agreed to fix the size of the Board of Directors at seven members. Yucaipa has the right to designate three individuals to the Board of Directors and to designate the Chairman of the Board.
Pursuant to a Voting Agreement, dated September 1, 1999, among Yucaipa, Patrick D. Brady, Allan I. Brown, Gregory Shlopak, the Shlopak Foundation, Cyrk International Foundation and the Eric Stanton Self-Declaration of Revocable Trust, each of Messrs. Brady, Brown, Shlopak and Stanton agreed to vote all of the shares beneficially held by them to elect the three Directors nominated by Yucaipa. On November 10, 1999, Ronald W. Burkle, George G. Golleher and Richard Wolpert were the three Yucaipa nominees elected to the Company's Board of Directors, of which Mr. Burkle became Chairman. Mr. Wolpert resigned from the Board of Directors on February 7, 2000. Thereafter, Yucaipa requested that Erika Paulson be named as its third designee to the Board of Directors and on May 25, 2000, Ms. Paulson was elected to fill the vacancy created by Mr. Wolpert's resignation. On June 15, 2001, Patrick D. Brady resigned from the Board of Directors. On August 24, 2001, Mr. Burkle and Ms. Paulson resigned from the Board of Directors. On May 25,2004 Greg Mays was elected to the Board to fill the vacancy which had been created by Mr. Brady's resignation. In a letter dated March 20, 2006, Yucaipa notified the Company that it was designating Ira Tochner and Erika Paulson to fill the vacancies which had been created by the August 2001 resignations and that it was further designating that Mr. Tochner be appointed Chairman of the Board, as it was entitled to do under the terms of its investment. As of March 31, 2006, the Company's Board had not yet effectuated the designated appointments but expects to do so in the very near future.
As a result of the notification from Yucaipa, the Board re-examined its membership composition to ensure that Directors unaffiliated with Yucaipa constituted a majority of its members going forward, as was provided in the Securities Purchase Agreement. As a result of that analysis, the Board and Mr. Mays concluded that his continued participation on the Board might give the appearance that Yucaipa had designated more than the three (of seven) seats to which it was entitled since in the past year Mr. Mays had been designated by Yucaipa to join the boards of directors of two companies in which it had significant investments. Consequently, on March 27, 2006, Mr. Mays agreed to resign from the Board and the Company terminated his Executive Services Agreement (see Item 11.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth the compensation the Company paid or accrued for services rendered in 2005, 2004 and 2003, for the individuals who have the responsibility for the roles of the executive officers of the Company:
Summary Compensation Table
1. In accordance with the rules of the Securities and Exchange Commission, other compensation in the form of perquisites and other personal benefits have been omitted for all of the individuals in the table because the aggregate amount of such perquisites and other personal benefits constituted less than the lesser of $50,000 or 10% of the total annual salary and bonuses for such individuals for 2005, 2004 and 2003.
2. Includes Board of Directors retainer and meeting fees. See Directors' Compensation below.
3. Includes $22,192 for services that related to 2003 but were paid in 2004.
OPTION GRANTS IN THE LAST FISCAL YEAR
There were no option grants during the last fiscal year.
AGGREGATED OPTION EXERCISES IN THE LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
There were no exercises of stock options during the last fiscal year.
The following table sets forth for each of our executive officers certain information regarding exercises of stock options during 2005 and stock options held at the end of 2005:
(1) This value is the difference between the market price of our common stock subject to the options on December 31, 2005 ($0.22 per share) and the option exercise (purchase) price, assuming the options were exercised and the shares sold on that date.
EXECUTIVE SERVICES AGREEMENTS
In May 2003, the Company entered into Executive Services Agreements with Messrs. Bartlett, Brown, Golleher, Kouba, Mays and Wallock. The purpose of the Agreements was to substantially lower the administrative costs of the Company going forward while at the same time retaining the availability of experienced executives knowledgeable about the Company for on-going administration as well as future opportunities. The Agreements provide for compensation at the rate of $1,000 per month to Messrs. Bartlett and Brown, $6,731 per week to Messrs. Golleher and Kouba, $4,040 per week to Mr. Mays and $3,365 per week to Mr. Wallock. Additional hourly compensation is provided after termination of the Agreements and, in some circumstances during the term, for extensive commitments of time related to any legal or administrative proceedings and merger and acquisition activities in which the Company may be involved. As of December 31, 2005, no such additional payments have been made. The Agreements call for the payment of health insurance benefits and provide for mutual releases upon termination. By amendments dated May 3, 2004, and, in the case of Mr. Wallock, May 27, 2006, the Agreements were amended to allow termination at any time by the Company by the lump sum payment of one year's compensation and by the executive upon one year's notice, except in certain circumstances wherein the executive can resign immediately and receive a lump sum payment of one year's salary. Under the amendments health benefits are to be provided during any notice period or for the time with respect to which an equivalent payment is made. As described under "Directors and Executive Officers of the Registrant," the Company entered into a new Executive Services Agreement with Mr. Mays on March 27, 2006, upon termination of his prior agreement.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Decisions concerning the 2005 compensation of Messrs. Kouba and Golleher, who serve as the Principal Executive Officers of the Company, were made by the Compensation, Governance, and Nominating Committee of the Board of Directors. The 2005 compensation of Mr. Mays, who serves, as the Company's Principal Financial Officer, was also determined by the Compensation, Governance, and Nominating Committee of the Board of Directors. In 2005, none of Messrs. Kouba, Golleher or Mays served as an executive officer, or on the Board of Directors, of any entity of which any of the other members of the Board of Directors served as an executive officer or as a member of its Board of Directors.
DIRECTORS' COMPENSATION
Directors are paid an annual retainer of $50,000. Directors also receive a fee of $2,000 for each Board of Directors, Audit and Compensation, Governance and Nominating Committees meeting attended. The Chairmen of the Audit and the Compensation, Governance and Nominating Committees also receive annual retainers of $7,500 and $5,000, respectively, plus an additional $500 for each committee meeting they chair.
As an inducement to the Company's Directors to continue their services to the Company in the wake of the events of August 21, 2001, and to provide assurances that the Company will be able to fulfill its obligations to indemnify directors, officers and agents of the Company and its subsidiaries (individually "Indemnitee" and collectively "Indemnitees") under Delaware law and pursuant to various contractual arrangements, in March 2002 the Company entered into an Indemnification Trust Agreement ("Agreement") for the benefit of the Indemnitees. Pursuant to this Agreement, the Company deposited a total of $2.7 million with an independent trustee to fund any indemnification amounts owed to an Indemnitee which the Company is unable to pay. These arrangements, and the Executive Services Agreements, were negotiated by the Company on an arms-length basis with the advice of the Company's counsel and other advisors. As of December 31, 2005, there have not been any claims made against the trust. On March 1, 2006, the trust expired by its own terms without any claims having been made and all funds held by the trust plus accrued interest, less trustee fees, totaling approximately $2.8 million were returned to the Company.
STOCK PERFORMANCE GRAPH
The following graph assumes an investment of $100 on December 31, 2000 and compares changes thereafter through December 31, 2005 in the market price of the Company's common stock with (1) the Nasdaq Composite Index (a broad market index) and (2) the Russell 2000 Index. The Russell 2000 Index was used in place of a published industry or line-of-business index because although the Company formerly had marketing services operations, the Company currently has no operating business. As such, a published industry or line-of-business index would not provide a meaningful comparison and the Company cannot reasonably identify a peer group. As an alternative, the Company used the Russell 2000 Index which represents a capitalization-weighted index designed to measure the performance of the 2,000 smallest publicly traded U.S. companies, in terms of market capitalization, that are included in the Russell 3000 Index. The Nasdaq Composite Index measures all Nasdaq domestic and international based common type stocks listed on The Nasdaq Stock Market and includes over 3,000 companies.
