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 had been McDonald’s Corporation (“McDonald’s”), for which 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 ongoing 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. 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, 2007, 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, 2007, the Company had a stockholders’ deficit of $14.9 million. For the year ended December 31, 2007, the Company had a net loss of $1.8 million. The Company incurred losses within its continuing operations in 2007 and continues to incur losses in 2008 for the general and administrative expenses 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, 2007, the Company’s significant loss from operations and lack of operating revenue, 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, 2007, the Company held an investment in Yucaipa AEC Associates, LLC (“Yucaipa AEC”), 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 in turn principally holds an investment in the common stock of Source Interlink Companies (“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. 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
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 at the time of $10.0 million to write down this investment.
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 from the cost method to the equity method for periods ending after July 1, 2004.
On February 28, 2005, Alliance merged with Source. Inasmuch as Source is a publicly traded company, the Company’s pro-rata investment in Yucaipa AEC, 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, which does not reflect any discount for illiquidity. 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 shares by Yucaipa AEC, the Company recorded an unrealized gain to accumulated other comprehensive income of $11.3 million. As the Company’s investment in Yucaipa AEC is accounted for under the equity method, the Company adjusts its investment based on its pro rata share of the earnings and losses of Yucaipa AEC. In addition, the Company recognizes its share in the other comprehensive income (loss) of Yucaipa AEC on the basis of changes in the fair value of Source through an adjustment in the unrealized gains and losses in the accumulated other comprehensive income component of the stockholders’ deficit. There were adjustments totaling $5.2 million during 2007 which reduced the recorded value of the Company’s investment in Yucaipa AEC. The Company has no power to dispose of or liquidate its holding in Yucaipa AEC or its indirect interest in Source which power is held by Yucaipa AEC. Furthermore, in the event of a sale or liquidation of the Source shares by Yucaipa AEC, the amount and timing of any distribution of the proceeds of such sale or liquidation to the Company is discretionary with Yucaipa AEC.
The Company is currently managed by J. Anthony Kouba, chief executive officer, in consultation with a principal financial officer and acting general counsel. In connection with such responsibility, Mr. Kouba entered into an Executive Services Agreement dated May 30, 2003, which was 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.
As previously reported on Form 8-K dated October 5, 2007, in September 2007 the Board appointed a Special Committee of independent directors to review the possible recapitalization of the Company which was approved by the stockholders as a non-binding stockholder proposal at the 2007 annual meeting of stockholders. In the proposed recapitalization, the outstanding preferred stock would be converted into shares of common stock equal to 70% of the shares outstanding following the recapitalization. The members of the Special Committee are Joseph Bartlett and Allan Brown.
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, 2007, the amount of the liquidation preference, which is equal to the sum of the preferred stock outstanding plus accrued dividends, was
$33.9 million, and the redemption value, which is equal to the sum of the preferred stock outstanding plus accrued dividends multiplied by 101%, was $34.2 million. As of December 31, 2007, assuming conversion of all of the convertible preferred stock and accrued dividends, Overseas Toys L.P. would own approximately 20.1% 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, Stanton and the trusts 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. On April 18, 2006, George Golleher, the third Yucaipa representative on the Board of Directors and former co-chief executive officer, resigned from the Board of Directors and Greg Mays, the Company’s chief financial officer, was designated by Yucaipa to fill the vacancy created Mr. Golleher’s resignation.
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 reduced. 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. 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.
In December 2005, the Company received notification that 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. Upon default by Cyrk and if such default is not cured within 15 days after receipt of written notice of default from the Company, Cyrk’s $2.3 million subordinated note payable to the Company, which was forgiven by the
Company in 2003, was subject to reinstatement. After evaluating its alternatives in December 2005 and providing written notice to Cyrk in January 2006, such $2.3 million subordinated note payable was reinstated in January 2006 pursuant to a Settlement Agreement and Mutual General Release with Cyrk as explained in the following paragraph.
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. Through December 31, 2007, the Company has collected $1.1 million from Cyrk under the New Subordinated Note.
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 lack of operating revenue, 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 $33.9 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.
As previously reported on Form 8-K dated October 5, 2007, in September 2007 the Board appointed a Special Committee of independent directors to review the possible recapitalization of the Company which was approved by the stockholders as a non-binding stockholder proposal at the 2007 annual meeting of stockholders. In the proposed recapitalization, the outstanding preferred stock would be converted into shares of common stock equal to 70% of the shares outstanding following the recapitalization. The members of the Special Committee are Joseph Bartlett and Allan Brown.
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 maintaining compliance with Section 404 of the Sarbanes-Oxley Act of 2002. If Section 404 compliance is not properly maintained, 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 $3.0 million as of December 31, 2007.
Forward Looking Information
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.
Item 1B.
Item 1B.
Unresolved Staff Comments
Not applicable.
Item 2.
Item 2.
Properties
In September 2007, 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 $4,700, into which the Company relocated its remaining scaled-down operations in 2004. For a summary of the Company’s minimum rental commitments under all non-cancelable operating leases as of December 31, 2007, see Notes to Consolidated Financial Statements.
Item 3.
Item 3.
Legal Proceedings
As a result of the Jacobson embezzlement described above in Item 1. Business, 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 the United States and Canadian cases settled, except for any plaintiff who opted out of such settlements. The opt-out periods have expired, and, to the Company’s knowledge, no one who has opted out of any of the aforesaid litigation has commenced any litigation against the Company.
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. On March 14, 2007, the Court granted a Motion for Summary Judgment brought by PWC entering judgment in the matter in favor of PWC. The Company has appealed this ruling and is seeking to reinstate the lawsuit.
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 investigate facts surrounding the alleged payment. The Company has recorded a contingent loss liability of $.5 million related to this matter.
On November 19, 2007, the Company was served with a Summons and Complaint by Winthrop Resources Corporation alleging breach of contract in connection with a lease the Company had entered into for an enterprise inventory system. Following the sale of the CPG business as described above under Item 1. Business - 2001 Sale of Business, the bulk of the lease obligations were assumed by the new Cyrk entity, but a smaller portion relating to previously incurred consulting and installation services was retained by the Company. The Company made all monthly payments of $18,354 for the initial term, but Winthrop contends that the lease was automatically renewed after such initial term and consequently sued for breach of contract when no further monthly payments were made. The Company believes it has satisfied all its financial obligations to Winthrop and is defending the lawsuit on that basis. The lawsuit is in the early stages of discovery and it is difficult at this point to predict what the ultimate outcome will be for the Company. The complaint seeks damages in excess of $50,000. The Company believes the Winthrop claim is without merit.
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, Related Stockholder Matters and Issuer Purchases of Equity Securities
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 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 March 12, 2008, the Company had approximately 406 holders of record of its common stock. The last reported sale price of the Company’s common stock on March 12, 2008, was $.35.
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 2007, the Company did not repurchase any of its common stock.
Stock Performance Graph
The following graph assumes an investment of $100 on December 31, 2002, and compares changes thereafter through December 31, 2007, 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 part of 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 Cumulative Total Return
See “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters,” for information on the Company’s equity compensation plans.
Item 6.
Item 6.
Selected Financial Data
By April 2002, the Company had effectively eliminated a majority of its ongoing promotions business operations. Accordingly, the discontinued activities of the Company have been classified as discontinued operations. The following selected financial data has 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 ongoing 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. 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, 2007, 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, 2007, the Company had a stockholders’ deficit of $14.9 million. For the year ended December 31, 2007, the Company had a net loss of $1.8 million. The Company incurred losses within its continuing operations in 2007 and continues to incur losses in 2008 for the general and administrative expenses 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, 2007, the Company’s significant loss from operations and lack of operating revenue, 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 J. Anthony Kouba, chief executive officer, in consultation with a principal financial officer and acting general counsel. In connection with such responsibilities, Mr. Kouba entered into an Executive Services Agreement dated May 30, 2003, which was 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.
As previously reported on Form 8-K dated October 5, 2007, in September 2007 the Board appointed a Special Committee of independent directors to review the possible recapitalization of the Company which was approved by the stockholders as a non-binding stockholder proposal at the 2007 annual meeting of stockholders. In the proposed recapitalization, the outstanding preferred stock would be converted into shares of
common stock equal to 70% of the shares outstanding following the recapitalization. The members of the Special Committee are Joseph Bartlett and Allan Brown.