The performance of the indices is shown on a total return (dividend reinvestment) basis; however, the Company paid no dividends on its common stock during the period shown. The graph lines merely connect the beginning and ending of the measuring periods and do not reflect fluctuations between those dates.
COMPARISON OF COMULATIVE TOTAL RETURN
(PERFORMANCE GRAPH)
REPORT OF THE COMPENSATION COMMITTEE ON EXECUTIVE COMPENSATION
This report has been prepared by the Company's Compensation, Governance and Nominating Committee of the Board of Directors (the "Compensation Committee") and addresses the Company's compensation policies with respect to its Co-Chief Executive Officers and its Chief Financial Officer.
The current compensation of the Company's Co-Chief Executive Officers and its Chief Financial Officer was set originally in May 2003 (i) in the case of Mr. Golleher, by the Compensation Committee (which then consisted of Messrs. Kouba and Bartlett) and (ii) in the case of Messrs. Kouba and Mays, by the Board of Directors, with Mr. Kouba abstaining as to his compensation (Mr. Mays was not on the Board at that time) pursuant to Executive Services Agreements entered into with those executives and others at that time. See Executive Services Agreements above. Inasmuch as the Company had not yet resolved significant liability exposure which it was facing at that time and had no operating business, the Committee and the Board determined that it would not then be feasible or economical to conduct an executive search or offer a customary compensation package to executive officer candidates. Rather, the Board appointed the two members of the Executive Committee of the Board to the role of Co-Chief Executive Officers, and appointed a Chief Financial Officer, at compensation lower than their customary consulting fees. In so doing, the Board was able to reduce overhead to the Company while retaining the services and availability of these experienced executives who were intimately familiar with the affairs of the Company.
After reviewing the salaries of the Co-Chief Executive Officers and Chief Financial Officer in 2005, the Compensation Committee chose to make no adjustments to the arrangements then in place. The Compensation Committee's policies for executive office compensation in 2005 were unchanged from 2003, as described above, and were not based on corporate performance since the Company had no operating business.
The Compensation Committee:
Allan I. Brown Joseph W. Bartlett
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following tables set forth certain information regarding beneficial ownership of the Company's common stock at February 28, 2006. Except as otherwise indicated in the footnotes, the Company believes that the beneficial owners of its common stock listed below, based on information furnished by such owners, have sole investment and voting power with respect to the shares of the Company's common stock shown as beneficially owned by them.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
The following table sets forth each person known by the Company (other than Directors and Executive Officers) to own beneficially more than 5% of the outstanding common stock:
1. The number of shares beneficially owned by each stockholder is determined in accordance with the rules of the Securities and Exchange Commission and is not necessarily indicative of beneficial ownership for any other purpose. Under these rules, beneficial ownership includes those shares of common stock that the stockholder has sole or shared voting or investment power and any shares of common stock that the stockholder has a right to acquire within sixty (60) days after December 31, 2005, through the exercise of any option, warrant or other right including the conversion of the series A preferred stock. The percentage ownership of the outstanding common stock, however, is based on the assumption, expressly required by the rules of the Securities and Exchange Commission, that only the person or entity whose ownership is being
reported has converted options, warrants or other rights into shares of common stock including the conversion of the series A preferred stock.
2. Represents shares of common stock issuable upon conversion of 31,118 shares of outstanding series A preferred stock and accrued dividends. Percentage based on common stock outstanding, plus all such convertible shares. Overseas Toys, L.P. is an affiliate of Yucaipa and is the holder of record of all the outstanding shares of series A preferred stock. Multi-Accounts, LLC is the sole general partner of Overseas Toys, L.P., and OA3, LLC is the sole managing member of Multi-Accounts, LLC. Ronald W. Burkle is the sole managing member of OA3, LLC. The address of each of Overseas Toys, L.P., Multi-Accounts, LLC, OA3, LLC, and Ronald W. Burkle is 9130 West Sunset Boulevard, Los Angeles, California 90069.
Overseas Toys, L.P. is party to a Voting Agreement, dated September 1, 1999, with Patrick D. Brady, Allan I. Brown, Gregory P. Shlopak, the Shlopak Foundation, Cyrk International Foundation and the Eric Stanton Self-Declaration of Revocable Trust, pursuant to which Overseas Toys, L.P., Multi-Accounts, LLC, OA3, LLC, and Ronald W. Burkle may be deemed to have shared voting power over 8,233,616 shares for the purpose of election of certain nominees of Yucaipa to the Company's Board of Directors, and may be deemed to be members of a "group" for the purposes of Section 13(d)(3) of the Securities Exchange Act of 1934, as amended. Overseas Toys, L.P., Multi-Accounts, LLC, OA3, LLC and Ronald W. Burkle disclaim beneficial ownership of any shares, except for the shares as to which they possess sole dispositive and voting power.
3. Based on 20,446,378 shares of common stock outstanding and issuable upon conversion of 31,118 shares of outstanding series A preferred stock and accrued dividends as of December 31, 2005.
4. Based on 16,653,193 shares of common stock outstanding as of December 31, 2005.
5. The information concerning these holders is based solely on information contained in filings pursuant to the Securities Exchange Act of 1934.
6. Eric Stanton, as trustee of the Eric Stanton Self-Declaration of Revocable Trust, has the sole power to vote, or to direct the vote of, and the sole power to dispose, or to direct the disposition of, 1,123,023 shares. Mr. Stanton, as trustee of the Eric Stanton Self-Declaration of Revocable Trust, is a party to a Voting Agreement, dated September 1, 1999, with Yucaipa and Patrick D. Brady, Allan I. Brown, Gregory P. Shlopak, the Shlopak Foundation Trust and the Cyrk International Foundation Trust pursuant to which Messrs. Brady, Brown, Shlopak and Stanton and the trusts have agreed to vote in favor of certain nominees of Yucaipa to the Company's Board of Directors. Mr. Stanton expressly disclaims beneficial ownership of any shares except for the 1,123,023 shares as to which he possesses sole voting and dispositive power.
7. The information concerning this holder is based solely on information contained in filings Mr. Shlopak has made with the Securities and Exchange Commission pursuant to Sections 13(d) and 13(g) of the Securities Exchange Act of 1934, as amended. Includes 84,401 shares held by a private charitable foundation as to which Mr. Shlopak, as trustee, has sole voting and dispositive power. Mr. Shlopak is a party to a Voting Agreement, dated September 1, 1999, with Yucaipa, Patrick D. Brady, Allan I. Brown, the Shlopak Foundation, Cyrk International Foundation and the Eric Stanton Self-Declaration of Revocable Trust, pursuant to which Messrs. Brady, Brown, Shlopak and Stanton and the trusts have agreed to vote in favor of certain nominees of Yucaipa to the Company's Board of Directors. Mr. Shlopak expressly disclaims beneficial ownership of any shares except for the 1,064,900 shares as to which he possesses sole voting and dispositive power.
SECURITY OWNERSHIP OF MANAGEMENT
The following table sets forth information at December 31, 2005, regarding the beneficial ownership of the Company's common stock (including common stock issuable upon the exercise of stock options exercisable within 60 days of December 31, 2005) by each director and each executive officer named in the Summary Compensation Table, and by all of the Company's directors and persons performing the roles of executive officers as a group:
* Represents less than 1%
(1) The address of each of the directors and executive officers is c/o Simon Worldwide, Inc., 5200 W. Century Boulevard, Suite 420, Los Angeles, California, 90045. The number of shares beneficially owned by each stockholder is determined in accordance with the rules of the Securities and Exchange Commission and is not necessarily indicative of beneficial ownership for any other purpose. Under these rules, beneficial ownership includes those shares of common stock that the stockholder has sole or shared voting or investment power and any shares of common stock that the stockholder has a right to acquire within sixty (60) days after December 31, 2005, through the exercise of any option, warrant or other right including the conversion of the series A preferred stock. The percentage ownership of the outstanding common stock, however, is based on the assumption, expressly required by the rules of the Securities and Exchange Commission, that only the person or entity whose ownership is being reported has converted options, warrants or other rights including the conversion of the series A preferred stock into shares of common stock.
(2) Based on 16,653,193 shares of common stock outstanding as of December 31, 2005.
(3) Includes 20,000 shares issuable pursuant to stock options exercisable within 60 days of December 31, 2005. Mr. Brown has the sole power to vote, or to direct the vote of, and the sole power to dispose, or to direct the disposition of, 1,113,023 shares of common stock. Mr. Brown is party to a Voting Agreement, dated September 1, 1999, with Yucaipa, Patrick D. Brady, Gregory P. Shlopak, the Shlopak Foundation, Cyrk International Foundation and the Eric Stanton Self-Declaration of Revocable Trust, pursuant to which Messrs. Brady, Brown, Shlopak and Stanton and the trusts have agreed to vote in favor of certain nominees of Yucaipa to the Company's Board of Directors. Mr. Brown expressly disclaims beneficial ownership of any shares except for the 1,133,023 shares as to which he possesses sole voting and dispositive power.
(4) The 90,000 shares are issuable pursuant to stock options exercisable within 60 days of December 31, 2005.
(5) The 60,000 shares are issuable pursuant to stock options exercisable within 60 days of December 31, 2005.
(6) Includes 30,000 shares issuable pursuant to stock options exercisable within 60 days of December 31, 2005.
(7) The 5,000 shares are issuable pursuant to stock options exercisable within 60 days of December 31, 2005.
(8) The 10,000 shares are issuable pursuant to stock options exercisable within 60 days of December 31, 2005.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The following table sets forth information as of December 31, 2005, regarding the Company's 1993 Omnibus Stock Plan (the "1993 Plan") and 1997 Acquisition Stock Plan (the "1997 Plan"). The Company's stockholders previously approved the 1993 Plan and the 1997 Plan and all amendments that were subject to stockholder approval. As of December 31, 2005, options to purchase 215,000 shares of common stock were outstanding under the 1993 Plan and no options were outstanding under the 1997 Plan. The Company's 1993 Employee Stock Purchase Plan was terminated effective December 31, 2001, and no shares of the Company's common stock are issuable under that plan. The 1993 Plan expired in May 2003, except as to options outstanding under the 1993 Plan.
(1) Available for issuance under the 1997 Plan.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table presents fees, including reimbursement for expenses, for professional services rendered by the Company's independent registered public accounting firm for the fiscal years ended December 31, 2005 and 2004:
(1) Audit fees are related to the audit of the Company's consolidated annual financial statements, review of the interim consolidated financial statements and services normally provided by the Company's independent registered public accounting firm in connection with statutory and regulatory filings and engagements.
(2) Audit-related fees are for assurance and related services that are reasonably related to the performance of the audit or review of the Company's consolidated financial statements and are not reported under Audit fees. This category includes fees billed related to employee benefit plan audits.
(3) Tax fees are related to tax compliance, planning, and consulting.
(4) All other fees are for services other than those reported in the other categories.
POLICY ON AUDIT COMMITTEE PRE-APPROVAL OF AUDIT AND NON-AUDIT SERVICES OF INDEPENDENT AUDITOR
Pre-approval is provided by the Audit Committee for up to one year of all audit and permissible non-audit services provided by the Company's independent auditor. Any pre-approval is detailed as to the particular service or category of service and is generally subject to a specific fee.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) DOCUMENTS FILED AS PART OF THIS REPORT
1. FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of December 31, 2005 and 2004
Consolidated Statements of Operations for the years ended December 31, 2005, 2004 and 2003
Consolidated Statements of Stockholders' Deficit for the years ended December 31, 2005, 2004 and 2003
Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003
Notes to Consolidated Financial Statements
2. FINANCIAL STATEMENT SCHEDULES FOR THE FISCAL YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003:
Schedule II: Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.
(b) EXHIBITS
Reference is made to the Exhibit Index, which follows.
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. Messrs. Golleher and Kouba of the Board of Directors have the responsibility for the role of the Principal Executive Officer of the registrant.
Date: March 31, 2006 SIMON WORLDWIDE, INC.
/s/ George G. Golleher /s/ J. Anthony Kouba -------------------------- -------------------------- GEORGE G. GOLLEHER J. ANTHONY KOUBA Co-Chief Executive Officer Co-Chief Executive Officer
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.
EXHIBITS
- ---------- (1) Filed as an exhibit to the Registrant's Registration Statement on Form S-1 (Registration No. 33-63118) or an amendment thereto and incorporated herein by reference.
(2) Management contract or compensatory plan or arrangement.
(3) Filed as an exhibit to the Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by reference.
(4) Filed as an exhibit to the Registrant's Registration Statement on Form 10-Q dated March 31, 1995, and incorporated herein by reference.
(5) Filed as an exhibit to the Annual Report on Form 10-K for the year ended December 31, 1997, and incorporated herein by reference.
(6) Filed as an exhibit to the Registrant's Report on Form 8-K dated September 1, 1999, and incorporated herein by reference.
(7) Filed as an exhibit to the Annual Report on Form 10-K for the year ended December 31, 1999, and incorporated herein by reference.
(8) Filed as an exhibit to the Registrant's Report on Form 8-K dated February 15, 2001, and incorporated herein by reference.
(9) Filed as an exhibit to the Registrant's original Report on Form 10-K for the year ended December 31, 2001, filed on March 29, 2002, and incorporated herein by reference.
(10) Filed as an exhibit to the Registrant's Report on Form 10-K/A for the year ended December 31, 2001, filed on April 18, 2003, and incorporated herein by reference.
(11) Filed as an exhibit to the Registrant's Report on Form 10-K for the year ended December 31, 2002, filed on July 29, 2003, and incorporated herein by reference.
(12) Filed as an exhibit to the Registrant's Report on Form 10-Q for the quarter ended March 31, 2004, filed on May 10, 2004, and incorporated herein by reference.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders of Simon Worldwide, Inc.:
We have audited the accompanying consolidated balance sheets of Simon Worldwide, Inc. and its subsidiaries as of December 31, 2005 and 2004 and the related consolidated statements of operations, stockholders' deficit and cash flows for each of the three years in the period ended December 31, 2005. We have also audited the financial statement schedule listed in the accompanying index. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedule are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and financial statement schedule. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Simon Worldwide Inc. and its subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has a stockholders' deficit, has suffered significant losses from operations, has no operating revenue and faces significant legal actions that raise substantial doubt about its ability to continue as a going concern. Management's plans in regards to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Also, in our opinion, the financial statement schedule presents fairly, in all material respects, the information set forth therein.
/s/ BDO Seidman, LLP
Los Angeles, California March 3, 2006
PART I - FINANCIAL INFORMATION
SIMON WORLDWIDE, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except share data)
See the accompanying Notes to Consolidated Financial Statements.
SIMON WORLDWIDE, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data)
See the accompanying Notes to Consolidated Financial Statements.
SIMON WORLDWIDE, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT For the years ended December 31, 2005, 2004 and 2003 (in thousands)
See the accompanying Notes to Consolidated Financial Statements.