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 liabilities. On an ongoing 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 had 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 $3.0 million as of December 31, 2007.
Investments are designated as available-for-sale in accordance with the provisions of Statement of Financial Accounting Standard No. 115 (“SFAS No. 115”), “Accounting for Certain Investments in Debt and Equity Securities,” and as such, unrealized gains and losses are reported in the accumulated other comprehensive income (loss) component of stockholders’ deficit. Other investments, for which there are no readily available market values, are accounted for under the cost method and carried at the lower of cost or estimated fair value. The Company assesses on a periodic basis whether declines in fair value of investments below their amortized cost are other than temporary. If the decline in fair value is judged to be other than temporary, the cost basis of the individual security is written down to fair value as a new cost basis and the amount of the write-down is included in earnings. During 2007, 2006 and 2005, the Company recorded investment impairments of approximately $2,000, $16,000 and $.2 million, respectively, 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.
At December 31, 2007, the Company held an investment in Yucaipa AEC Associates, LLC (“Yucaipa AEC”), 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 in turn principally holds an investment in the common stock of Source Interlink Companies (“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. 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 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.
The Company’s accounting policy for long-term investments is considered critical because long-term investments represent the Company’s most material asset other than cash. The Company’s review for impairment relies heavily on its ability to project future cash flows related to its cost basis investments. Because these investments are in a portfolio of primarily privately held companies, readily determinable market values are not available. Consequently, the Company must use its judgment in determining the related values of these investments by considering current results, trends and future prospects, capital market conditions, and other economic factors. The Company accounts for its investment in Yucaipa AEC Associates using the equity method in accordance with Emerging Issues Task Force (“EITF”) Issue No. 03-16, “Accounting Investments in Limited Liability Companies.”
On February 28, 2005, Alliance merged with Source. Inasmuch as Source is a publicly traded company, the Company’s pro-rata investment in Yucaipa AEC, 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, which does not reflect any discount for illiquidity. 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 shares by Yucaipa AEC, the Company recorded an unrealized gain to accumulated other comprehensive income of $11.3 million. As the Company’s investment in Yucaipa AEC is accounted for under the equity method, the Company adjusts its investment based on its pro rata share of the earnings and losses of Yucaipa AEC. In addition, the Company recognizes its share in the other comprehensive income (loss) of Yucaipa AEC on the basis of changes in the fair value of Source through an adjustment in the unrealized gains and losses in the accumulated other comprehensive income component of the stockholders’ deficit. There were adjustments during 2007 which reduced the recorded value of the Company’s investment in Yucaipa AEC totaling $5.2 million. The Company has no power to dispose of or liquidate its holding in Yucaipa AEC or its indirect interest in Source which power is held by Yucaipa AEC. Furthermore, in the event of a sale or liquidation of the Source shares by Yucaipa AEC, the amount and timing of any distribution of the proceeds of such sale or liquidation to the Company is discretionary with Yucaipa AEC.
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 2007, the Company recorded a nominal investment impairment 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: (1) 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 (2) 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 November 19, 2007, the Company was served with a Summons and Complaint by Winthrop Resources Corporation alleging breach of contract in connection with a lease the Company had entered into for an enterprise inventory system. Following the sale of the CPG business as described above under Item 1. Business - 2001 Sale of Business, the bulk of the lease obligations were assumed by the new Cyrk entity, but a smaller portion relating to previously incurred consulting and installation services was retained by the Company. The Company made all monthly payments of $18,354 for the initial term, but Winthrop contends that the lease was automatically renewed after such initial term and consequently sued for breach of contract when no further monthly payments were made. The Company believes it has satisfied all its financial obligations to Winthrop and is defending the lawsuit on that basis. The lawsuit is in the early stages of discovery and it is difficult at this point to predict what the ultimate outcome will be for the Company. The
complaint seeks damages in excess of $50,000. The Company believes the Winthrop claim is without merit. Accordingly, no contingent loss liability has been recorded in connection with this case.
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. Such contingent loss liability remains on the Company’s balance sheet at December 31, 2007.
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 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.
In December 2005, the Company received notification that 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. Upon default by Cyrk and if such default is not cured within 15 days after receipt of written notice of default from the Company, Cyrk’s $2.3 million subordinated note payable to the Company, which was forgiven by the Company in 2003, was subject to reinstatement. After evaluating its alternatives in December 2005 and providing written notice to Cyrk in January 2006, such $2.3 million subordinated note payable was reinstated in January 2006 pursuant to a Settlement Agreement and Mutual General Release with Cyrk as explained in the following paragraph.
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.
Impairment of Long-Lived Assets
Periodically, the Company assesses, based on undiscounted cash flows, if there has been an impairment in the carrying value of its long-lived assets and, if so, the amount of any such impairment by comparing the estimated fair value 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.
Recently Issued Accounting Standards
In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109,”
which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. In addition, FIN 48 provides guidance on the derecognition, classification, accounting in interim periods, and disclosure requirements for uncertain tax positions. FIN 48 was effective for fiscal years beginning after December 15, 2006. The Company’s adoption of FIN 48 on January 1, 2007, did not have a material effect on the Company’s consolidated statements of financial position or results of operations.
In September 2006, the FASB issued Statement of Financial Accounting Standard No. 157 (“SFAS 157”), “Fair Value Measurements,” which provides guidance for applying the definition of fair value to various accounting pronouncements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company does not expect the adoption SFAS 157 to have a material effect on its consolidated statements of financial position or results of operations.
In February 2008, the FASB issued Staff Position (FSP) FAS 157-2, “Effective Date of FASB Statement No. 157,” which defers the implementation for the non-recurring nonfinancial assets and liabilities from fiscal years beginning after November 15, 2007 to fiscal years beginning after November 15, 2008. The provisions of SFAS No. 157 will be applied prospectively. The statement provisions effective as of January 1, 2008, are not expected to have a material effect on the Company’s consolidated statements of financial position or results of operations. The Company does not believe that the remaining provisions will have a material effect on the Company’s consolidated financial position and results of operations when they become effective on January 1, 2009.
In February 2007, the FASB issued Statement of Financial Accounting Standard No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115,” (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value at specified election dates and report unrealized gains and losses in earnings on items for which the fair value option has been elected. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the effect that adoption of this statement will have on the Company’s consolidated statements of financial position and results of operations when it becomes effective in 2008.
In December 2007, the FASB issued Statement of Financial Accounting Standard No. 141® Business Combinations (“SFAS 141R”), which replaces SFAS No. 141, Business Combinations. SFAS 141R requires the acquiring entity in a business combination to record all assets acquired and liabilities assumed at their acquisition-date fair values, (ii) changes the recognition of assets acquired and liabilities assumed arising from contingencies, (iii) requires contingent consideration to be recognized at its fair value on the acquisition date and, for certain arrangements, requires changes in fair value to be recognized in earnings until settled, (iv) requires companies to revise any previously issued post-acquisition financial information to reflect any adjustments as if they had been recorded on the acquisition date, (v) requires the reversals of valuation allowances related to acquired deferred tax assets and changes to acquired income tax uncertainties to be recognized in earnings, and (vi) requires the expensing of acquisition-related costs as incurred. SFAS 141R also requires additional disclosure of information surrounding a business combination to enhance financial statement users’ understanding of the nature and financial impact of the business combination. SFAS No. 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, with the exception of accounting for changes in a valuation allowance for acquired deferred tax assets and the resolution of uncertain tax positions accounted for under FIN 48, which is effective on January 1, 2009, for all acquisitions. The Company is currently assessing the impact, if any, of SFAS 141R on its consolidated financial statements .
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements - An Amendment of ARB No. 51,” (“SFAS 160”). SFAS 160 establishes accounting and reporting standards for the non-controlling interest in a subsidiary. SFAS 160 also requires that a retained noncontrolling interest upon the deconsolidation of a subsidiary be initially measured at its fair value. Upon adoption of SFAS 160, the Company will be required to report its noncontrolling interests as a separate component of
stockholders’ equity. The Company will also be required to present net income allocable to the noncontrolling interests and net income attributable to the stockholders of the Company separately in its consolidated statements of operations. SFAS 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements of SFAS 160 shall be applied prospectively. SFAS 160 will be effective for the Company’s 2009 fiscal year. The Company does not expect the adoption of SFAS 160 will have a material impact on its consolidated financial statements.