SIMON WORLDWIDE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
See the accompanying Notes to Condensed Consolidated Financial Statements.
SIMON WORLDWIDE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS, LOSS OF CUSTOMERS, RESULTING EVENTS AND GOING CONCERN
Prior to August 2001, the Company, incorporated in Delaware and founded in 1976, had been operating as a multi-national full-service promotional marketing company, specializing in the design and development of high-impact promotional products and sales promotions. The majority of the Company's revenue was derived from the sale of products to consumer products and services companies seeking to promote their brand names and corporate identities and build brand loyalty. The major client of the Company was McDonald's Corporation ("McDonald's"), for whom the Company's Simon Marketing subsidiary designed and implemented marketing promotions, which included premiums, games, sweepstakes, events, contests, coupon offers, sports marketing, licensing and promotional retail items. Net sales to McDonald's and Philip Morris, another significant client, accounted for 78% and 8%, respectively, of total net sales in 2001.
On August 21, 2001, the Company was notified by McDonald's that they were terminating their approximately 25-year relationship with Simon Marketing as a result of the arrest of Jerome P. Jacobson ("Mr. Jacobson"), a former employee of Simon Marketing who subsequently pled guilty to embezzling winning game pieces from McDonald's promotional games administered by Simon Marketing. No other Company employee was found to have any knowledge of or complicity in his illegal scheme. Simon Marketing was identified in the criminal indictment of Mr. Jacobson, along with McDonald's, as an innocent victim of Mr. Jacobson's fraudulent scheme. Further, on August 23, 2001, the Company was notified that its second largest customer, Philip Morris, was also ending its approximately nine-year relationship with the Company. As a result of the above events, the Company no longer has an on-going promotions business.
Since August 2001, the Company has concentrated its efforts on reducing its costs and settling numerous claims, contractual obligations and pending litigation. By April 2002, the Company had effectively eliminated a majority of its ongoing promotions business operations and was in the process of disposing of its assets and settling its liabilities related to the promotions business and defending and pursuing litigation with respect thereto. The process is ongoing and will continue for some indefinite period primarily dependent upon ongoing litigation. As a result of these efforts, the Company has been able to resolve a significant number of outstanding liabilities that existed in August 2001 or arose subsequent to that date. As of December 31, 2005, the Company had reduced its workforce to 4 employees from 136 employees as of December 31, 2001.
During the second quarter of 2002, the discontinued activities of the Company, consisting of revenues, operating costs, certain general and administrative costs and certain assets and liabilities associated with the Company's promotions business, were classified as discontinued operations for financial reporting purposes. At December 31, 2005, the Company had a stockholders' deficit of $.8 million. For the year ended December 31, 2005, the Company had a net loss of $3.2 million. The Company incurred losses within its continuing operations in 2005 and continues to incur losses in 2006 for the general and administrative expenses incurred to manage the affairs of the Company and resolve outstanding legal matters. By utilizing cash which had been received pursuant to the settlement of the Company's litigation with McDonald's in 2004 (see Note 4), management believes it has sufficient capital resources and liquidity to operate the Company for the foreseeable future. However, as a result of the stockholders' deficit at December 31, 2005, the Company's significant loss from operations and the pending legal matters, the Company's independent registered public accounting firm has expressed substantial doubt about the Company's ability to continue as a going concern. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.
The Company is currently managed by members of the Board of Directors, consisting of Messrs. George Golleher and J. Anthony Kouba, who jointly act as Chief Executive Officers, in consultation with a principal financial officer and acting general counsel. In connection with such responsibilities, Messrs. Golleher and Kouba entered into Executive Services Agreements dated May 30, 2003, which were subsequently amended in May 2004.
The Board of Directors continues to consider various alternative courses of action for the Company, including possibly acquiring or combining with one or more operating businesses. The Board of Directors has reviewed and analyzed a number of proposed transactions and will continue to do so until it can determine a course of action going forward to best benefit all shareholders, including the holder of the Company's outstanding preferred stock (see Note 12). The Company cannot predict when the Directors will have developed a proposed course of action or whether any such course of action will be successful. Management believes it has sufficient capital resources and liquidity to operate the Company for the foreseeable future.
As a result of the Jacobson embezzlement, numerous consumer class action and representative action lawsuits were filed in Illinois and multiple jurisdictions nationwide and in Canada. All actions brought in the United States were eventually consolidated and settled (the "Boland Settlement"), except for any plaintiff who opted out of such settlement. One such opt-
out plaintiff, seeking to redeem a purported $1 million winning game ticket, had brought a lawsuit in Kentucky, which was transferred to Illinois and ordered to arbitration. The plaintiff has appealed the arbitration order.
On or about September 13, 2002, an action was filed against Simon Marketing and McDonald's in Canada in Ontario Provincial Court alleging substantially the same facts as in the United States class action lawsuits and adding an allegation that Simon Marketing and McDonald's deliberately diverted from seeding in Canada game pieces with high-level winning prizes in certain McDonald's promotional games. The plaintiffs were Canadian citizens seeking restitution and damages on a class-wide basis. On October 28, 2002, a second action was filed against Simon Marketing and McDonald's in Ontario Provincial Court containing similar allegations. The plaintiffs in the aforesaid actions seek an aggregate of $110 million in damages. Simon Marketing has retained Canadian local counsel to represent it in these actions. The Company believes that the plaintiffs in these actions did not opt out of the Boland Settlement. The Company and McDonald's have filed motions to dismiss or stay these cases on the basis of the Boland Settlement. The Canadian Court has dismissed the case filed in September 2002, but has allowed the October 2002 case to move forward. An appeal of that decision by McDonald's and the Company has been denied by the Court of Appeal. During the third quarter of 2005, the Company entered into a settlement agreement with plaintiff in the case on behalf of the class pursuant to which the Company agreed to pay $650,000 Canadian ($554,512 US) to be used for costs, fees and expenses relating to the settlement with excess proceeds to be distributed to two charities. The settlement is subject to certification of the class with respect to the Company and approval of the terms of settlement by the Canadian court.
On March 29, 2002, Simon Marketing filed a lawsuit against PricewaterhouseCoopers LLP ("PWC") and two other accounting firms, citing the accountants' failure to oversee, on behalf of Simon Marketing, various steps in the distribution of high-value game pieces for certain McDonald's promotional games. The complaint alleged that this failure allowed the misappropriation of certain of these high-value game pieces by Mr. Jacobson. The lawsuit, filed in Los Angeles Superior Court, sought unspecified actual and punitive damages resulting from economic injury, loss of income and profit, loss of goodwill, loss of reputation, lost interest, and other general and special damages. Defendants' demurrers to the first and a second amended complaint were sustained in part, including the dismissal of all claims for punitive damages with no leave to amend. A third amended complaint was filed, and defendants' demurrer to all causes of action was sustained without leave to amend. A dismissal of the case has resulted. The Company has appealed this ruling with respect to PWC only.
On October 19, 2005 the Company received notice of a lawsuit against it in the Bankruptcy Court for the Northern District of Illinois by the Committee representing the unsecured creditors of H A 2003 Inc., formerly known as HA-LO Industries, Inc. ("HA-LO"), seeking to recover as a voidable preference a certain payment made in May 2001 by HA-LO to the Company for the sale of inventory in the amount of $459,852 plus interest. Based on an assessment by management and during the three months ended September 30, 2005, the Company recorded a contingent loss liability of $.5 million related to this matter.
2. SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of the Company. All intercompany accounts and transactions have been eliminated in consolidation.
STOCK-BASED COMPENSATION PLANS AND PRO FORMA STOCK-BASED COMPENSATION EXPENSE
At December 31, 2005, the Company had one stock-based compensation plan, which is described below. In December 2004, the FASB issued a revision entitled, "Share-Based Payment," to Statement No. 123, "Accounting for Stock-Based Compensation." This revision ("Statement No. 123(R)") supersedes APB Opinion No. 25 and its related implementation guidance. As such, Statement No. 123(R) eliminates the alternative to use the intrinsic value method of accounting under APB Opinion No. 25 that was available under Statement No. 123 as originally issued. Under APB Opinion No. 25, issuing stock options to employees generally resulted in recognition of no compensation cost. Statement No. 123(R) requires entities to recognize in the financial statements the cost of employee services received in exchange for awards of equity instruments based on the fair value at grant-date of those awards (with limited exceptions). The Company currently applies APB Opinion No. 25 and related interpretations in accounting for its stock-based compensation plan. In March 2005, the Securities and Exchange Commission (the "SEC") issued Staff Accounting Bulletin No. 107, "Share-Based Payment", which summarizes the views of the SEC staff regarding the interaction between Statement No. 123(R) and certain SEC rules and regulations, and is intended to assist in the initial implementation. Statement No. 123(R) is effective for the annual reporting period beginning January 1, 2006. The Company does not expect the adoption of Statement No. 123(R) to have a material effect on its consolidated statements of financial position or results of operations, due to the small number of outstanding options.
Had compensation cost for the Company's grants for stock-based compensation plans been determined consistent with Statement No. 123, the Company's net income (loss) available to common stockholders and income (loss) per common share would have been adjusted to the pro forma amounts indicated below:
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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.
CONCENTRATION OF CREDIT RISK
The Company places its cash in what it believes to be credit-worthy financial institutions. However, cash balances exceed FDIC insured levels at various times during the year.
FINANCIAL INSTRUMENTS
The carrying amounts of cash equivalents, investments, short-term borrowings and long-term obligations, if any, approximate their fair values.
CASH EQUIVALENTS
Cash equivalents consist of short-term, highly liquid investments, which have original maturities at the date of purchase of three-months or less.
INVESTMENTS
Investments are stated at fair value. Current investments are designated as available-for-sale in accordance with the provisions of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," and as such, unrealized gains and losses are reported in a separate component of stockholders' deficit. Long-term investments, for which there are no readily available market values, were originally accounted for under the cost method and were carried at the lower of cost or estimated fair value.
In March 2004, the Emerging Issues Task Force ("EITF") of the FASB, issued EITF 03-16, "Accounting Investments in Limited Liability Companies," which required the Company to change its method of accounting for its investment in Yucaipa AEC Associates from the cost method to the equity method for periods ending after July 1, 2004.
The Company recorded an investment impairment during 2005 of $.2 million, net of related amounts recorded in unrealized gain on the balance sheet, to adjust the recorded value of its investments accounted for under the cost method to the estimated future undiscounted cash flows the Company expects from such investments.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and are depreciated using the straight-line method over the estimated useful lives of the assets or over the terms of the related leases, if such periods are shorter. The cost and accumulated depreciation for property and equipment sold, retired or otherwise disposed of are relieved from the accounts, and the resulting gains or losses are reflected in income.
IMPAIRMENT OF LONG-LIVED ASSETS
Periodically, the Company assesses, based on undiscounted cash flows, if there has been an other-than-temporary impairment in the carrying value of its long-lived assets and, if so, the amount of any such impairment by comparing anticipated undiscounted future cash flows with the carrying value of the related long-lived assets. In performing this analysis, management considers such factors as current results, trends and future prospects, in addition to other economic factors.
INCOME TAXES
The Company determines deferred taxes in accordance with SFAS No. 109, "Accounting for Income Taxes," which requires that deferred tax assets and liabilities be computed based on the difference between the financial statement and income tax bases of assets and liabilities using the enacted marginal tax rate. Deferred income tax expenses or credits are based on the changes in the asset or liability from period to period.
FOREIGN CURRENCY TRANSLATION
At December 31, 2005, the Company had subsidiaries in Europe and Hong Kong, with the wind-down of such subsidiaries being substantially complete. The Company translates these subsidiaries' financial statements, which are denominated in foreign currency, by translating balance sheet accounts at the balance sheet date exchange rate and income statement accounts at the average rates of exchange during the period. Translation gains and losses are recorded in a separate component of stockholders' deficit and transaction gains and losses are reflected in income.
EARNINGS (LOSS) PER COMMON SHARE
Earnings (loss) per common share have been determined in accordance with the provisions of SFAS No. 128, "Earnings per Share," which requires dual presentation of basic and diluted earnings per share on the face of the income statement and a reconciliation of the numerator and denominator of the basic earnings per share computation to the numerator and denominator of the diluted earnings per share computation (see Note 16).
3. COMMITMENTS AND CONTINGENCIES
In addition to the legal matters discussed in Note 1, the Company is also involved in other litigation and legal matters which have arisen in the ordinary course of business. The Company does not believe that the ultimate resolution of these other litigation and legal matters will have a material adverse effect on its financial condition, results of operations or net cash flows.
On October 19, 2005 the Company received notice of a lawsuit against it in the Bankruptcy Court for the Northern District of Illinois by the Committee representing the unsecured creditors of H A 2003 Inc., formerly known as HA-LO Industries, Inc. ("HA-LO"), seeking to recover as a voidable preference a certain payment made in May 2001 by HA-LO to the Company in the amount of $459,852 plus interest. Based on an assessment by management during the three months ended September 30, 2005, the Company recorded a contingent loss liability of $.5 million related to this matter.
In February 2001, the Company sold its Corporate Promotions Group ("CPG") business to Cyrk, Inc. ("Cyrk"), formerly known as Rockridge Partners, Inc., for $8 million cash and a note in the amount of $2.3 million. Cyrk also assumed certain liabilities of the CPG business. Subsequently, in connection with the settlement of a controversy between the parties, Cyrk supplied a $500,000 letter of credit to secure partial performance of certain assumed liabilities and the balance due on the note was forgiven, subject to a reinstatement thereof in the event of default by Cyrk under such assumed liabilities.
One of the obligations assumed by Cyrk was to Winthrop Resources Corporation ("Winthrop"). As a condition to Cyrk assuming this obligation, however, the Company was required to provide a $4.2 million letter of credit as collateral for Winthrop in case Cyrk did not perform the assumed obligation. The available amount under this letter of credit reduces over time as the underlying obligation to Winthrop reduces. As of September 30, 2005, the available amount under the letter of
credit was $2.1 million which was secured, in part, by $1.6 million of restricted cash of the Company. The Company's letter of credit was also secured, in part, by the aforesaid $500,000 letter of credit provided by Cyrk for the benefit of the Company.
Because the Company remained secondarily liable under the Winthrop lease restructuring, recognizing a liability at inception for the fair value of the obligation is not required under the provisions of FASB Interpretation 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others--an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34." However, in the fourth quarter of 2003, Cyrk informed the Company that it was continuing to suffer substantial financial difficulties and that it might not be able to continue to discharge its obligations to Winthrop which were secured by the Company's letter of credit. As a result of the foregoing, and in accordance with the provisions of FASB Statement No. 5, "Accounting for Contingencies," the Company recorded a charge in 2003 of $2.8 million to Other Expense with respect to the liability arising from the Winthrop lease. Such liability was revised downward to $2.5 million during 2004 and to $1.6 million during 2005 based on the reduction in the Winthrop liability.
During the fourth quarter of 2005, the Company received notification that Winthrop has drawn upon the letter of credit due to a default by Cyrk. Cyrk has agreed to indemnify the Company if Winthrop made any draw under this letter of credit. No assurances can be made that the Company will be successful in enforcing those rights or, if successful, collecting damages from Cyrk. See Note 18. Subsequent Events.