Significant Contractual Obligations
The following table includes certain significant contractual obligations of the Company at December 31, 2007:
(a)
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.
Other Commercial Commitments
The following table includes certain commercial commitments of the Company at December 31, 2007:
The amount committed at December 31, 2007, relates to a letter of credit provided by the Company to support the Company’s periodic payroll tax obligations.
Results of Continuing and Discontinued Operations
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. 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
Compared to 2006
There were no revenues during 2007 and 2006.
General and administrative expenses totaled $2.9 million in 2007 compared to $3.5 million in 2006. The decrease was primarily due to lump sum payments totaling $.6 million made in 2006 to certain directors upon
termination of their services to the Company in accordance with their Executive Services Agreements and a reduction in labor costs associated with the co-chief executive officer leaving the Company, partially offset by costs associated with the holding of the Company’s 2007 Annual Meeting of Stockholders on July 19, 2007. 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.
Interest income totaled $.8 million in 2007 compared to $.9 million in 2006. The decrease is primarily related a decrease in the average fed funds rate, to which the Company’s largest cash account in indexed, as well as a decrease in the average unrestricted cash balance due to 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.
The Company recorded an investment gain during 2007 of approximately $3,000, net of a nominal investment impairment of approximately $2,000. During 2006, the Company recorded an investment impairment of approximately $16,000. The investment impairments were recorded to adjust the recorded value of its investments accounted for under the cost method to the estimated future undiscounted cash flows the Company expected from such investments.
Redeemable preferred stock dividends totaled $1.32 million in 2007 compared to $1.27 million in 2006. Dividends are paid in additional shares of preferred stock, and accordingly, any subsequent year’s dividend will be based on a larger amount of preferred stock outstanding. Thus, each year’s dividend increases at an annual rate of 4%, compounded quarterly, in accordance with the terms of the preferred stock.
Compared to 2005
There were no revenues during 2006 and 2005.
General and administrative expenses totaled $3.5 million in 2006 compared to $3.1 million in 2005. The increase was primarily due to lump sum payments totaling $.6 million made to certain directors upon termination of their services to the Company in accordance with their Executive Services Agreements and an increase in board fees of $.1 million due to the net addition of two directors, partially offset by a decrease in insurance costs and labor costs totaling $.3 million, resulting from the former co-chief executive officer’s termination of his services to the Company in the second quarter of 2006.
Interest income totaled $.9 million in 2006 compared to $.6 million in 2005. The increase is primarily related an increase in the average fed funds rate, to which the Company’s largest cash account in indexed, as well as an increase in the average unrestricted cash balance due to the Company’s Indemnification Trust which expired during 2006 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 being returned to the Company.
The Company recorded investment impairments during 2006 and 2005 of approximately $16,000 and $.2 million, respectively, to adjust the recorded value of its investments accounted for under the cost method to the estimated future undiscounted cash flows the Company expected from such investments.
Redeemable preferred stock dividends totaled $1.27 million in 2006 compared to $1.22 million in 2005.
Discontinued Operations
Compared to 2006
There were no revenues or gross profit during 2007 and 2006. In addition, there were approximately $47,000 of general and administrative expenses during 2007 which related to adjustments to decrease the recorded value of a cash surrender value related asset. As the Company completed the liquidation of the Company’s subsidiaries in Europe and Hong Kong, during the first quarter of 2006, there were no general and administrative expenses during 2006.
The Company recorded a gain on settlement of approximately $.3 million during 2007 compared to $.7 million during 2006. These amounts represented collections, net of imputed interest of approximately $45,000 during 2007 and $60,000 during 2006, related to the New Subordinated Note with Cyrk.
Other income (expense) was $0 during 2007 and $(27,000) during 2006. The amount for 2006 related to a loss on disposal of the Company’s remaining subsidiaries in Europe and Hong Kong.
Interest income totaled approximately $45,000 during 2007 and approximately $59,000 during 2006. These amounts relate to imputed interest income earned on the New Subordinated Note with Cyrk. As the Company receives payments, a greater portion of such payment is allocated to principal and a lesser portion of such payment is allocated to interest which accounts for the decrease in interest income from 2006 to 2007.
Compared to 2005
There were no revenues or gross profit during 2006 and 2005.
General and administrative expenses totaled $0 in 2006 compared to $.2 million in 2005. The decrease was primarily due to the completion of the liquidation of the Company’s subsidiaries in Europe and Hong Kong, during the first quarter of 2006.
During 2006, the Company recorded a gain on settlement of approximately $.7 million which represented collections, net of imputed interest of approximately $60,000, related to the New Subordinated Note with Cyrk.
During 2005, the Company recorded a settlement loss related to a settlement agreement with plaintiff on behalf of the class in an action pending against the Company in Ontario Provincial Court in Canada seeking restitution and damages on a class-wide basis alleging diversion from seeding in Canada of high-level winning prizes in certain McDonald’s promotional games administered by Simon Marketing. 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 paid $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.
Other income (expense) was $(27,000) during 2006 and $.3 million during 2005. The amount for 2006 related to a loss on disposal of the Company’s remaining subsidiaries in Europe and Hong Kong. The amount for 2005 primarily related to a decrease in a contingent loss accrual of $.8 million related to a reduction in the Winthrop liability partially offset by a contingent loss accrual of $.5 million related to the HA-LO matter. See Item 3. Legal Proceedings.
Interest income totaled approximately $59,000 during 2006 and $0 during 2005. The 2006 amount relates to imputed interest income earned on the New Subordinated Note with Cyrk. As the New Subordinated Note with Cyrk began in 2006, there was no interest income in 2005.
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, 2007, the Company’s significant loss from operations and lack of operating revenue, 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 incurred losses within its continuing operations in 2007 and continues to incur losses in 2008 for the general and administrative expenses 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, 2007 and 2006 was $15.7 million and $16.8 million, respectively.
Net cash used in operating activities from continuing operations during 2007 totaled $2.1 million, primarily due to a loss from continuing operations resulting from the general and administrative expenses 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 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 2006 totaled $2.6 million, primarily due to a loss from continuing operations resulting from the general and administrative expenses to manage the affairs of the Company and resolve outstanding legal matters.
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 to manage the affairs of the Company and resolve outstanding legal matters, partially offset by a investment impairment charge of $.2 million.
There was nominal cash provided by investing activities during 2007.
Net cash provided by investing activities during 2006 totaled $2.8 million primarily due to a decrease in restricted cash resulting from the Company’s Indemnification Trust, described below, expiring during 2006 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.
Net cash provided by investing activities during 2005 totaled $.2 million, primarily due to a decrease in restricted cash.
There were no financing cash flows within continuing operations during 2007, 2006, and 2005.
In March 2002, the Company, Simon Marketing and a Trustee entered into an Indemnification Trust Agreement (the “Trust”), which required the Company and Simon Marketing to fund an irrevocable trust in the amount of $2.7 million. The Trust was set up to augment the Company’s existing insurance coverage for indemnifying directors, officers, and certain described consultants, who were entitled to indemnification against liabilities arising out of their status as directors, officers and/or consultants. 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.
There was no restricted cash included within continuing operations at December 31, 2007 and 2006. There was, however, restricted cash amounts included within discontinued operations of $0 and $.2 million at December 31, 2007 and 2006, respectively.
Discontinued Operations
Working capital deficit attributable to discontinued operations at December 31, 2007 and 2006, was $.9 million and $.2 million, respectively.
Net cash provided by operating activities within discontinued operations during 2007 totaled $.4 million primarily due to cash received pursuant to the New Subordinated Note with Cyrk. In addition, there was $.4 million transferred from discontinued operations to continuing operations as discontinued operations already had sufficient assets from discontinued operations to cover liabilities from discontinued operations.
Net cash provided by operating activities within discontinued operations during 2006 totaled $.7 million primarily due to cash received pursuant to the New Subordinated Note with Cyrk. In addition, there was $.3 million transferred to discontinued operations from continuing operations as discontinued operations required additional assets from discontinued operations to cover liabilities from discontinued operations.
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 to discontinued 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.
Cash provided by investing activities of discontinued operations totaled $.2 million, $.2 million, and $2.4 million during 2007, 2006 and 2005, respectively, primarily due to reductions in restricted cash.
There were no financing activities of discontinued operations during 2007, 2006, and 2005.
As of December 31, 2004, the Company had approximately $3.0 million in outstanding letters of credit with various expiration dates through August 2007, 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 had agreed to indemnify the Company if Winthrop made 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 and has recorded a contingent loss liability of $.5 million related to this matter.
Restricted cash included within discontinued operations at December 31, 2007 and 2006, totaled $0 and $.2 million, respectively. The amount at December 31, 2006, consisted of amounts deposited with lenders to satisfy the Company’s obligations pursuant to its outstanding standby letters of credit. There was no restricted cash included within continuing operations at December 31, 2007 and 2006.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements, investments in special purpose entities, or undisclosed borrowings or debts. In addition, the Company has no derivative contracts or synthetic leases.
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 consisted of certain consolidated subsidiaries that were denominated in foreign currencies. However, because the close-down of these subsidiaries is complete, there are no assets or liabilities remaining at these subsidiaries. As such, the Company is no longer 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
Inapplicable.
Item 9A(T).
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of December 31, 2007, 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, the principal executive officer of the Company, and Greg Mays, the principal financial officer, reviewed and participated in this evaluation. Based on this evaluation, the Company made the determination that its disclosure controls were effective.
Report of Management on Internal Control Over Financial Reporting
The management of the Company is responsible for establishing and maintaining adequate internal control over the Company’s financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Internal control over financial reporting is the process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.
There are inherent limitations in the effectiveness of internal control over financial reporting, including the possibility that misstatements may not be prevented or detected. Accordingly, even effective internal controls over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Furthermore, the effectiveness of internal controls can change as circumstances change.
Management has evaluated the effectiveness of internal control over financial reporting as of December 31, 2007, using criteria described in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on management’s assessment, management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2007.
This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
Changes in Internal Control Over Financial Reporting
During the Company’s fourth fiscal quarter and since the date of the evaluation noted 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, Executive Officers and Corporate Governance
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, Stanton and the trusts 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 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
Compensation Discussion and Analysis
Overview
The principal responsibilities of the Compensation Committee are:
•
to discharge the Board’s responsibilities relating to the compensation of the Company’s directors, officers and key employees;
•
to be responsible for the administration of the Company’s incentive compensation and stock plans;
•
to be responsible for the review and recommendation to the Board of the Company’s Compensation Discussion and Analysis; and
•
to be responsible for the production of an annual report on executive compensation for inclusion in the Company’s proxy statement or Form 10-K, as applicable.
During 2007, the Compensation Committee met one time. At this meeting, discussion focused on the review of the Company’s compensation structure for non-employee directors by Pearl Meyer & Partners which was engaged by the Company to perform such review. Pearl Meyer was not engaged to review compensation
paid to the Company’s executive officers and, accordingly, did not provide advice on that topic. Based on the review undertaken by Pearl Meyer, and in consideration of the role of the Board of the Company, particularly the fact that it has also operated as a management committee for the Company, the Board considered it appropriate to leave the compensation structure for directors unchanged. The Compensation Committee also considered all compensation paid to management, including the Chief Executive Officer and concluded that, in consideration of the efforts needed in reviewing future transactions and other matters currently facing the Company, current compensation levels were appropriate.
Compensation Philosophy and Objectives
The Compensation Committee has tried to structure compensation to:
•
provide competitive compensation that will attract and retain qualified officers and key employees;
•
reward officers and key employees for their contributions to the Company; and
•
align officers’ and key employees’ interests with the interests of shareholders.
The Compensation Committee endeavors to achieve these objectives while at the same time providing for administrative costs to be as low as possible.
Setting Executive Compensation
The Company did not make any change to the compensation arrangements existing prior to the beginning of 2007 for the Company’s executive officers, as the Compensation Committee determined that the existing arrangements were structured to achieve the key objectives outlined above, which the Compensation Committee believes will ultimately enhance shareholder value.
The Compensation Committee considered various factors in determining the amount of compensation, including wind-down of the Company’s former promotions business operations, additional responsibilities and potential liabilities assumed resulting from the Sarbanes-Oxley Act of 2002, the completion of projects critical to the Company’s long-term success, and the Company’s need to retain experienced executives, knowledgeable about the Company for ongoing administration as well as future opportunities. These factors, however, were not assigned individual mathematical weights when the Compensation Committee made such determinations, and therefore, such determinations were based on the Compensation Committee’s judgment as to what is reasonable and appropriate. While the Compensation Committee considered general market trends in setting compensation levels under the Executive Services Agreements, it did not benchmark compensation levels to specific companies.
Executive Compensation Components
As detailed below under the title “Executive Services Agreements with Officers,” the agreements that the Company has entered into with its executive officers are generally terminable by the Company at any time by the lump sum payment of one year’s compensation and by the executive upon one year’s notice, provided that in certain circumstances, the executive can resign immediately and receive a lump sum payment of one year’s salary. The Executive Services Agreement with Mr. Mays is terminable on 90 days notice by either the Company or Mr. Mays. During any such notice period or for the time with respect to which an equivalent payment is made, the executive is entitled to receive health benefits from the Company and provide for mutual releases upon termination. The Company believes that it has structured its post-termination payments so as to be able to attract needed talent, but to minimize the magnitude of its post-termination financial obligations. Given that the Company currently has no operating business, the Compensation Committee has structured compensation pursuant to the Executive Services Agreement to consist exclusively of cash compensation, paid currently.
The Company has historically made equity awards to its directors and executive officers, though did not make any such awards in 2007 as the Compensation Committee believed that the key objectives of compensation outlined above were more appropriately satisfied by cash compensation, paid currently, pending
a refocus of the Company’s business. Previously, awards were made pursuant to the terms of the Company’s 1993 Omnibus Stock Plan, which expired by its terms in 2003, and pursuant to the terms of the Company’s 1997 Acquisition Stock Plan, which expired by its terms on April 4, 2007, although there are no outstanding awards granted under that plan. The Company does not have any program, plan, or practice of timing option grants to its executives in coordination with the release of material non-public information and did not have any such program, plan, or practice during 2007.
The Company has not formally adopted any stock ownership or stock retention guidelines, in part due to the illiquid nature of the Company’s stock.
Tax and Accounting Implications
Deductibility of Executive Compensation:
As part of its role, the Compensation Committee reviews and considers the deductibility of executive compensation under Section 162(m) of the Internal Revenue Code, which provides that the Company may not deduct compensation of more than $1,000,000 that is paid to certain individuals. Given the level of compensation paid by the Company to its executive officers, this $1,000,000 limitation has not been a limiting issue for the Company in structuring its compensation.
Nonqualified Deferred Compensation:
On October 22, 2004, the American Jobs Creation Act of 2004 was signed into law, changing the tax rules applicable to nonqualified deferred compensation arrangements. While the Company does not have any nonqualified deferred compensation arrangements, the Company will continue to monitor these regulations in order to be in compliance should it, in the future, elect to make payments of nonqualified deferred compensation.
Accounting for Stock-Based Compensation:
Beginning on January 1, 2006, the Company began accounting for stock-based payments in accordance with the requirements of FASB Statement 123(R), “Share-based Payment.”
Summary Compensation Table
The following table sets forth the compensation the Company paid or earned by individuals who have served as principal executive officer or principal financial officer during the year. The Company has no other executive officers. During 2007 and 2006, there were no bonuses, stock awards, option awards, non-equity incentive plan compensation, pension earnings, or non-qualified deferred compensation earnings.
(a)
All cash compensation received by each individual in their capacity as an executive officer consists of salary.
(b)
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 was less than $10,000.
(c)
Amount consists of $50,000 for board retainer and $28,000 for board meeting fees.
(d)
Amount consists of $50,000 for board retainer and $38,000 for board meeting fees.
(e)
Amount consists of $50,000 for board retainer and $16,000 for board meeting fees.
(f)
Consists of $210,000 for severance paid for termination of 2003 Executive Services Agreement, $48,077 for board retainer, $26,000 for board meeting fees, and $5,390 for other accrued compensation paid. The Company and Mr. Mays subsequently entered into a new agreement in March 2006 which provided for the same annual salary and is terminable by either party upon 90 days notice.
Grants of Plan-Based Awards
There were no grants of equity or non-equity plan-based awards during the last fiscal year.