4. DISCONTINUED OPERATIONS
As discussed in Note 1, the Company had effectively eliminated a majority of its on-going promotions business operations by April 2002. Accordingly, the discontinued activities of the Company have been classified as discontinued operations in the accompanying consolidated financial statements. The Company includes sufficient cash within its discontinued operations to ensure assets from discontinued operations to be disposed of cover liabilities from discontinued operations. Management believes it has sufficient capital resources and liquidity to operate the Company for the foreseeable future. At December 31, 2005, the Company's elimination of its on-going promotions business operations is substantially complete.
Assets and liabilities related to discontinued operations at December 31, 2005 and 2004, as disclosed in the accompanying consolidated financial statements, consist of the following:
Net income (loss) from discontinued operations for the years ended December 31, 2005, 2004 and 2003, as disclosed in the accompanying consolidated financial statements, consists of the following:
GENERAL AND ADMINISTRATIVE EXPENSES
During 2004, certain events occurred that indicated the Company would not realize amounts related to an insurance policy for the benefit of a former company executive and on which the Company is the beneficiary of the cash surrender value. As such, the Company recorded a charge against such asset of $1.0 million.
LOSS (GAIN) ON SETTLEMENT OF OBLIGATIONS
As previously reported, an action has been pending against the Company in Ontario Provincial Court in Canada seeking restitution and damages on a class-wide basis for the diversion from seeding in Canada of high-level winning prizes in certain McDonald's promotional games administered by Simon Marketing. During 2005, the Company entered into a settlement agreement with plaintiff in the case on behalf of the class pursuant to which the Company agreed to pay $650,000 Canadian ($554,512 US) to be used for costs, fees and expenses relating to the settlement with excess proceeds to be distributed to two charities. The settlement is subject to certification of the class with respect to the Company and approval of the terms of settlement by the Canadian court.
During 2004, and in connection with the Company's settlement of its litigation with McDonald's and related entities, the Company received net cash proceeds, after attorney's fees, of approximately $13 million and, due to the elimination of liabilities associated with the settlement of $12 million, the Company recorded a gain of $25 million. This gain was partially offset by a settlement loss of $.5 million, resulting in a 2004 net gain on settlement of obligations of $24.5 million.
OTHER INCOME (EXPENSE)
In the fourth quarter of 2003, Cyrk informed the Company that it was continuing to suffer substantial financial difficulties and that it might not be able to continue to discharge its obligations to Winthrop which was secured by the Company's letter of credit. As a result of the foregoing, and in accordance with FASB Statement No. 5, "Accounting for Contingencies," the Company recorded a charge in 2003 of $2.8 million with respect to the liability arising from the Winthrop lease. The liability component of such charge was recorded to Accrued Expenses and Other Current Liabilities. Such liability was revised downward to $2.5 million during 2004 and to $1.6 million during 2005 based on the reduction in the Winthrop liability. The other income for 2005 was partially offset by a contingent loss accrual of $.5 million related to the HA-LO matter. See Note 3.
5. RESTRICTED CASH
Restricted cash included within discontinued operations at December 31, 2005 and 2004, totaled $.4 million and $2.8 million, respectively, and primarily consisted of amounts deposited with lenders to satisfy the Company's obligations pursuant to its outstanding standby letters of credit.
Restricted cash included within continuing operations at December 31, 2005 and 2004, totaled $2.8 million and $3.0 million, respectively, and primarily consisted of amounts deposited into an irrevocable trust, totaling $2.7 million and, at December 31, 2004, amounts deposited with lenders to satisfy the Company's obligations pursuant to its standby letter of credit. On March 1, 2006, the trust expired by its own terms without any claims having been made and all funds held by the trust plus accrued interest, less trustee fees, totaling approximately $2.8 million were returned to the Company.
6. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
Depreciation and amortization expense on property and equipment totaled approximately $9,000, $20,000, and $64,000 during 2005, 2004 and 2003, respectively.
7. INVESTMENTS
In the past, with its excess cash, the Company had made strategic and venture investments in a portfolio of privately held companies. These investments were in technology and internet related companies that were at varying stages of development, and were intended to provide the Company with an expanded technology and internet presence, to enhance the Company's position at the leading edge of e-business and to provide venture investment returns. These companies in which the Company has invested are subject to all the risks inherent in technology and the internet. In addition, these companies are subject to the valuation volatility associated with the investment community and capital markets. The carrying value of the Company's investments in these companies is subject to the aforementioned risks. Periodically, the Company performs a review of the carrying value of all its investments in these companies, and considers such factors as current results, trends and future prospects, capital market conditions and other economic factors. The carrying value of the Company's investment portfolio totaled $11.5 million as of December 31, 2005.
At December 31, 2005, the Company held an investment in Yucaipa AEC Associates, LLC ("Yucaipa AEC Associates"), a limited liability company that is controlled by Yucaipa, which also controls the holder of the Company's outstanding preferred stock. Yucaipa AEC Associates, in turn, primarily held an equity investment in the Source Interlink Companies ("Source"), received upon the merger of Alliance Entertainment Companies ("Alliance") with Source. Alliance is a home entertainment product distribution, fulfillment, and infrastructure company providing both brick-and-mortar and e-commerce home entertainment retailers with complete business-to-business solutions. At December 31, 2001, the Company's investment in Yucaipa AEC Associates had a carrying value of $10.0 million which was accounted for under the cost method. In June 2002, certain events occurred which indicated an impairment and the Company recorded a pre-tax non-cash charge of $10.0 million to write down this investment in June 2002.
In March 2004, the Emerging Issues Task Force ("EITF") of the FASB, issued EITF 03-16, "Accounting for Investments in Limited Liability Companies," which required the Company to change its method of accounting for its investment in Yucaipa AEC Associates from the cost method to the equity method for periods ending after July 1, 2004.
On February 28, 2005, Alliance merged with Source Interlink Companies, Inc. ("Source"), a direct-to-retail magazine distribution and fulfillment company in North America and a provider of magazine information and front-end management services principally for retailers. Inasmuch as Source is a publicly traded company, the Company's pro-rata investment in Yucaipa AEC Associates, which holds the shares in Source, is equal to the number of Source shares indirectly held by the
Company multiplied by the stock price of Source on the date of closing of the merger. Accordingly, on February 28, 2005, the date of closing of the merger, and to reflect the value of the new marketable securities constituting the primary asset of Yucaipa AEC Associates, the Company recorded an unrealized gain to Other Comprehensive Income of $11.3 million ($10.8 million net of tax), which does not reflect any discount for illiquidity. As the Company's investment in Yucaipa AEC Associates is accounted for under the equity method, the Company will adjust its investment based in its pro rata share of the earnings and losses of Yucaipa AEC Associates. Other than the merger of Alliance with Source, there were no such adjustments during 2005. The Company has no power to dispose of or liquidate its holding in Yucaipa AEC Associates or its indirect interest in Source which power is held by Yucaipa AEC Associates. Furthermore, in the event of a sale or liquidation of the Source shares by Yucaipa AEC Associates, the amount and timing of any distribution of the proceeds of such sale or liquidation to the Company is discretionary with Yucaipa AEC Associates.
While the Company will continue to periodically evaluate its investments, there can be no assurance that its investment strategy will be successful, and thus the Company might not ever realize any benefits from its portfolio of investments. During 2005, the Company recorded an investment impairment of $.2 million, net of related amounts recorded in unrealized gain on the balance sheet, to adjust the recorded value of its other investments that are accounted for under the cost method to the estimated future undiscounted cash flows the Company expects from such investments.