Executive Services Agreements with Officers
In May 2003, the Company entered into Executive Services Agreements with Messrs. Kouba and Mays. 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 provide for compensation at the rate of $6,731 per week to Messrs. Kouba and $4,040 per week to Mr. Mays. 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, 2007, no such additional payments have been made. The Agreements call for the payment of health insurance benefits and provide for mutual releases upon termination. Health benefits provided during 2007 by the Company to Messrs. Kouba and Mays were $18,912 and $34,400, respectively. 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 amendments health benefits are to be provided during any notice period or for the time with respect to which an equivalent payment is made. The Company entered into a new Executive Services Agreement with Mr. Mays on March 27, 2006, upon termination of his prior agreement. As detailed below under the heading “Post-Employment Compensation,” the New Executive Services Agreement to which Mr. Mays is party does not provide for any payments to Mr. Mays in the event of voluntary termination by Mr. Mays and only 90 days payment to Mr. Mays in the event of involuntary termination.
Outstanding Equity Awards at Fiscal Year-End
The following table includes information relating to the value of all unexercised options previously awarded to the executive officers named above as of December 31, 2007. In addition, there were no unexercisable options, unearned options, or stock awards outstanding as of December 31, 2007.
Option Exercises and Stock Vested
There were no options exercised by the executive officers named above during the year ended December 31, 2007. In addition, the Company did not made any stock awards and there was no vesting of stock awards during 2007.
Post-Employment Compensation
The Company does not have any pension plans or non-qualified deferred compensation arrangements.
As described in the “Executive Services Agreements with Officers” section above, the Agreements with the executives call for the payment of health insurance benefits and provide for mutual releases 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. As detailed below, the New Executive Services Agreement to which Mr. Mays is party is more limited in its severance payments.
Potential Payments upon Termination
Voluntary Termination:
Mr. Kouba may voluntary terminate his Executive Services Agreement with the Company under certain circumstances and receive a lump sum payment in the amount of $350,000. The New Executive Services Agreement between Mr. Mays and the Company does not provide for any payment in the case of voluntary termination.
Involuntary Termination:
In the event that the Company terminates Mr. Kouba’s Executive Services Agreement without cause, Mr. Kouba would be entitled to receive a lump sum payment in the amount of $350,000. The New Executive Services Agreement between Mr. Mays and the Company does not provide for any payment in the case of involuntary termination other than the 90-day notice period which would total $52,500.
Retirement:
Neither Mr. Kouba’s Executive Services Agreement nor Mr. Mays’ New Executive Services Agreement provides for any payment in the case of retirement.
Change in Control:
Mr. Kouba may terminate his Executive Services Agreement with the Company within 6 months of a change in control and receive a lump sum payment in the amount of $350,000. The New Executive Services Agreement between Mr. Mays and the Company does not provide for any payment in the case of a change in control.
Health Insurance Benefits:
In the event of voluntary or involuntary termination or a change in control, Mr. Kouba and Mr. Mays would be entitled to health insurance benefits at substantially the same benefit level as provided during employment in the approximate amounts of $28,368 and $53,412, respectively, paid in monthly installments over an 18-month period.
Directors’ Compensation
The following table provides compensation information for 2007 for each member of our Board of Directors except for board members already disclosed in the Summary Compensation table above. Also during 2007, there were no stock awards, option awards, non-equity incentive plan compensation, pension earnings, non-qualified deferred compensation earnings, or other compensation:
(a)
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 Committee meeting attended. The chairmen of the Audit and the Compensation Committees also receive annual retainers of $7,500 and $5,000, respectively, plus an additional $500 for each committee meeting they chair.
(b)
Amount consists of $50,000 for board retainer, $33,000 for board meeting fees, $12,000 in other board fees, $7,500 for Audit Committee chair fee, and $10,000 as a fee for serving as member of the Special Committee described under Item 1. Business - General. Mr. Bartlett held 80,000 stock options, all of which were vested, at December 31, 2007.
(c)
Amount consists of $50,000 for board retainer, $30,500 for board meeting fees, $12,000 in other board fees, $5,000 for Compensation Committee chair fee, and $10,000 as a fee for serving as member of the Special Committee described under Item 1. Business - General. Mr. Brown held 20,000 stock options, all of which were vested, at December 31, 2007.
(d)
Amount consists of $50,000 for board retainer and $12,000 for board meeting fees.
(e)
Amount consists of $50,000 for board retainer and $14,000 for board meeting fees.
(f)
Amount consists of $50,000 for board retainer and $16,000 for board meeting fees. Mr. Wallock held 5,000 stock options, all of which were vested, at December 31, 2007.
As indicated above, the Company engaged Pearl Meyer & Partners to review market practices and make general recommendations with respect to non-employee director compensation. In undertaking this review, Pearl Meyer reviewed a range of companies across multiple business sectors with market capitalizations of between $50 million and $150 million. The Compensation Committee considered the general findings made by Pearl Meyer and considered the nature of the duties performed by the Company’s non-employee directors and the challenges faced by the Company. Based on a consideration of these factors, the Compensation Committee concluded that it would leave in place the existing compensation structure for its directors. The Compensation Committee believes that the existing compensation structure is needed to retain qualified advisors to the Company, ultimately enhancing shareholder value, while at the same time providing for administrative costs to be as low as possible.
Executive Services Agreements with Directors
In May 2003, the Company entered into Executive Services Agreements with Messrs. Bartlett, Brown, 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 ongoing administration as well as future opportunities. The Agreements provide for compensation at the rate of $1,000 per month to Messrs. Bartlett and Brown, 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. During 2007, $20,000 of 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 at the expense of the Company for up to an 18-month period following termination of services.
Compensation Committee Interlocks and Insider Participation
The Compensation Committee consists of Messrs. Bartlett and Brown. No person who served as a member of the Compensation Committee was, during the past fiscal year, an officer or employee of the Company, was formerly an officer of the Company or any of its subsidiaries, or had any relationship requiring disclosure herein. No executive officer of the Company served as a member of the Board of Directors or compensation committee of another entity (or other committee of the Board of Directors performing equivalent functions), one of whose executive officers served as a director of the Company.
Compensation Committee Report
We have reviewed and discussed with management the Compensation Discussion and Analysis to be included in the Company’s Form 10-K. Based on such reviews and discussions, we recommend to the Board of Directors that the Compensation Discussion and Analysis be included in the Company’s Form 10-K.
The Compensation Committee consists of:
Allan I. Brown
Joseph W. Bartlett
The information contained in this Report of the Compensation Committee on Executive Compensation shall not be deemed to be “soliciting material.” No portion of this Report of the Compensation Committee on Executive Compensation shall be deemed to be incorporated by reference into any filing under the Securities Act, or the Exchange Act, through any general statement incorporating by reference in its entirety this Annual Report on Form 10-K in which this report appears, except to the extent that the Company specifically incorporates this report or any portion of it by reference. In addition, this report shall not be deemed to be filed under either the Securities Act or the Exchange Act.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following tables set forth certain information regarding beneficial ownership of the Company’s common stock at March 12, 2008. 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:
(a)
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 March 12, 2008, 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.
(b)
Represents shares of common stock issuable upon conversion of 34,033 shares of outstanding series A preferred stock. 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.
(c)
Based on 20,385,558 shares of common stock outstanding and issuable upon conversion of 34,033 shares of outstanding series A preferred stock and accrued dividends as of March 12, 2008.
(d)
Based on 16,260,324 shares of common stock outstanding as of March 12, 2008.
(e)
The information concerning these holders is based solely on information contained in filings pursuant to the Securities Exchange Act of 1934.
(f)
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.
(g)
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 March 12, 2008, 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 March 12, 2008) 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%
(a)
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 March 12, 2008, 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.
(b)
Based on 16,260,324 shares of common stock outstanding as of March 12, 2008, which does not include the dilutive effect of the convertible preferred stock.
(c)
Includes 20,000 shares issuable pursuant to stock options exercisable within 60 days of March 12, 2008. 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.
(d)
The 80,000 shares are issuable pursuant to stock options exercisable within 60 days of March 12, 2008.
(e)
The 60,000 shares are issuable pursuant to stock options exercisable within 60 days of March 12, 2008.
(f)
The 10,000 shares are issuable pursuant to stock options exercisable within 60 days of March 12, 2008.
(g)
The 5,000 shares are issuable pursuant to stock options exercisable within 60 days of March 12, 2008.
(h)
Includes a total of 175,000 stock options exercisable within 60 days of March 12, 2008.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth information as of December 31, 2007, 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, 2007, options to purchase 175,000 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. The 1997 Plan expired April 4, 2007, with no options outstanding.
Item 13.
Item 13.
Certain Relationships, Related Transactions and Director Independence
The Board of Directors has determined that Messrs. Bartlett, Brown and Tochner and Ms. Paulson are “independent” directors, meeting all applicable independence standards promulgated by the Securities and
Exchange Commission (“SEC”), including Rule 10A-3(b)(1) pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and by the National Association of Securities Dealers, Inc. (“NASD”). In making this determination, the Board of Directors affirmatively determined that none of such directors has a relationship that, in the opinion of the Board of Directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. Messrs. Kouba, Mays and Wallock are not independent directors under the independence standards promulgated by the SEC and NASD.
Item 14.
Item 14.
Principal Accounting Fees and Services
The following table presents fees, including reimbursement for expenses, for professional services rendered by BDO Seidman, LLP, the Company’s independent registered public accounting firm for the fiscal years ended December 31, 2007 and 2006:
(a)
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.
(b)
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 an employee benefit plan audit. The Company’s last required employee benefit audit was for fiscal year 2005.
(c)
Tax fees are related to tax compliance, planning, and consulting.
(d)
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. The Company’s independent registered public accounting firm did not provide any non-audit services to the Company except as specifically pre-approved by the Audit Committee.
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, 2007 and 2006
Consolidated Statements of Operations for the years ended December 31, 2007, 2006 and 2005
Consolidated Statements of Stockholders’ Deficit for the years ended December 31, 2007, 2006 and 2005
Consolidated Statements of Cash Flows for the years ended December 31, 2007, 2006 and 2005
Notes to Consolidated Financial Statements
2. Financial Statement Schedules. 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.
SIMON WORLDWIDE, INC.
J. Anthony Kouba
J. ANTHONY KOUBA
Chief Executive Officer
Date: March 28, 2008
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
Footnotes:
(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 Annual Report on Form 10-K for the year ended December 31, 1997, and incorporated herein by reference.
(5)
Filed as an exhibit to the Registrant’s Report on Form 8-K dated September 1, 1999, and incorporated herein by reference.
(6)
Filed as an exhibit to the Annual Report on Form 10-K for the year ended December 31, 1999, and incorporated herein by reference.
(7)
Filed as an exhibit to the Registrant’s Report on Form 8-K dated February 15, 2001, and incorporated herein by reference.
(8)
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.
(9)
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.
(10)
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.
(11)
Filed as an exhibit to the Registrant’s Report on Form 10-K for the year ended December 31, 2005, filed on March 31, 2006, 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, 2007 and 2006 and the related consolidated statements of operations, stockholders’ deficit and cash flows for each of the three years in the period ended December 31, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the financial statement presentation. 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, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 2 to the consolidated financial statements, effective January 1, 2007, the Company adopted the provisions of Emerging Issues Task Force Issue 06-5 “Accounting for Purchases of Life Insurance - Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4.”
The accompanying consolidated 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 and has a lack of any operating revenue that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/
BDO Seidman, LLP
Los Angeles, California
March 28, 2008
PART IV - FINANCIAL INFORMATION
SIMON WORLDWIDE, INC.
CONSOLIDATED BALANCE SHEETS
See the accompanying Notes to Consolidated Financial Statements.
SIMON WORLDWIDE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
See the accompanying Notes to Consolidated Financial Statements.
SIMON WORLDWIDE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT
For the years ended December 31, 2007, 2006, and 2005
See the accompanying Notes to Consolidated Financial Statements.
SIMON WORLDWIDE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
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, Going Concern and Management’s Plans
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. 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, 2007, 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, 2007, the Company had a stockholders’ deficit of $14.9 million. For the year ended December 31, 2007, the Company had a net loss of $1.8 million. The Company incurred losses within its continuing operations in 2007 and continues to incur losses in 2008 for the general and administrative expenses 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, 2007, the Company’s significant loss from operations, lack of operating revenue, and 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 J. Anthony Kouba, chief executive officer, in consultation with a principal financial officer and acting general counsel. In connection with such responsibility, Mr. Kouba entered into an Executive Services Agreement dated May 30, 2003, which was 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
SIMON WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
outstanding redeemable preferred stock (see Note 11). 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 the United States and Canadian cases settled, except for any plaintiff who opted out of such settlements. The opt-out periods have expired, and, to the Company’s knowledge, no one who has opted out of any of the aforesaid litigation has commenced any litigation against the Company.
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. On March 14, 2007, the Court granted a Motion for Summary Judgment brought by PWC entering judgment in the matter in favor of PWC. The Company has appealed this ruling and is seeking to reinstate the lawsuit.
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.
2.
Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.
Change in Accounting Principle
In September 2006, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue 06-5, “Accounting for Purchases of Life Insurance - Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4” (“EITF 06-5”). EITF 06-5 provides guidance on consideration of any additional amounts included in the contractual terms of an insurance policy other than the cash surrender value in determining the amount that could be realized under an insurance contract, consideration of the contractual ability to surrender individual-life policies (or certificates in a group policy) at the same time in determining the amount that could be realized under an insurance contract, and whether the cash surrender value component of the amount that could be realized under an insurance contract should be discounted when contractual limitations on the ability to surrender a policy exist. EITF 06-5 was effective for the Company’s fiscal year beginning January 1, 2007, and required the recognition of the effects of adoption be recorded as either a change in accounting principle through a cumulative-effect adjustment to beginning retained earnings in the year of adoption or a change in accounting principle through retrospective application to all prior periods. The Company adopted EITF 06-5 on January 1, 2007, and elected the cumulative-effect transition method of adoption. This resulted in an increase in the recorded amount of a cash surrender value
SIMON WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
related asset on the Company’s consolidated statement of financial position within discontinued operations by $.7 million with a corresponding cumulative-effect adjustment to the Company’s accumulated deficit as of January 1, 2007.
Stock-Based Compensation Plans and Pro Forma Stock-Based Compensation Expense
At December 31, 2007, the Company had one stock-based compensation plan. The Company adopted the disclosure provisions of Financial Accounting Standards Board (“FASB”) Statement No. 123, “Accounting for Stock-Based Compensation,” as amended by FASB Statement No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure - An Amendment of FASB Statement No. 123,” and revised by FASB Statement No. 123(R), “Share-Based Payment.” Statement No. 123(R) eliminated the alternative to use the intrinsic value method of accounting under APB Opinion No. 25, “Accounting for Stock Issued to Employees,” 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 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 adopted Statement No. 123(R) using the modified prospective transition method as of January 1, 2006. The modified prospective transition method requires only newly issued or modified awards of equity instruments, or previously issued but unvested awards of equity instruments to be accounted for at fair value. As such, the Company’s consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of Statement No. 123(R). In addition, because there were no employee stock options granted or vested after the effective date of Statement No. 123(R), there is no impact on net income as reported in the accompanying consolidated financial statements.
Had compensation cost for the Company’s grants for stock-based compensation plans been determined consistent with Statement No. 123 prior to the Company’s adoption date of January 1, 2006, 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 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.
SIMON WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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, accounts payable, and accrued liabilities 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 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 the accumulated other comprehensive income (loss) component of stockholders’ deficit. Other investments, for which there are no readily available market values, are accounted for under the cost method and carried at the lower of cost or estimated fair value. The Company assesses on a periodic basis whether declines in fair value of investments below their amortized cost are other than temporary. If the decline in fair value is judged to be other than temporary, the cost basis of the individual security is written down to fair value as a new cost basis and the amount of the write-down is included in earnings. During 2007, 2006 and 2005, the Company recorded investment impairments of approximately $2,000, $16,000 and $.2 million, respectively, 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.
The Company accounts for its investment in Yucaipa AEC Associates using the equity method in accordance with Emerging Issues Task Force (“EITF”) Issue No. 03-16, “Accounting Investments in Limited Liability Companies.”
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 impairment in the carrying value of its long-lived assets and, if so, the amount of any such impairment by comparing the estimated fair value 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 accounts for income 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 enacted tax rates. Deferred income tax
SIMON WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
expenses or credits are based on the changes in the asset or liability from period to period. A valuation allowance is recognized if, based on the available evidence, it is more likely than not that some or all of the deferred tax asset will not be realized.