8. LEASE OBLIGATIONS
The approximate minimum rental commitments under all noncancelable leases at December 31, 2005, totaled approximately $33,000, which are due in 2006.
For the years ended December 31, 2005, 2004, and 2003, rental expense for all operating leases included within continuing operations was approximately $44,000, $117,000, and $165,000, respectively, and rental expense for all operating leases included within discontinued operations was $0, $0, and $180,000, respectively. Rent is charged to operations on a straight-line basis.
9. INCOME TAXES
The Company had no provision or benefit for income taxes for 2005, 2004 and 2003.
As required by SFAS No. 109 "Accounting for Income Taxes," the Company periodically evaluates the positive and negative evidence bearing upon the realizability of its deferred tax assets. The Company, however, has considered recent events (see Note 1) and results of operations and concluded, in accordance with the applicable accounting methods, that it is more likely than not that the deferred tax assets will not be realizable. As a result, the Company has determined that a valuation allowance of approximately $39.7 million is required at December 31, 2005. The tax effects of temporary differences that gave rise to deferred tax assets as of December 31, 2005 and 2004, were as follows (in thousands):
As of December 31, 2005, the Company had federal and state net operating loss carryforwards of approximately $72.4 million and $47.4 million, respectively. The federal net operating loss carryforward will begin to expire in 2020 and the state net operating loss carryforwards began to expire in 2005. As of December 31, 2005, the Company also had foreign tax credit carryforwards of $.1 million that expire in 2009. As of December 31, 2005, the Company had federal and state capital loss carryforwards of $16.7 million which begin to expire in 2006 through 2008.
The following is a reconciliation of the statutory federal income tax rate to the actual effective income tax rate:
An audit by the Internal Revenue Service covering the tax years 1996 through 2000 was concluded during 2003. The Company incurred no additional income tax upon conclusion of the IRS audit.
10. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
At December 31, 2005 and 2004, accrued expenses and other current liabilities consisted of the following:
11. INDEMNIFICATION TRUST AGREEMENT
In March 2002, the Company, Simon Marketing and a Trustee entered into an Indemnification Trust Agreement (the "Agreement" or the "Trust"), which requires the Company and Simon Marketing to fund an irrevocable trust in the amount of $2.7 million. The Trust was set up and will be used to augment the Company's existing insurance coverage for indemnifying directors, officers and certain described consultants, who are entitled to indemnification against liabilities arising out of their status as directors, officers and/or consultants (individually "Indemnitee" or collectively "Indemnitees"). The Trust will pay Indemnitees for amounts to which the Indemnitees are legally and properly entitled under the Company's indemnity obligation and are not paid to the Indemnitees by another party. During the term of the Trust, which continues until the earlier to occur of: (i) the later of: (a) four years from the date of the Agreement; or (b) as soon thereafter as no claim is pending against any Indemnitee which is indemnifiable under the Company's indemnity obligations; or (ii) March 1, 2022, the Company is required to replenish the Trust (up to $2.7 million) for funds paid out to an Indemnitee. Upon termination of the Trust, if, after payment of all outstanding claims against the Trust have been satisfied, there are funds remaining in the Trust, such funds and all other assets of the Trust shall be distributed to Simon Marketing. These funds are included in restricted cash in the accompanying Consolidated Balance Sheets. As of December 31, 2005, there have not been any claims made against the trust. See Note 18. Subsequent Events.
12. REDEEMABLE PREFERRED STOCK
In November 1999, Overseas Toys, L.P., an affiliate of Yucaipa, a Los Angeles, California based investment firm, invested $25 million in the Company in exchange for preferred stock and a warrant to purchase additional preferred stock. Under the terms of the investment, which was approved at a Special Meeting of Stockholders on November 10, 1999, the Company issued 25,000 shares of a newly authorized senior cumulative participating convertible preferred stock ("preferred stock") to Yucaipa for $25 million. Yucaipa is entitled, at their option, to convert each share of preferred stock into common stock equal to the sum of $1,000 per share plus all accrued and unpaid dividends, divided by $8.25 (3,793,185 shares as of December 31, 2005, and 3,644,848 shares as of December 31, 2004).
In connection with the issuance of the preferred stock, the Company also issued a warrant to purchase 15,000 shares of a newly authorized series of preferred stock at a purchase price of $15 million. Each share of this series of preferred stock issued upon exercise of the warrant is convertible, at Yucaipa's option, into common stock equal to the sum of $1,000 per share plus all accrued and unpaid dividends, divided by $9.00 (1,666,667 shares as of December 31, 2003). The warrant expired on November 10, 2004.
Assuming conversion of all of the convertible preferred stock, Yucaipa would own approximately 18.6% and 18.0% of the then outstanding common shares at December 31, 2005 and 2004.
Yucaipa has voting rights equivalent to the number of shares of common stock into which their preferred stock is convertible on the relevant record date. Also, Yucaipa is entitled to receive a quarterly dividend equal to 4% of the base liquidation preference of $1,000 per share outstanding, payable in cash or in-kind at the Company's option.
In the event of liquidation, dissolution or winding up of the affairs of the Company, Yucaipa, as holder of the preferred stock, will be entitled to receive the redemption price of $1,000 per share plus all accrued dividends plus: (1) (a) 7.5% of the amount that the Company's retained earnings exceeds $75 million less (b) the aggregate amount of any cash dividends paid on common stock which are not in excess of the amount of dividends paid on the preferred stock, divided by (2) the total number of preferred shares outstanding as of such date (the "adjusted liquidation preference"), before any payment is made to other stockholders.
The Company may redeem all or a portion of the preferred stock at a price equal to the adjusted liquidation preference of each share, if the average closing prices of the Company's common stock have exceeded $12.00 for sixty consecutive trading days on or after November 10, 2002, or, any time on or after November 10, 2004. The preferred stock is subject to mandatory redemption if a change in control of the Company occurs.
In connection with this transaction, the managing partner of Yucaipa was appointed chairman of the Company's Board of Directors and Yucaipa was entitled to nominate two additional individuals to a seven person board.
13. STOCK PLAN
1993 OMNIBUS STOCK PLAN
Under its 1993 Omnibus Stock Plan, as amended (the "Omnibus Plan"), which terminated in May 2003 except as to options outstanding at that time, the Company reserved up to 3,000,000 shares of its common stock for issuance pursuant to the grant of incentive stock options, nonqualified stock options or restricted stock. The Omnibus Plan is administered by the Compensation Committee of the Board of Directors. Subject to the provisions of the Omnibus Plan, the Compensation Committee had the authority to select the optionees or restricted stock recipients and determine the terms of the options or restricted stock granted, including: (i) the number of shares; (ii) the exercise period (which may not exceed ten years); (iii) the exercise or purchase price (which in the case of an incentive stock option cannot be less than the market price of the common stock on the date of grant); (iv) the type and duration of options or restrictions, limitations on transfer and other restrictions; and (v) the time, manner and form of payment.
Generally, an option is not transferable by the option holder except by will or by the laws of descent and distribution. Also, generally, no incentive stock option may be exercised more than 60 days following termination of employment. However, in the event that termination is due to death or disability, the option is exercisable for a maximum of 180 days after such termination.
Options granted under this plan generally become exercisable in three equal installments commencing on the first anniversary of the date of grant. Options granted during 2003 become exercisable in two equal installments commencing on the first anniversary of the date of grant. No further options may be granted under the Omnibus Plan.
1997 ACQUISITION STOCK PLAN
The 1997 Acquisition Stock Plan (the "1997 Plan") is intended to provide incentives in connection with the acquisitions of other businesses by the Company. The 1997 Plan is identical in all material respects to the Omnibus Plan, except that the number of shares available for issuance under the 1997 Plan is 1,000,000 shares.
The fair value of each option grant under the above plans was estimated using the Black-Scholes option pricing model with the following assumptions for 2003 grants: expected dividend yield of 0%; expected life of 9.4 years; expected volatility of 40%; and, a risk-free interest rate of 2.0%. There were no stock options granted under the plans during 2005 and 2004.
The following summarizes the status of the Company's stock options as of December 31, 2005, 2004 and 2003, and changes for the years then ended:
(1) Available for issuance under the 1997 Plan.
The following table summarizes information about stock options outstanding at December 31, 2005:
14. RELATED PARTY TRANSACTIONS
As an inducement to the Company's Directors to continue their services to the Company, in the wake of the events of August 21, 2001, and to provide assurances that the Company will be able to fulfill its obligations to indemnify directors, officers and agents of the Company and its subsidiaries (individually, "Indemnitee" and collectively, "Indemnitees") under Delaware law and pursuant to various contractual arrangements, in March 2002 the Company entered into an Indemnification Trust Agreement ("Agreement") for the benefit of the Indemnitees. Pursuant to this Agreement, the Company has deposited a total of $2.7 million with an independent trustee in order to fund any indemnification amounts owed to an Indemnitee, which the Company is unable to pay. These arrangements, and all other arrangements, were negotiated by the Company on an arms-length basis with the advice of the Company's counsel and other advisors. As of December 31, 2005, there have not been any claims made against the trust. See Note 18. Subsequent Events.
On February 7, 2003, the Company entered into agreements with Messrs. Golleher and Kouba in order to induce them to continue to serve as members of the Executive Committee of the Board of Directors and to compensate them for the additional obligations, responsibilities and potential liabilities of such service, including responsibilities imposed under the federal securities laws by virtue of the fact that, as members of the Executive Committee, they served, in effect, as the Chief Executive Officers of the Company since the Company had no Executive Officers. The agreements provided for a fee of $100,000 to each of Messrs. Golleher and Kouba for each of 2003 and 2002. Also on that date, the Company entered into a similar agreement with Greg Mays who provided financial and accounting services to the Company as a consultant but, in effect, served as the Company's Chief Financial Officer. The agreement provided for a fee of $50,000 to Mr. Mays for each of 2003 and 2002.
In May 2003 the Company entered into Executive Services Agreements with Messrs. Bartlett, Brown, Golleher, Kouba, Mays and Terrence Wallock, acting general counsel of the Company. The purpose of the Agreements was to substantially lower the administrative costs of the Company going forward while at the same time retaining the availability of experienced executives knowledgeable about the Company for ongoing administration as well as future opportunities. The Agreements replace the letter agreements with Messrs. Bartlett, Golleher and Kouba dated August 28, 2001. The Agreements provide for compensation at the rate of $1,000 per month to Messrs. Bartlett and Brown, $6,731 per week to Messrs. Golleher and Kouba, $4,040 per week to Mr. Mays and $3,365 per week to Mr. Wallock. Additional hourly compensation is provided for time spent in litigation after termination of the Agreements and, in some circumstances during the term, for extensive commitments of time for litigation and merger and acquisition activities. As of December 31, 2005, no such additional payments have been made. The Agreements call for the payment of health insurance benefits and provide for a mutual release upon termination. By amendments dated May 3, 2004, the Agreements were amended to allow termination at any time by the Company by the lump sum payment of one year's compensation and by the Executive upon one year's notice, except in certain circumstances wherein the Executive can resign immediately and receive a lump sum payment of one year's salary. Under the amendment, health benefits are to be provided during any notice period or for the time with respect to which an equivalent payment is made.
15. SEGMENTS AND RELATED INFORMATION
Until the events of August 2001 occurred (see Note 1), the Company operated in one industry--the promotional marketing industry. The Company's business in this industry encompassed the design, development and marketing of high-impact promotional products and programs.
There were no sales during 2005, 2004, and 2003. The Company had no accounts receivable at December 31, 2005.
Substantially all the Company's long-lived assets as of December 31, 2005, 2004 and 2003, were in the United States.
Long-lived assets include property and equipment, and other non-current assets.
16. EARNINGS PER SHARE DISCLOSURE
The following is a reconciliation of the numerators and denominators of the basic and diluted Earnings Per Share ("EPS") computation for income (loss) available to common stockholders and other related disclosures required by SFAS No.128 "Earnings Per Share":
For the years ended December 31, 2005, 2004, and 2003, 3,793,185, 3,644,848, and 3,547,296, respectively, shares of convertible preferred stock were not included in the computation of diluted EPS because to do so would have been antidilutive. In addition, for the years ended December 31, 2005, 2004, and 2003, 215,000, 172,500, and 130,000 shares related to stock options exercisable, were not included in the computation of diluted EPS as the average market price of the Company's common stock during such periods of $.23, $.17, and $.07, respectively, did not exceed the weighted average exercise price of such options of $4.51, $6.09, and $9.16, respectively.
17. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a tabulation of the quarterly results of operations for the years ended December 31, 2005 and 2004, respectively:
(a) See Note 4.
18. SUBSEQUENT EVENTS
During the fourth quarter of 2005, Winthrop drew down the $1.6 million balance of the Company's letter of credit due to Cyrk's default on its obligations to Winthrop. An equal amount of the Company's restricted cash was drawn down by the Company's bank which had issued the letter of credit. Due to this default, Cyrk's $2.3 million subordinated note payable to the Company, which forgiven by the Company in 2003, was reinstated in the first quarter of 2006.
On January 31, 2006, the Company and Cyrk entered into a Settlement Agreement and Mutual General Release pursuant to which: (1) Cyrk agreed to pay $1.6 million to the Company, of which $435,000 was paid on or before March 1, 2006 and the balance is payable, pursuant to a subordinated note (the "New Subordinated Note"), in forty-one (41) approximately equal consecutive monthly installments beginning April 1, 2006; (ii) Cyrk entered into a Confession of Judgment in Washington State Court for all amounts owing to the Company under the New Subordinated Note and the $2.3 million note (the "Old Subordinated Note"); (iii) Cyrk's parent company agreed to subordinate approximately $4.3 million of Cyrk debt to the debt owed to the Company by Cyrk; and (iv) Cyrk and the Company entered into mutual releases of all claims except those arising under the Settlement Agreement, the New Subordinated Note or the Confession Judgment. So long as Cyrk does not default on the New Subordinated Note, the Company has agreed not to enter the Confession of Judgment in court. Cyrk's obligations under the New Subordinated Note and the Old Subordinated Note are subordinated to Cyrk's obligations to the financial institution which is Cyrk's senior lender, which obligations are secured by, among other things, substantially all of Cyrk's assets. In the event of a default by Cyrk of its obligations under the New Subordinated Note, there is no assurance that the Company will be successful in enforcing the Confession of Judgment.
On March 1, 2006, the Company's Indemnification Trust Agreement (see Note 11) expired by its own terms without any claims having been made and all funds held by the trust plus accrued interest, less trustee fees, totaling approximately $2.8 million were returned to the Company.
Schedule II Simon Worldwide, Inc. Valuation and Qualifying Accounts For the Years Ended December 31, 2005, 2004 and 2003 (in thousands)
(a) As a result of the loss of business from McDonald's in 2001, the Company recorded a 100% allowance against its accounts receivable to reduce them to their net realizable value. In 2004, the Company completed its settlement with McDonald's and, as such, removed any accounts receivable and related allowance for doubtful accounts from its books.