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 15).
Recently Issued Accounting Standards
In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109, “which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. In addition, FIN 48 provides guidance on the derecognition, classification, accounting in interim periods, and disclosure requirements for uncertain tax positions. FIN 48 was effective for fiscal years beginning after December 15, 2006. The Company’s adoption of FIN 48 on January 1, 2007, did not have a material effect on the Company’s consolidated statements of financial position or results of operations.
In September 2006, the FASB issued Statement of Financial Accounting Standard No. 157 (“SFAS 157”), “Fair Value Measurements,” which provides guidance for applying the definition of fair value to various accounting pronouncements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company does not expect the adoption SFAS 157 to have a material effect on its consolidated statements of financial position or results of operations.
In February 2008, the FASB issued Staff Position (FSP) FAS 157-2, Effective Date of FASB Statement No. 157, which defers the implementation for the non-recurring nonfinancial assets and liabilities from fiscal years beginning after November 15, 2007 to fiscal years beginning after November 15, 2008. The provisions of SFAS No. 157 will be applied prospectively. The statement provisions effective as of January 1, 2008, are not expected to have a material effect on the Company’s consolidated statements of financial position or results of operations. The Company does not believe that the remaining provisions will have a material effect on the Company’s consolidated financial position and results of operations when they become effective on January 1, 2009.
In February 2007, the FASB issued Statement of Financial Accounting Standard No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115,” (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value at specified election dates and report unrealized gains and losses in earnings on items for which the fair value option has been elected. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the effect that adoption of this statement will have on the Company’s consolidated statements of financial position and results of operations when it becomes effective in 2008.
In December 2007, the FASB issued Statement of Financial Accounting Standard No. 141(R) Business Combinations (“SFAS 1418”), which replaces SFAS No. 141, Business Combinations. SFAS 141R requires the acquiring entity in a business combination to record all assets acquired and liabilities assumed at their acquisition-date fair values, (ii) changes the recognition of assets acquired and liabilities assumed arising from
SIMON WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
contingencies, (iii) requires contingent consideration to be recognized at its fair value on the acquisition date and, for certain arrangements, requires changes in fair value to be recognized in earnings until settled, (iv) requires companies to revise any previously issued post-acquisition financial information to reflect any adjustments as if they had been recorded on the acquisition date, (v) requires the reversals of valuation allowances related to acquired deferred tax assets and changes to acquired income tax uncertainties to be recognized in earnings, and (vi) requires the expensing of acquisition-related costs as incurred. SFAS 141R also requires additional disclosure of information surrounding a business combination to enhance financial statement users’ understanding of the nature and financial impact of the business combination. SFAS No. 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, with the exception of accounting for changes in a valuation allowance for acquired deferred tax assets and the resolution of uncertain tax positions accounted for under FIN 48, which is effective on January 1, 2009 for all acquisitions. The Company is currently assessing the impact, if any, of SFAS 141R on its consolidated financial statements .
In December 2007, the FASB issued SFAS No. 160 Noncontrolling Interests in Consolidated Financial Statements - An Amendment of ARB No. 51 (“SFAS 160”). SFAS 160 establishes accounting and reporting standards for the non-controlling interest in a subsidiary. SFAS 160 also requires that a retained noncontrolling interest upon the deconsolidation of a subsidiary be initially measured at its fair value. Upon adoption of SFAS 160, the Company will be required to report its noncontrolling interests as a separate component of stockholders’ equity. The Company will also be required to present net income allocable to the noncontrolling interests and net income attributable to the stockholders of the Company separately in its consolidated statements of operations. SFAS 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements of SFAS 160 shall be applied prospectively. SFAS 160 will be effective for the Company’s 2009 fiscal year. The Company does not expect the adoption of SFAS 160 will have a material impact on its consolidated financial statements.
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 November 19, 2007, the Company was served with a Summons and Complaint by Winthrop Resources Corporation alleging breach of contract in connection with a lease the Company had entered into for an enterprise inventory system. Following the sale of the CPG business as described above under Item 1. Business - 2001 Sale of Business, the bulk of the lease obligations were assumed by the new Cyrk entity, but a smaller portion relating to previously incurred consulting and installation services was retained by the Company. The Company made all monthly payments of $18,354 for the initial term, but Winthrop contends that the lease was automatically renewed after such initial term and consequently sued for breach of contract when no further monthly payments were made. The Company believes it has satisfied all its financial obligations to Winthrop and is defending the lawsuit on that basis. The lawsuit is in the early stages of discovery and it is difficult at this point to predict what the ultimate outcome will be for the Company. The complaint seeks damages in excess of $50,000. The Company believes the Winthrop claim is without merit. Accordingly, no contingent loss liability has been recorded in connection with this case.
In connection with the October 2005 notice of a lawsuit brought against it by the Committee representing the unsecured creditors of H A 2003 Inc., formerly known as HA-LO Industries, Inc. (see Note 1), the Company recorded a contingent loss liability of $.5 million. Such contingent loss liability remains at December 31, 2007.
SIMON WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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. Because the Company remained secondarily liable under the Winthrop lease restructuring, recognizing a liability at inception for the fair value of the obligation was 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. The available amount under this letter of credit reduced over time as the underlying obligation to Winthrop reduced. 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.
In December 2005, the Company received notification that 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. Upon default by Cyrk and if such default is not cured within 15 days after receipt of written notice of default from the Company, Cyrk’s $2.3 million subordinated note payable to the Company, which was forgiven by the Company in 2003, was subject to reinstatement. After evaluating its alternatives in December 2005 and providing written notice to Cyrk in January 2006, such $2.3 million subordinated note payable was reinstated in January 2006 pursuant to a Settlement Agreement and Mutual General Release with Cyrk as explained in the following paragraph.
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 or in the event of payment in full, the Company has agreed not to enter the Confession of Judgment relating to the Old Subordinated Note 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
SIMON WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
the New Subordinated Note, there is no assurance that the Company will be successful in enforcing the Confession of Judgment.
During 2007 and 2006, the Company collected approximately $360,000 and $734,000, respectively, under the New Subordinated Note with a reserve recorded for the remaining balance, except for $27,000 at December 31, 2007, as collectibility is not reasonably assured based on the Company’s experience of prior arrangements with Cyrk including the default of the Winthrop obligation and settlement of controversy noted above. See Note 4.
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. During 2006, the Company’s elimination of its promotions business operations in Europe and Hong Kong was completed.
Assets and liabilities related to discontinued operations at December 31, 2007 and 2006, as disclosed in the accompanying consolidated financial statements, consist of the following:
SIMON WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Net income (loss) from discontinued operations for the years ended December 31, 2007, 2006 and 2005, as disclosed in the accompanying consolidated financial statements, consists of the following:
General and Administrative Expenses
There were approximately $47,000 of general and administrative expenses during 2007 which related to adjustments to decrease the recorded value of a cash surrender value related asset. As the Company completed the liquidation of the Company’s subsidiaries in Europe and Hong Kong, during the first quarter of 2006, there were no general and administrative expenses during 2006 and the amount for 2005 related to final general and administrative expenses for such subsidiaries.
Loss (Gain) on Settlement of Obligations
During 2007, the Company collected approximately $359,000, of which approximately $314,000 represented collections of principal and approximately $45,000 represented collections of imputed interest, under the New Subordinated Note with a reserve recorded for the remaining balance except for $27,000 as collectibility is not reasonably assured.
During 2006, the Company collected approximately $734,000, of which approximately $675,000 represented collections of principle and approximately $59,000 represented collections of imputed interest, under the New Subordinated Note with a reserve recorded for the remaining balance as collectibility was not reasonably assured.
As previously reported, an action had 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 paid $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.
Interest Income
Interest income totaled approximately $45,000 during 2007 and approximately $59,000 during 2006. These amounts relate to imputed interest income earned on the New Subordinated Note with Cyrk. As the Company receives payments, a greater portion of such payment is allocated to principal and a lesser portion of such payment is allocated to interest which accounts for the decrease in interest income from 2006 to 2007.
SIMON WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Other Income (Expense)
Other income (expense) for 2006 primarily related to a loss on disposal of the Company’s remaining subsidiaries in Europe and Hong Kong.
Other income (expense) for 2005 primarily related to a decrease in a contingent loss accrual of $.8 million related to a reduction in the Winthrop liability 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, 2007 and 2006, totaled $0 and $.2 million, respectively. The amount at December 31, 2006, primarily consisted of amounts deposited with lenders to satisfy the Company’s obligations pursuant to its outstanding standby letters of credit.
There was no restricted cash within continuing operations at December 31, 2007 and 2006.
6.
Investments
Yucaipa AEC Associates
At December 31, 2007, the Company held an investment in Yucaipa AEC Associates, LLC (“Yucaipa AEC”), a limited liability company that is controlled by Yucaipa, which also controls the holder of the Company’s outstanding preferred stock. Yucaipa AEC, in turn, primarily held an equity investment in the Source Interlink Companies (“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, which was 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 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 from the cost method to the equity method for periods ending after July 1, 2004.
On February 28, 2005, Alliance merged with Source. Inasmuch as Source is a publicly traded company, the Company’s pro rata investment in Yucaipa AEC, 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, which does not reflect any discount for illiquidity. Accordingly, on February 28, 2005, the date of closing of the merger to reflect its share of the gain upon receipt of the Source shares by Yucaipa AEC, the Company recorded an unrealized gain to accumulated other comprehensive income of $11.3 million, which does not reflect any discount for illiquidity. As the Company’s investment in Yucaipa AEC is accounted for under the equity method, the Company adjusts its investment based on its pro rata share of the earnings and losses of Yucaipa AEC. In addition, the Company recognizes its share in the other comprehensive income (loss) of Yucaipa AEC on the basis of changes in the fair value of Source through an adjustment in the unrealized gains and losses in the accumulated other comprehensive income component of the stockholders’ deficit. There were adjustments during 2007 and 2006 which reduced the recorded value of the Company’s investment in Yucaipa AEC totaling $5.2 million and $3.2 million, respectively. There were no such adjustments during 2005. The Company has no power to dispose of or liquidate its holding in Yucaipa AEC or its indirect interest in Source
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
which power is held by Yucaipa AEC. Furthermore, in the event of a sale or liquidation of the Source shares by Yucaipa AEC, the amount and timing of any distribution of the proceeds of such sale or liquidation to the Company is discretionary with Yucaipa AEC.
Other Investments
At December 31, 2007 and 2006, the carrying values of other investments were $59,000 and $82,000, respectively. These are presented as part of other assets in the consolidated balance sheets. During 2007, 2006 and 2005, the Company recorded impairment charges of approximately $2,000, $16,000 and $.2 million, respectively, due to management’s determination that the declines in fair value of certain investments below their cost bases were other-than-temporary.
7.
Lease Obligations and Other Commercial Commitments
The approximate minimum rental commitments under all noncancelable leases at December 31, 2007, totaled approximately $42,000, which are due in 2008.
For the years ended December 31, 2007, 2006, and 2005, rental expense for all operating leases included within continuing operations was approximately $50,000, $45,000 and $44,000, respectively. There was no rental expense for operating leases within discontinued operations during 2007, 2006, and 2005. Rent is charged to operations on a straight-line basis.
The Company also has a letter of credit totaling approximately $35,000 at December 31, 2007, which supports the Company’s periodic payroll tax obligations.
8.
Income Taxes
The Company had no provision or benefit for income taxes for 2007, 2006, and 2005.
As required by Statement of Financial Accounting Standard 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 $45.8 million and $45.5 million is required at December 31, 2007 and 2006, respectively. The tax effects of temporary differences that gave rise to deferred tax assets as of December 31, 2007 and 2006, were as follows (in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
As of December 31, 2007, the Company had federal and state net operating loss carryforwards of approximately $66.1 million and $35.1 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, 2007, the Company had federal and state capital loss carryforwards of $23.5 million which expire in 2008.
The following is a reconciliation of the statutory federal income tax rate to the actual effective income tax rate:
In February 2007, the Company received a notice of audit from the Internal Revenue Service (“IRS”) covering the tax year 2004. The IRS has completed its audit and, in February 2008, the Company received notice from the IRS that it had no changes to the 2004 tax year under audit.
9.
Accrued Expenses and Other Current Liabilities
At December 31, 2007 and 2006, accrued expenses and other current liabilities consisted of the following:
10.
Indemnification Trust Agreement
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 would 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 was 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. On March 1,
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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.
11.
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, a total of 40,000 shares of preferred stock were authorized for issuance. Pursuant to this authorization, the Company issued 25,000 shares of senior cumulative participating convertible 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 (4,107,476 shares as of December 31, 2007, and 3,947,203 shares as of December 31, 2006).
In connection with the issuance of the preferred stock, the Company also issued a warrant to purchase 15,000 shares of preferred stock at a purchase price of $15 million. The warrant expired on November 10, 2004. Each share of this series of preferred stock issued upon exercise of the warrant was 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).
Assuming conversion of all of the convertible preferred stock, Yucaipa would own approximately 20.1% and 19.1% of the then outstanding common shares at December 31, 2007 and 2006, respectively.
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 an annual dividend equal to 4% of the base liquidation preference of $1,000 per share outstanding, payable quarterly 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 and prior to November 10, 2004. The preferred stock is subject to a mandatory offer of redemption if a change in control of the Company occurs. As of December 31, 2007, the amount of the liquidation preference, which is equal to the sum of the preferred stock outstanding plus accrued dividends, was $33.9 million, and the redemption value, which is equal to the sum of the preferred stock outstanding plus accrued dividends multiplied by 101%, was $34.2 million. As of December 31, 2007, assuming conversion of all of the convertible preferred stock and accrued dividends, Overseas Toys L.P. would own approximately 20.1% of the then outstanding common stock.
In connection with this investment, Yucaipa is entitled to appoint the chairman of the Company’s Board of Directors and to nominate two additional individuals to a seven person board.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
12.
Stock Plan
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 became exercisable in two equal installments commencing on the first anniversary of the date of grant. As the Omnibus Plan terminated in May 2003 except as to options outstanding at that time, no further options may be granted under the plan.
Acquisition Stock Plan
The 1997 Acquisition Stock Plan (the “1997 Plan”) was intended to provide incentives in connection with the acquisitions of other businesses by the Company. The 1997 Plan was identical in all material respects to the Omnibus Plan, except that the number of shares available for issuance under the 1997 Plan was 1,000,000 shares. The 1997 Plan expired on April 4, 2007. There were no stock options granted under the 1997 Plan during 2007, 2006, and 2005.
The following summarizes the status of the Company’s stock options as of December 31, 2007, 2006 and 2005, and changes for the years then ended:
(a)
Available for issuance under the 1997 Plan. The 1997 Plan expired on April 4, 2007.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table summarizes information about stock options outstanding at December 31, 2007:
13.
Related Party Transactions
In May 2003, the Company entered into Executive Services Agreements with Messrs. Bartlett, Brown, 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 replaced the letter agreements with Messrs. Bartlett 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 Mr. 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. During 2007, $20,000 of 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.
During 2006, 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 with Yucaipa. 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 and pursuant thereto the parties exchanged mutual releases and Mr. Mays was paid severance under the Agreement of $210,000. The Company and Mr. Mays subsequently entered into a new agreement which may be terminated by either party upon 90 days written notice and which requires Mr. Mays to continue to provide accounting services and act as chief financial officer of the Company under his existing salary and employment conditions until either party terminates the arrangement.
On April 18, 2006, George Golleher, a former Yucaipa representative on the Board of Director and former co-chief executive officer, resigned from the Board of Directors and the Company terminated his Executive Services Agreement and pursuant thereto the parties exchanged mutual releases and Mr. Golleher was paid severance under the Agreement of $350,000.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
14.
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 2007, 2006, and 2005. In addition, the Company had no accounts receivable at December 31, 2007 and 2006.
All the Company’s long-lived assets as of December 31, 2007 and 2006, were in the United States.
15.
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, 2007, 2006, and 2005, 4,084,390, 3,947,203, and 3,793,185, respectively, shares of redeemable 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, 2007, 2006, and 2005, 176,233, 193,753, and 199,445, weighted average shares, respectively, 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 $.36, $.34, and $.23, respectively, did not exceed the weighted average exercise price of such options of $4.40, $4.62, and $4.51, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
16.
Quarterly Results of Operations (Unaudited)
The following is a tabulation of the quarterly results of operations for the years ended December 31, 2007 and 2006, respectively: