-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, C30hOyeRJzFTAqiX3nZFXXEbwy9SsEVgmWtt3Y90637RBiixL2j94Od/lIYuYp5W xZZDvOLxM1YFaC79ePkK0Q== 0000950135-01-503629.txt : 20020411 0000950135-01-503629.hdr.sgml : 20020411 ACCESSION NUMBER: 0000950135-01-503629 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20010930 FILED AS OF DATE: 20011119 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SIMON WORLDWIDE INC CENTRAL INDEX KEY: 0000864264 STANDARD INDUSTRIAL CLASSIFICATION: APPAREL & OTHER FINISHED PRODS OF FABRICS & SIMILAR MATERIAL [2300] IRS NUMBER: 043081657 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-21878 FILM NUMBER: 1795356 BUSINESS ADDRESS: STREET 1: 101 EDGEWATER DRIVE CITY: WAKEFIELD STATE: MA ZIP: 01880 BUSINESS PHONE: 5082835800 MAIL ADDRESS: STREET 1: 101 EDGEWATER DRIVE CITY: WAKEFIELD STATE: MA ZIP: 01880 FORMER COMPANY: FORMER CONFORMED NAME: CYRK INC DATE OF NAME CHANGE: 19940214 FORMER COMPANY: FORMER CONFORMED NAME: CYRK INTERNATIONAL INC DATE OF NAME CHANGE: 19930521 10-Q 1 b40921swe10-q.txt SIMON WORLDWIDE INC. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended SEPTEMBER 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________________ to ___________________ Commission File Number 0-21878 SIMON WORLDWIDE, INC. (Exact name of Registrant as specified in its charter) DELAWARE 04-3081657 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 101 EDGEWATER DRIVE, WAKEFIELD, MASSACHUSETTS 01880 (Address of principal executive offices) (Zip Code) (781) 246-3030 (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- At October 31, 2001, 16,653,193 shares of the Registrant's common stock were outstanding. SIMON WORLDWIDE, INC. FORM 10-Q TABLE OF CONTENTS PART I FINANCIAL INFORMATION PAGE NUMBER Item 1. Financial Statements (Unaudited) Consolidated Balance Sheets - September 30, 2001 and December 31, 2000 3 Consolidated Statements of Operations - For the three and nine months ended September 30, 2001 and 2000 4 Consolidated Statements of Comprehensive Income - For the three and nine months ended September 30, 2001 and 2000 5 Consolidated Statements of Cash Flows - For the nine months ended September 30, 2001 and 2000 6 Notes to Consolidated Financial Statements 7-13 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 14-20 PART II OTHER INFORMATION Item 1. Legal Proceedings 21 Item 6. Exhibits and Reports on Form 8-K 21 SIGNATURES 22 2 PART I - FINANCIAL INFORMATION SIMON WORLDWIDE, INC. CONSOLIDATED BALANCE SHEETS (Unaudited) (In thousands, except share data)
September 30, 2001 December 31, 2000 ------------------ ----------------- ASSETS Current assets: Cash and cash equivalents $ 54,476 $ 68,162 Restricted cash 6,228 -- Investment 5,914 7,969 Accounts receivable: Trade, less allowance for doubtful accounts of $3,630 at September 30, 2001 and $2,074 at December 31, 2000 31,215 48,877 Officers -- 4,340 Inventories 4,427 10,175 Prepaid expenses and other current assets 3,033 5,120 Deferred charges, officer 3,413 -- Refundable income taxes -- 4,417 Deferred income taxes -- 7,120 Proceeds from sale of business -- 8,363 --------- --------- Total current assets 108,706 164,543 Property and equipment, net 7,631 12,510 Excess of cost over net assets acquired, net -- 48,033 Investments 11,250 12,500 Deferred income taxes -- 4,734 Other assets 5,640 7,815 Proceeds from sale of business 2,300 2,300 --------- --------- $ 135,527 $ 252,435 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Short-term borrowings $ 449 $ 5,523 Accounts payable: Trade 32,211 36,035 Affiliates 141 281 Accrued expenses and other current liabilities 40,096 53,265 Investment payable -- 7,875 Accrued restructuring expenses 3,170 1,193 --------- --------- Total current liabilities 76,067 104,172 Long-term obligations 6,697 6,587 --------- --------- Total liabilities 82,764 110,759 --------- --------- Commitments and contingencies Mandatorily redeemable preferred stock, Series A1 senior cumulative participating convertible, $.01 par value, 26,275 shares issued and outstanding at September 30, 2001 and 25,500 shares issued and outstanding at December 31, 2000, stated at redemption value of $1,000 per share 26,275 25,500 Stockholders' equity: Preferred stock, $.01 par value; 1,000,000 shares authorized; 26,275 Series A1 shares issued at September 30, 2001 and 25,500 Series A1 shares issued at December 31, 2000 -- -- Common stock, $.01 par value; 50,000,000 shares authorized; 16,653,193 shares issued and outstanding at September 30, 2001 and 16,059,130 shares issued and outstanding at December 31, 2000 167 161 Additional paid-in capital 135,966 138,978 Retained deficit (109,172) (22,128) Accumulated other comprehensive income (loss): Unrealized gain on investment 1,472 94 Cumulative translation adjustment (1,945) (929) --------- --------- Total stockholders' equity 26,488 116,176 --------- --------- $ 135,527 $ 252,435 ========= =========
The accompanying notes are an integral part of the consolidated financial statements. 3 SIMON WORLDWIDE, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (In thousands, except per share data)
For the three months For the nine months -------------------- ------------------- ended September 30, ended September 30, ------------------- ------------------- 2001 2000 2001 2000 ---- ---- ---- ---- Net sales $ 93,819 $ 178,702 $ 311,413 $ 580,338 Cost of sales 73,421 141,300 247,079 475,954 Write-down of inventory in connection with restructuring -- -- -- 1,695 --------- --------- --------- --------- Gross profit 20,398 37,402 64,334 102,689 Selling, general and administrative expenses 19,685 38,462 71,712 116,041 Goodwill amortization expense 454 894 1,574 2,670 Impairment of intangible asset 46,671 -- 46,671 -- Severance, retention and other charges 2,124 -- 2,124 -- Restructuring and other nonrecurring charges -- -- 20,212 5,325 --------- --------- --------- --------- Operating loss (48,536) (1,954) (77,959) (21,347) Interest income (533) (1,078) (1,756) (3,192) Interest expense 94 330 487 974 Other (income) expense (3,548) 1,000 (2,798) (1,245) --------- --------- --------- --------- Loss before income taxes (44,549) (2,206) (73,892) (17,884) Income tax expense (benefit) 22,644 (772) 12,374 (6,259) --------- --------- --------- --------- Net loss (67,193) (1,434) (86,266) (11,625) Preferred stock dividends 261 250 778 750 --------- --------- --------- --------- Net loss available to common stockholders $ (67,454) $ (1,684) $ (87,044) $ (12,375) ========= ========= ========= ========= Loss per common share - basic and diluted $ (4.05) $ (0.10) $ (5.31) $ (0.78) ========= ========= ========= ========= Weighted average shares outstanding - basic and diluted 16,652 16,048 16,389 15,942 ========= ========= ========= =========
The accompanying notes are an integral part of the consolidated financial statements. 4 SIMON WORLDWIDE, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) (In thousands)
For the three months For the nine months -------------------- ------------------- ended September 30, ended September 30, ------------------- ------------------- 2001 2000 2001 2000 ---- ---- ---- ---- Net loss $(67,193) $ (1,434) $(86,266) $(11,625) -------- -------- -------- -------- Other comprehensive income (loss), before tax: Foreign currency translation adjustments 343 (55) (1,016) (191) Unrealized holding gains (losses) arising during period (7,404) -- 1,472 (2,290) -------- -------- -------- -------- Other comprehensive income (loss), before tax (7,061) (55) 456 (2,481) Income tax expense (benefit) related to items of other comprehensive income (loss) (3,700) -- 94 (954) -------- -------- -------- -------- Other comprehensive loss, net of tax (3,361) (55) 362 (1,527) -------- -------- -------- -------- Comprehensive loss $(70,554) $ (1,489) $(85,904) $(13,152) ======== ======== ======== ========
The accompanying notes are an integral part of the consolidated financial statements. 5 SIMON WORLDWIDE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands)
For the nine months ended September 30, 2001 2000 ---- ---- Cash flows from operating activities: Net loss $(86,266) $(11,625) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 4,341 7,040 Loss (gain) on sale of property and equipment 33 (60) Realized gain on sale of investments (4,048) (3,245) Provision for doubtful accounts 2,930 2,151 Deferred income taxes 11,854 -- Non-cash restructuring charges 8,918 47 Charge for impaired assets 46,871 -- Charge for impaired investments 1,250 2,000 Issuance of common stock related to acquisition agreement 575 575 Increase (decrease) in cash from changes in working capital items: Accounts receivable 15,072 25,933 Inventories 3,695 119 Prepaid expenses and other current assets 1,681 1,018 Refundable income taxes 4,417 (7,340) Accounts payable (3,830) 103 Accrued expenses and other current liabilities (15,610) (25,416) -------- -------- Net cash used in operating activities (8,117) (8,700) -------- -------- Cash flows from investing activities: Purchase of property and equipment (2,858) (7,025) Proceeds from sale of property and equipment 66 223 Purchase of investments (7,875) (4,500) Proceeds from sale of CPG division 8,363 -- Proceeds from sale of investments 7,481 3,378 Other, net (50) (988) -------- -------- Net cash provided by (used in) investing activities 5,127 (8,912) -------- -------- Cash flows from financing activities: Repayments of short-term borrowings, net (5,074) (7,281) Proceeds from (repayments of) long-term obligations 110 (2,989) Proceeds from issuance of common stock 623 533 Dividends paid -- (500) -------- -------- Net cash used in financing activities (4,341) (10,237) -------- -------- Effect of exchange rate changes on cash (127) (277) -------- -------- Net decrease in cash and cash equivalents (7,458) (28,126) Cash and cash equivalents, beginning of year 68,162 99,698 -------- -------- Cash and cash equivalents, end of period, including restricted cash of $6,228 at September 30, 2001 $ 60,704 $ 71,572 ======== ======== Supplemental disclosure of cash flow information: Cash paid during the period for: Interest $ 328 $ 758 ======== ======== Income taxes $ 429 $ 2,948 ======== ======== Supplemental non-cash investing activities: Issuance of additional stock related to acquisition $ 1,413 $ 1,413 ======== ======== Dividends paid in kind on mandatorily redeemable preferred stock $ 775 $ 250 ======== ========
The accompanying notes are an integral part of the consolidated financial statements. 6 SIMON WORLDWIDE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation The accompanying unaudited financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes in accordance with generally accepted accounting principles for complete financial statements and should be read in conjunction with the audited financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2000. In the opinion of management, the accompanying unaudited financial statements contain all adjustments necessary for fair presentation of the Company's financial position, results of operations and cash flows at the dates and for the periods presented. See going concern discussion in Note 2 below. The operating results for the nine months ended September 30, 2001 are not necessarily indicative of the results to be expected for the full year. 2. Loss of Significant Customers, Resulting Events and Going Concern On August 21, 2001, the Company was notified by McDonald's Corporation ("McDonald's") that they were terminating their approximately 25-year relationship with the Company's main operating subsidiary, Simon Marketing, Inc. ("Simon Marketing"), as a result of the arrest of Jerome P. Jacobson ("Mr. Jacobson"), a former employee of Simon Marketing who was alleged to have embezzled winning game pieces from McDonald's promotional games administered by Simon Marketing. An Indictment filed by the U.S. Attorney in the United States District Court for the Middle District of Florida alleges that Mr. Jacobson "embezzled more than $20 million worth of high-value winning McDonald's promotional game pieces from his employer, Simon". Simon Marketing is identified in the Indictment, along with McDonald's, as one of the victims of Mr. Jacobson's alleged fraudulent scheme. (Also, see section, "Legal Actions Associated with the McDonald's Matter", below.) Further, on August 23, 2001, the Company was notified that its second largest customer, Philip Morris Incorporated ("Philip Morris"), was also ending their approximately nine year relationship with the Company. Net sales to McDonald's and Philip Morris accounted for 65% and 9%, respectively, of total net sales in 2000 and 80% and 8%, respectively, of total net sales in the first nine months of 2001. The Company's financial condition, results of operations and net cash flows have been and will continue to be materially adversely affected by the loss of the McDonald's and Philip Morris business. In addition, the absence of business from McDonald's and Philip Morris has adversely affected the Company's relationship with and access to foreign manufacturing sources. As a result of the loss of these major customers along with the resulting legal matters discussed further below, there is 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 has taken and will continue to take action to reduce its cost structure while all options are explored in the wake of these events. The options being considered include the sale of all or a portion of the Company and a reorganization and/or liquidation of the net assets of the Company which may be through bankruptcy proceedings. Pursuant to actions taken in the third quarter of 2001, the Company recorded a third quarter pre-tax charge of approximately $48.8 million. The third quarter charge relates principally to the write-down of goodwill attributable to Simon Marketing ($46.7 million), lump sum severance costs associated with the involuntary termination of 177 employees ($1.3 million), legal fees associated with the McDonald's matter ($.6 million) and amortization of deferred charges, officer ($.2 million). In November 2001, the Company and its subsidiaries approved a plan that will further reduce its workforce by approximately 215 additional employees. This action will result in a fourth quarter charge of approximately $3.6 million for lump sum severance related expenses. The Company expects to incur additional charges in the fourth quarter of 2001 attributable to additional employee termination costs, asset write-downs, lease cancellations and other exit costs associated with further cost reductions. The Company is unable to quantify the magnitude of these charges and their ultimate effect on the Company's financial condition, results of operations and net cash flows. 7 As a result of the forgoing matters, including the loss of its two largest customers in August 2001, the Company entered into a variety of commitments with its Chief Executive Officer and certain directors and employees which provide for retention and severance payments under certain circumstances. In the third quarter of 2001, the Company entered into a Retention and Amendment Agreement ("Agreement") with its Chief Executive Officer ("Officer"), which provides that upon termination of employment from the Company within the parameters defined in this Agreement, the Officer will receive a lump sum payment of $750,000. This amount has been segregated in a separate cash account in October 2001 in which a security interest has been granted to the Officer. Additionally, pursuant to this Agreement, loans to the Officer for the aggregate principal amount of $2.0 million will be forgiven at a rate of $200,000 per month, so long as the Officer is employed by the Company, until the loans are reduced to zero. During the third quarter of 2001, $200,000 related to the forgiveness of this debt was expensed. In connection with this Agreement, along with the terms of his existing employment agreement, all loans to the Officer have been reclassified on the balance sheet from accounts receivable to deferred charges. In the third quarter of 2001, the Company paid a retention fee of $150,000 to each of the three non-management members of the Company's Board of Directors. In light of recent events, the Board members will be required to provide additional time and services to the Company. The Company expects the Directors to serve in this capacity for at least six months. To the extent a director resigns before the end of the six-month period, the director must refund to the Company the pro rata portion of the retention fee equal to the percentage of the six-month period not served. Additionally, these directors will be compensated at an hourly rate of $750 for services outside of Board and committee meetings (for which they are paid $2,000 per meeting in accordance with existing Company policy). In addition, agreements were entered into in September and October 2001 with certain employees (to induce them to continue their employment with the Company) which provide for retention payments ranging from 8% to 100% of their respective annual salaries conditioned upon continued employment through specified dates and/or severance payments up to 100% of these employee's respective annual salaries should such employees be terminated within the parameters of their agreements. Payments under these agreements are to be made at various dates beginning in September 2001 and extending through no later than September 2002. The Company estimates its obligations under these agreements to be approximately $3.1 million. Approximately $1.7 million of these commitments have been segregated in separate cash accounts in October 2001 in which security interests have been granted to certain employees. Legal Actions Associated with the McDonald's Matter Subsequent to August 21, 2001, numerous consumer class action and representative action lawsuits (hereafter variously referred to as, "actions", "complaints" or "lawsuits") have been filed in multiple jurisdictions nationwide. Plaintiffs in these actions assert diverse causes of action, including negligence, breach of contract, fraud, restitution, unjust enrichment, misrepresentation, false advertising, breach of warranty, unfair competition and violation of various state consumer fraud statutes. A complaint filed in federal court in New Jersey also alleges a pattern of racketeering. Plaintiffs in many of these actions allege, among other things, that defendants, including the Company, Simon Marketing, and McDonald's, misrepresented that plaintiffs had a chance at winning certain high-value prizes when in fact the prizes were stolen by Mr. Jacobson. Plaintiffs seek various forms of relief, including restitution of monies paid for McDonald's food, disgorgement of profits, recovery of the "stolen" game prizes, other compensatory damages, attorney's fees, punitive damages and injunctive relief. The lawsuits are all in the very early stages and discovery has yet to commence in any of these proceedings. Simon Marketing and other co-defendants are seeking to consolidate the various actions. Simon Marketing has consented to the removal to federal court, by McDonald's, of each of the complaints filed in state courts other than in California and Illinois. On October 9, 2001, McDonald's filed a motion with the Judicial Panel on Multidistrict Litigation seeking to transfer all complaints pending in federal courts nationwide, including the removed cases and any subsequently filed cases, to a single federal court in the Northern District of Illinois. That motion is currently being briefed. On October 12, 2001, McDonald's, with Simon Marketing's consent, filed a Petition to Coordinate in a single court in Orange County all actions pending in California State Superior Court. Simon Marketing has also joined in an Application filed by McDonald's to stay all California proceedings pending a ruling on the Petition for Coordination. In addition, recently, the Illinois state court ordered the actions filed there to be consolidated before a single judge and the Illinois state court plaintiffs have consented to re-file a single, operative complaint. 8 The Company is unable to predict the outcome of any or all of these lawsuits and the ultimate effect, if any, on the Company's financial condition, results of operations or net cash flows. On October 23, 2001, Simon Marketing and the Company filed suit against McDonald's in California Superior Court for the County of Los Angeles. The complaint alleges, among other things, fraud, defamation and breach of contract in connection with the termination of Simon Marketing's relationship with McDonald's. Also on October 23, 2001, the Company and Simon Marketing were named as defendants, along with a former employee of Simon Marketing, and certain other individuals unrelated to the Company or Simon Marketing, in a complaint filed by McDonald's in the United States District Court for the Northern District of Illinois. The complaint alleges that Simon Marketing has engaged in fraud, breach of contract, breach of fiduciary obligations and civil conspiracy and alleges that McDonald's is entitled to indemnification and damages of an unspecified amount. On November 13, 2001, the Company filed suit against Philip Morris in California Superior Court for the County of Los Angeles. The complaint, which alleges breach of contract, unjust enrichment and breach of the implied covenant of good faith and fair dealing, seeks to recover in excess of $4 million in damages resulting from the termination of the Company's relationship with Philip Morris. The Company is unable to predict the outcome of the McDonald's complaint, or of its suit against McDonald's or Philip Morris, and their ultimate effects, if any, on the Company's financial condition, results of operations or net cash flows. For additional information related to certain matters discussed in this footnote, reference is made to the Company's Reports on Form 8-K dated August 21, 2001, September 17, 2001, September 21, 2001 and October 30, 2001, respectively. 3. Commitments As a result of the precipitous drop in the value of the Company's common stock after the announcement of the loss of its two largest customers (see Note 2), the Company has accelerated the recognition of contingent payment obligations arising from the acquisition of Simon Marketing in 1997. Consequently, a $5.0 million third quarter 2001 charge to stockholders' equity is included in accrued expenses and other current liabilities to reflect these commitments. Payments to be made under these commitments totaling approximately $5.8 million are due in June 2002. 4. Sale of Business Pursuant to its decision in December 2000, the Company sold its Corporate Promotions Group ("CPG") business on February 15, 2001 to Cyrk, Inc., formerly known as Rockridge Partners, Inc. ("Rockridge"), an investor group led by Gemini Investors LLC, a Wellesley, Massachusetts-based private equity investment firm, pursuant to a Purchase Agreement entered into as of January 20, 2001 (as amended, the "Purchase Agreement") for approximately $14.0 million which included the assumption of approximately $3.7 million of Company debt. $2.3 million of the purchase price was paid with a 10% per annum five-year subordinated note from Rockridge, with the balance being paid in cash. The 2000 financial statements reflected this transaction and included a pre-tax charge recorded in the fourth quarter of 2000 of $50.1 million due to the loss on the sale of the CPG business, $22.7 million of which was associated with the write-off of goodwill attributable to CPG. This charge had the effect of increasing the 2000 net loss available to common stockholders by approximately $49.0 million or $3.07 per share. Net sales in 2000 attributable to the CPG business were $146.8 million, or 19% of consolidated Company revenues. Net sales in the first quarter of 2001, for the period through February 14, 2001, attributable to the CPG business, were $17.7 million, or 17% of consolidated Company revenues. Net sales in the first quarter of 2000 attributable to the CPG business were $33.6 million, or 19% of consolidated Company revenues. CPG was engaged in the corporate catalog and specialty advertising segment of the promotions industry. The group was formed as a result of the Company's acquisitions of Marketing Incentives, Inc. ("MI") and Tonkin, Inc. ("Tonkin") in 1996 and 1997, respectively. Pursuant to the Purchase Agreement, Rockridge purchased from the Company (i) all of the outstanding capital stock of Cyrk Acquisition Corp. ("CAC"), successor to the business of MI, and Tonkin, each a wholly-owned subsidiary of the Company, (ii) certain other assets of the Company, including those assets at the Company's Danvers and Wakefield, Massachusetts facilities necessary for the operation of the CPG business and (iii) all intellectual property of the CPG business as specified in the Purchase Agreement. Rockridge assumed certain liabilities of the CPG business as specified in the Purchase Agreement and all of the assets and liabilities of CAC and Tonkin and, pursuant to the Purchase Agreement, the Company agreed to transfer its former name, Cyrk, to the buyer. Rockridge extended employment offers to certain 9 former employees of the Company who had performed various support activities, including accounting, human resources, information technology, legal and other various management functions. There is no material relationship between Rockridge 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. The sale of CPG effectively terminated the restructuring effort announced by the Company in May 2000 with respect to the CPG business. 5. Inventories Inventories consist of the following (in thousands):
September 30, 2001 December 31, 2000 ------------------ ----------------- Raw materials $ -- $ 178 Work in process 2,830 3,099 Finished goods 1,597 6,898 ------- ------- $ 4,427 $10,175 ======= =======
6. Deferred Tax Assets As required by Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes", the Company annually evaluates the positive and negative evidence bearing upon the realizability of its deferred tax assets. The Company, however, has considered recent events (see Note 2) 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. To the extent that these assets have been deemed to be unrealizable, a valuation allowance and tax provision of $22.6 million has been recorded in the third quarter of 2001. 7. Investments Current In December 2000, the Company purchased 1,500,000 shares of a marketable security at $5.25 per share. The Company sold 654,000 shares in the third quarter of 2001 and realized a pre-tax gain on the sale of $4.0 million. As of September 30, 2001 and December 31, 2000, these shares (846,000 and 1,500,000, respectively) are stated at fair value of approximately $5.9 million and $8.0 million, respectively. Long-term The Company has made strategic and venture investments in a portfolio of privately-held companies that are being accounted for under the cost method. These investments are in Internet-related companies that are at varying stages of development, including startups, and are intended to provide the Company with expanded 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 the Internet, including their dependency upon the widespread acceptance and use of the Internet as an effective medium for commerce. In addition, these companies are subject to the valuation volatility associated with the investment community and the capital markets. The carrying value of the Company's investments in these Internet-related companies is subject to the aforementioned risks inherent in Internet business. Each quarter, the Company performs a review of the carrying value of all its investments in these Internet-related companies, and considers such factors as current results, trends and future prospects, capital market conditions and other economic factors. Based on its reviews in 2001, the Company has recorded a year to date charge to other expense of approximately $1.3 million for an other-than-temporary investment impairment associated with its venture portfolio. While the Company will continue to periodically evaluate its Internet 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. 10 8. Short-Term Borrowings In June 2001, the Company secured a new primary domestic letter of credit facility of up to $21.0 million for the purpose of financing the importation of various products from Asia and for issuing standby letters of credit. Pursuant to the provisions of this facility, the Company had bank commitments to issue or consider issuing for product related letter of credit borrowings of up to $15.0 million and bank commitments to issue or consider issuing for standby letters of credit of up to $6.0 million through May 15, 2002. As a result of the loss of its McDonald's and Philip Morris business (see Note 2) the Company no longer has the ability to issue a letter of credit under this facility without it being fully cash collateralized. At September 30, 2001, the Company was contingently liable for letters of credit used to finance the purchase of inventory in the aggregate amount of $1.1 million. Such letters of credit expire at various dates through November 2001. Restricted cash consists of amounts deposited with lenders to satisfy the Company's obligations pursuant to its outstanding standby letters of credit. The outstanding standby letters of credit have maturities ranging from February 2002 through October 2002. 9. Restructuring and Other Nonrecurring Charges A summary of restructuring and other nonrecurring charges for the nine months ended September 30, 2001 and 2000 are as follows (in thousands):
2001 2000 ------- ------- Restructuring charge $20,212 $ 6,360 Settlement charge -- 660 ------- ------- $20,212 $ 7,020 ======= =======
2001 Restructuring Pursuant to the February 2001 sale of its CPG business, and its previously announced intentions, the Company conducted a second quarter 2001 evaluation of its remaining businesses with the objective of restoring consistent profitability through a more rationalized, cost-efficient business model. As a result of this evaluation, and pursuant to a plan approved by its Board of Directors, the Company has taken action to shutdown or consolidate certain businesses, sell certain assets and liabilities related to its legacy corporate catalog business in the United Kingdom and eliminate approximately two-thirds (40 positions) of its Wakefield, Massachusetts corporate office workforce. Additionally, the Company announced the resignation of its co-chief executive officer and two other executive officers, including the Company's chief financial officer. Consequently, the Company announced that all responsibilities for the chief executive officer position have been consolidated under Allan I. Brown, who has served as co-chief executive officer since November 1999 and as the chief executive officer of Simon Marketing, Inc., the Company's wholly-owned subsidiary based in Los Angeles, California since 1975. For additional information related to these events, reference is made to the Company's Report on Form 8-K dated June 15, 2001. As a result of these actions, the Company recorded a second quarter 2001 pre-tax charge of approximately $20.2 million for restructuring expenses. The second quarter charge relates principally to employee termination costs ($10.5 million), asset write-downs which were primarily attributable to a consolidation of its Wakefield, Massachusetts workspace ($6.5 million), a loss on the sale of the UK business ($2.1 million) and the settlement of certain lease obligations ($1.1 million). Total cash outlays related to restructuring activities are expected to be approximately $11.3 million. The restructuring plan is anticipated to be substantially complete by the end of 2001. A summary of activity in the restructuring accrual related to the 2001 restructuring action is as follows (in thousands): Balance at March 31, 2001 $ -- Restructuring provision 20,212 Non-cash asset write-downs (8,874) Employee termination costs and other cash payments made through September 30, 2001 (8,666) -------- Balance at September 30, 2001 $ 2,672 ======== 11 2000 Restructuring As a result of its May 2000 restructuring, the Company recorded a net charge to 2000 operations of $5.7 million for involuntary termination costs, asset write-downs and the settlement of lease obligations. The original restructuring charge of nearly $6.4 million was revised downward to $5.7 million as a result of the sale of the CPG business (see Note 4). The restructuring plan was substantially complete by the end of 2000. A summary of activity in the restructuring accrual related to the 2000 restructuring action is as follows (in thousands): Balance at January 1, 2000 $ -- Restructuring provision 6,360 Employee termination costs and other cash payments made through December 31, 2000 (2,858) Non-cash asset write-downs (1,684) Accrual reversal (625) ------- Balance at December 31, 2000 1,193 Employee termination costs and other cash payments made through September 30, 2001 (651) Non-cash asset write-downs (44) ------- Balance at September 30, 2001 $ 498 =======
2000 Settlement Charge The Company recorded a second quarter 2000 nonrecurring pre-tax charge to operations of $.7 million associated with the settlement of a change in control agreement with an employee of the Company who was formerly an executive officer. 10. Earnings Per Share Disclosure The following is a reconciliation of the numerators and denominators of the basic and diluted EPS computation for "loss available to common stockholders" and other related disclosures required by Statement of Financial Accounting Standards No. 128, "Earnings per Share" (in thousands, except share data):
For the Quarters Ended September 30, 2001 2000 --------------------------------------------- -------------------------------------------- Income Shares Per Share Income Shares Per Share (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount --------------------------------------------- -------------------------------------------- Basic and diluted EPS: Net loss $ (67,193) 16,651,796 $(4.04) $ (1,434) 16,047,753 $ (0.09) Preferred stock dividends 261 250 ---------- ---------- ---------- ---------- Loss available to common stockholders $ (67,454) 16,651,796 $(4.05) $ (1,684) 16,047,753 $ (0.10) ========== ========== ====== ========== ========== ==========
For the quarters ended September 30, 2001 and 2000, 3,319,482 of convertible preferred stock and common stock equivalents and 3,456,424 of convertible preferred stock, common stock equivalents and contingently and non-contingently issuable shares related to acquired companies, respectively, were not included in the computation of diluted EPS because to do so would have been antidilutive. 12
For the Nine Months Ended September 30, 2001 2000 ------------------------------------- --------------------------------------- Income Shares Per Share Income Shares Per Share (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount ------------------------------------- --------------------------------------- Basic and diluted EPS: Net loss $ (86,266) 16,388,641 $(5.26) $ (11,625) 15,942,339 $(0.73) Preferred stock dividends 778 750 Loss available to common ---------- ---------- ---------- ---------- stockholders $ (87,044) 16,388,641 $(5.31) $ (12,375) 15,942,339 $(0.78) ========== ========== ====== ========== ========== ======
For the nine months ended September 30, 2001 and 2000, 3,431,351 and 3,484,359, respectively, of convertible preferred stock, common stock equivalents and contingently and non-contingently issuable shares related to acquired companies were not included in the computation of diluted EPS because to do so would have been antidilutive. 13 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is a discussion of the financial condition and results of operations of the Company for the three and nine month periods ended September 30, 2001, as compared to the same periods in the previous year. This discussion should be read in conjunction with the Consolidated Financial Statements of the Company and related Notes included elsewhere in this Form-10Q. 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 the Company's Amended Cautionary Statement for Purposes of the "Safe Harbor" Provisions of the Private Securities Litigation Reform Act of 1995, filed as Exhibit 99.1 hereto. GENERAL Until the unanticipated events of August 2001 occurred, including the loss of its two largest customers, (see Loss of Significant Customers, Resulting Events and Going Concern section below), the Company 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 product and services companies seeking to promote their brand names and corporate identities and build brand loyalty. Recently, the Company's business has been heavily concentrated with two large customers: McDonald's Corporation ("McDonald's") and, to a lesser extent, Philip Morris Incorporated ("Philip Morris"). Net sales to McDonald's and Philip Morris accounted for 65% and 9%, respectively, of total net sales in 2000 and 80% and 8%, respectively, of total net sales in the first nine months of 2001. Beginning in 1996, the Company grew as a result of a series of acquisitions of companies engaged in the corporate catalog and advertising specialty segment of the promotion industry. Certain of these acquired companies operated within the Company's Corporate Promotions Group ("CPG") and have had a history of disappointing financial results. As a result, the Company sold these businesses in February of 2001 (see Sale of Business section below). In 1997, the Company expanded into the consumer promotion arena with its acquisition of Simon Marketing, Inc. ( "Simon Marketing"), a Los Angeles-based marketing and promotion agency. The Company conducted its business with McDonald's through its Simon Marketing subsidiary. Simon Marketing designed and implemented marketing promotions for McDonald's, which included premiums, games, sweepstakes, events, contests, coupon offers, sports marketing, licensing and promotional retail items. LOSS OF SIGNIFICANT CUSTOMERS, RESULTING EVENTS AND GOING CONCERN 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 was alleged to have embezzled winning game pieces from McDonald's promotional games administered by Simon Marketing. An Indictment filed by the U.S. Attorney in the United States District Court for the Middle District of Florida alleges that Mr. Jacobson "embezzled more than $20 million worth of high-value winning McDonald's promotional game pieces from his employer, Simon". Simon Marketing is identified in the Indictment, along with McDonald's, as one of the victims of Mr. Jacobson's alleged fraudulent scheme. (Also, see section, "Legal Actions Associated with the McDonald's Matter", below.) Further, on August 23, 2001, the Company was notified that its second largest customer, Philip Morris, was also ending their approximately nine year relationship with the Company. Net sales to McDonald's and Philip Morris accounted for 65% and 9%, respectively, of total net sales in 2000 and 80% and 8%, respectively, of total net sales in the first nine months of 2001. The Company's financial condition, results of operations and net cash flows have been and will continue to be materially adversely affected by the loss of the McDonald's and Philip Morris business. In addition, the absence of business from McDonald's and Philip Morris has adversely affected the Company's relationship with and access to foreign manufacturing sources. 14 At September 30, 2001, as a result of the loss of its McDonald's and Philip Morris business, the Company had $2.2 million of written purchase orders as compared to $268.1 million at September 30, 2000. As a result of the loss of these major customers along with the resulting legal matters discussed further below, there is 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 has taken and will continue to take action to reduce its cost structure while all options are explored in the wake of these events. The options being considered include the sale of all or a portion of the Company and a reorganization and/or liquidation of the net assets of the Company which may be through bankruptcy proceedings. Pursuant to actions taken in the third quarter of 2001, the Company recorded a third quarter pre-tax charge of approximately $48.8 million. The third quarter charge relates principally to the write-down of goodwill attributable to Simon Marketing ($46.7 million), lump sum severance costs associated with the involuntary termination of 177 employees ($1.3 million), legal fees associated with the McDonald's matter ($.6 million) and amortization of deferred charges, officer ($.2 million). In November 2001, the Company and its subsidiaries approved a plan that will further reduce its workforce by approximately 215 additional employees. This action will result in a fourth quarter charge of approximately $3.6 million for lump sum severance related expenses. The Company expects to incur additional charges in the fourth quarter of 2001 attributable to additional employee termination costs, asset write-downs, lease cancellations and other exit costs associated with further cost reductions. The Company is unable to quantify the magnitude of these charges and their ultimate effect on the Company's financial condition, results of operations and net cash flows. As a result of the forgoing matters, including the loss of its two largest customers in August 2001, the Company entered into a variety of commitments with its Chief Executive Officer and certain directors and employees which provide for retention and severance payments under certain circumstances. In the third quarter of 2001, the Company entered into a Retention and Amendment Agreement ("Agreement") with its Chief Executive Officer ("Officer"), which provides that upon termination of employment from the Company, the Officer will receive a lump sum payment of $750,000. This amount has been segregated in a separate cash account in October 2001 in which a security interest has been granted to the Officer. Additionally, pursuant to this Agreement, loans to the Officer for the aggregate principal amount of $2.0 million will be forgiven at a rate of $200,000 per month, so long as the Officer is employed by the Company, until the loans are reduced to zero. During the third quarter of 2001, $200,000 related to the forgiveness of this debt was expensed. In connection with this Agreement, along with the terms of his existing employment agreement, all loans to the Officer have been reclassified on the balance sheet from accounts receivable to deferred charges. In the third quarter of 2001, the Company paid a retention fee of $150,000 to each of the three non-management members of the Company's Board of Directors. In light of recent events, the Board members will be required to provide additional time and services to the Company. The Company expects the Directors to serve in this capacity for at least six months. To the extent a director resigns before the end of the six-month period, the director must refund to the Company the pro rata portion of the retention fee equal to the percentage of the six-month period not served. Additionally, these directors will be compensated at an hourly rate of $750 for services outside of Board and committee meetings (for which they are paid $2,000 per meeting in accordance with existing Company policy). In addition, agreements were entered into in September and October 2001 with certain employees (to induce them to continue their employment with the Company) which provide for retention payments ranging from 8% to 100% of their respective annual salaries conditioned upon continued employment through specified dates and/or severance payments up to 100% of these employee's respective annual salaries should such employees be terminated within the parameters of their agreements. Payments under these agreements are to be made at various dates beginning in September 2001 and extending through no later than September 2002. The Company estimates its obligations under these agreements to be approximately $3.1 million. Approximately $1.7 million of these commitments have been segregated in separate cash accounts in October 2001 in which security interests have been granted to certain employees. Legal Actions Associated with the McDonald's Matter Subsequent to August 21, 2001, numerous consumer class action and representative action lawsuits (hereafter variously referred to as, "actions", "complaints" or "lawsuits") have been filed in multiple jurisdictions nationwide. Plaintiffs in these 15 actions assert diverse causes of action, including negligence, breach of contract, fraud, restitution, unjust enrichment, misrepresentation, false advertising, breach of warranty, unfair competition and violation of various state consumer fraud statutes. A complaint filed in federal court in New Jersey also alleges a pattern of racketeering. Plaintiffs in many of these actions allege, among other things, that defendants, including the Company, Simon Marketing, and McDonald's, misrepresented that plaintiffs had a chance at winning certain high-value prizes when in fact the prizes were stolen by Mr. Jacobson. Plaintiffs seek various forms of relief, including restitution of monies paid for McDonald's food, disgorgement of profits, recovery of the "stolen" game prizes, other compensatory damages, attorney's fees, punitive damages and injunctive relief. The lawsuits are all in the very early stages and discovery has yet to commence in any of these proceedings. Simon Marketing and other co-defendants are seeking to consolidate the various actions. Simon Marketing has consented to the removal to federal court, by McDonald's, of each of the complaints filed in state courts other than in California and Illinois. On October 9, 2001, McDonald's filed a motion with the Judicial Panel on Multidistrict Litigation seeking to transfer all complaints pending in federal courts nationwide, including the removed cases and any subsequently filed cases, to a single federal court in the Northern District of Illinois. That motion is currently being briefed. On October 12, 2001, McDonald's, with Simon Marketing's consent, filed a Petition to Coordinate in a single court in Orange County all actions pending in California State Superior Court. Simon Marketing has also joined in an Application filed by McDonald's to stay all California proceedings pending a ruling on the Petition for Coordination. In addition, recently, the Illinois state court ordered the actions filed there to be consolidated before a single judge and the Illinois state court plaintiffs have consented to re-file a single, operative complaint. The Company is unable to predict the outcome of any or all of these lawsuits and the ultimate effect, if any, on the Company's financial condition, results of operations or net cash flows. On October 23, 2001, Simon Marketing and the Company filed suit against McDonald's in California Superior Court for the County of Los Angeles. The complaint alleges, among other things, fraud, defamation and breach of contract, in connection with the termination of Simon Marketing's relationship with McDonald's. Also on October 23, 2001, the Company and Simon Marketing were named as defendants, along with a former employee of Simon Marketing, and certain other individuals unrelated to the Company or Simon Marketing, in a complaint filed by McDonald's in the United States District Court for the Northern District of Illinois. The complaint alleges that Simon Marketing has engaged in fraud, breach of contract, breach of fiduciary obligations and civil conspiracy and alleges that McDonald's is entitled to indemnification and damages of an unspecified amount. On November 13, 2001, the Company filed suit against Philip Morris in California Superior Court for the County of Los Angeles. The complaint, which alleges breach of contract, unjust enrichment and breach of the implied covenant of good faith and fair dealing, seeks to recover in excess of $4 million in damages resulting from the termination of the Company's relationship with Philip Morris. The Company is unable to predict the outcome of the McDonald's complaint, or of its suit against McDonald's or Philip Morris, and their ultimate effects, if any, on the Company's financial condition, results of operations or net cash flows. For additional information related to certain matters discussed in this section, reference is made to the Company's Reports on Form 8-K dated August 21, 2001, September 17, 2001, September 21, 2001 and October 30, 2001, respectively. SALE OF BUSINESS Pursuant to its decision in December 2000, the Company sold its CPG business on February 15, 2001 to Cyrk, Inc., formerly known as Rockridge Partners, Inc. ("Rockridge"), an investor group led by Gemini Investors LLC, a Wellesley, Massachusetts-based private equity investment firm, pursuant to a Purchase Agreement entered into as of January 20, 2001 (as amended, the "Purchase Agreement") for approximately $14.0 million, which included the assumption of approximately $3.7 million of Company debt. $2.3 million of the purchase price was paid with a 10% per annum five-year subordinated note from Rockridge, with the balance being paid in cash. The 2000 financial statements reflected this transaction and included a pre-tax charge recorded in the fourth quarter of 2000 of $50.1 million due to the loss on the sale of the CPG business, $22.7 million of which was associated with the write-off of goodwill attributable to CPG. This charge had the effect of increasing the 2000 net loss available to common stockholders by approximately $49.0 million or $3.07 per share. Net sales in 2000 attributable to the CPG business were $146.8 million, or 19% of consolidated Company revenues. Net sales in the first quarter of 2001, for the 16 period through February 14, 2001, attributable to the CPG business, were $17.7 million, or 17% of consolidated Company revenues. Net sales in the first quarter of 2000 attributable to the CPG business were $33.6 million, or 19% of consolidated Company revenues. CPG was engaged in the corporate catalog and specialty advertising segment of the promotions industry. The group was formed as a result of the Company's acquisitions of Marketing Incentives, Inc. ("MI") and Tonkin, Inc. ("Tonkin") in 1996 and 1997, respectively. Pursuant to the Purchase Agreement, Rockridge purchased from the Company (i) all of the outstanding capital stock of Cyrk Acquisition Corp. ("CAC"), successor to the business of MI, and Tonkin, each a wholly-owned subsidiary of the Company, (ii) certain other assets of the Company, including those assets at the Company's Danvers and Wakefield, Massachusetts facilities necessary for the operation of the CPG business and (iii) all intellectual property of the CPG business as specified in the Purchase Agreement. Rockridge assumed certain liabilities of the CPG business as specified in the Purchase Agreement and all of the assets and liabilities of CAC and Tonkin and, pursuant to the Purchase Agreement, the Company agreed to transfer its former name, Cyrk, to the buyer. Rockridge extended employment offers to certain former employees of the Company who had performed various support activities, including accounting, human resources, information technology, legal and other various management functions. There is no material relationship between Rockridge 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. The sale of CPG effectively terminated the restructuring effort announced by the Company in May 2000 with respect to the CPG business. For additional information related to this transaction, reference is made to the Company's Report on Form 8-K dated February 15, 2001. RESTRUCTURING Pursuant to the February 2001 sale of its CPG business, and its previously announced intentions, the Company conducted a second quarter 2001 evaluation of its remaining businesses with the objective of restoring consistent profitability through a more rationalized, cost-efficient business model. As a result of this evaluation, and pursuant to a plan approved by its Board of Directors, the Company has taken action to shutdown or consolidate certain businesses, sell certain assets and liabilities related to its legacy corporate catalog business in the United Kingdom and eliminate approximately two-thirds (40 positions) of its Wakefield, Massachusetts corporate office workforce. Additionally, the Company announced the resignation of its co-chief executive officer and two other executive officers, including the Company's chief financial officer. Consequently, the Company announced that all responsibilities for the chief executive officer position have been consolidated under Allan I. Brown, who has served as co-chief executive officer since November 1999 and as the chief executive officer of Simon Marketing, Inc., the Company's wholly-owned subsidiary based in Los Angeles, California since 1975. For additional information related to these events, reference is made to the Company's Report on Form 8-K dated June 15, 2001. As a result of these actions, the Company recorded a second quarter 2001 pre-tax charge of approximately $20.2 million for restructuring expenses. The second quarter charge relates principally to employee termination costs ($10.5 million), asset write-downs which were primarily attributable to a consolidation of its Wakefield, Massachusetts workspace ($6.5 million), a loss on the sale of the UK business ($2.1 million) and the settlement of certain lease obligations ($1.1 million). Total cash outlays related to restructuring activities are expected to be approximately $11.3 million. The restructuring plan is anticipated to be substantially complete by the end of 2001. OUTLOOK As a result of the loss of its McDonald's and Philip Morris business, along with the resulting legal matters as discussed above, and the uncertainty regarding its future ability to generate positive net cash flows, there is substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. The Company has taken and will continue to take action to reduce its cost structure as all options are explored in the wake of these events. The options being considered include the sale of all or a portion of the Company and a reorganization and/or liquidation of the net assets of the Company which may be through bankruptcy proceedings. 17 RESULTS OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2000 As noted in the Loss of Significant Customers, Resulting Events and Going Concern section above, the Company took a series of actions in the third quarter of 2001 which resulted in recording a third quarter pre-tax charge of approximately $48.8 million. See notes to consolidated financial statements. Net sales decreased $84.9 million, or 47%, to $93.8 million in the third quarter ended September 30, 2001 from $178.7 million in the third quarter of 2000. The decrease in net sales was primarily attributable to revenues associated with McDonald's and Philip Morris and revenues associated with the CPG business sold in February 2001. See notes to consolidated financial statements. Gross profit decreased $17.0 million, or 45%, to $20.4 million in the third quarter of 2001 from $37.4 million in the third quarter of 2000. As a percentage of net sales, gross profit increased to 21.7% in the third quarter of 2001 from 20.9% in the third quarter of 2000. The decrease in nominal gross margin dollars is primarily attributable to the decrease in revenues associated with McDonald's and Philip Morris and revenues associated with the CPG business. The increase in the gross margin percentage was due to the sales mix associated with certain promotional programs. Selling, general and administrative expenses excluding amortization of goodwill totaled $19.7 million in the third quarter of 2001 as compared to $38.5 million in the third quarter of 2000. The Company's decreased spending was due principally to the effects of the sale of the CPG business. See notes to consolidated financial statements. As a percentage of net sales, selling, general and administrative costs totaled 21.0% in the third quarter of 2001 as compared to 21.5% in the third quarter of 2000 as a result of a lower sales base. Other income of $3.5 million in the third quarter of 2001 represents a $4.0 million gain realized on the sale of an investment which was partially offset by a $.5 million charge to other expense to reflect an other-than-temporary investment impairment associated with its venture portfolio. The Company has recorded a $1.0 million charge to other expense in the third quarter of 2000 to reflect an other-than-temporary investment impairment associated with its venture portfolio. See notes to consolidated financial statements. As required by Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes", the Company annually evaluates the positive and negative evidence bearing upon the realizability of its deferred tax assets. The Company, however, has considered recent events (see notes to consolidated financial statements) 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. To the extent that these assets have been deemed to be unrealizable, a valuation allowance and tax provision of $22.6 million has been recorded in the third quarter of 2001. NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2000 As noted in the Loss of Significant Customers, Resulting Events and Going Concern section above, the Company took a series of actions in the third quarter of 2001 which resulted in recording a third quarter pre-tax charge of approximately $48.8 million. See notes to consolidated financial statements. During the second quarter of 2001, the Company evaluated its remaining businesses with the objective of restoring consistent profitability through a more rationalized, cost-efficient business model. As a result of this evaluation, and pursuant to a plan approved by its Board of Directors, the Company and its subsidiaries have taken action to shutdown or consolidate certain businesses, sell certain assets and liabilities related to its legacy corporate catalog business in the United Kingdom and eliminate approximately two-thirds (40 positions) of its Wakefield, Massachusetts corporate office workforce. Additionally, the Company announced the resignation of its co-chief executive officer and two other executive officers, including the Company's chief financial officer. Consequently, the Company announced that all responsibilities for the chief executive officer position have been consolidated under Allan I. Brown, who has served as co-chief executive officer since November 1999 and as the chief executive officer of Simon Marketing, Inc., the Company's wholly-owned subsidiary based in Los Angeles, California since 1975. For additional information related to these events, reference is made to the Company's Report on Form 8-K dated June 15, 2001. 18 As a result of these actions, the Company recorded a second quarter 2001 pre-tax charge of approximately $20.2 million for restructuring expenses. See notes to consolidated financial statements. In connection with its May 2000 announcement to restructure its promotional product divisions, the Company recorded a pre-tax restructuring charge of $6.4 million. See notes to consolidated financial statements. The Company also recorded a nonrecurring pre-tax charge to operations of $.7 million in the second quarter of 2000 associated with the settlement of a change in control agreement with an employee of the Company who was formerly an executive officer. See notes to consolidated financial statements. Net sales decreased $268.9 million, or 46%, to $311.4 million in the first nine months of 2001 from $580.3 million in the first nine months of 2000. The decrease in net sales was primarily attributable to revenues associated with McDonald's and Philip Morris and revenues associated with the CPG business sold in February 2001. See notes to consolidated financial statements. Gross profit (excluding the restructuring charge in 2000) decreased $40.1 million, or 38%, to $64.3 million in the first nine months of 2001 from $104.4 million in the first nine months of 2000. As a percentage of net sales, gross profit increased to 20.7% in 2001 from 18.0% in 2000. The decrease in nominal gross margin dollars is primarily attributable to the decrease in revenues associated with McDonald's and Philip Morris and the revenues associated with the CPG business. The increase in the gross margin percentage was due to the sales mix associated with certain promotional programs. Selling, general and administrative expenses, excluding amortization of goodwill, totaled $71.7 million in the first nine months of 2001 as compared to $116.0 million in the first nine months of 2000. The Company's decreased spending was due principally to the effects of the sale of the CPG business. See notes to consolidated financial statements. As a percentage of net sales, selling, general and administrative costs totaled 23.0% in the first nine months of 2001 as compared to 20.0% in the first nine months of 2000 as a result of a lower sales base. Other income in 2001 includes a $4.0 million gain realized on the sale of an investment in the third quarter which was partially offset by a $1.3 million charge in the first nine months of 2001 to reflect an other-than-temporary investment impairment associated with its venture portfolio. Other income in 2000 includes a $3.2 million gain realized on the sale of an investment in the first quarter which was partially offset by a $2.0 million year to date charge related to an other-than-temporary investment impairment associated with its venture portfolio. See notes to consolidated financial statements. As required by Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes", the Company annually evaluates the positive and negative evidence bearing upon the realizability of its deferred tax assets. The Company, however, has considered recent events (see notes to consolidated financial statements) 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. To the extent that these assets have been deemed to be unrealizable, a valuation allowance and tax provision of $22.6 million has been recorded in the third quarter of 2001. LIQUIDITY AND CAPITAL RESOURCES Working capital at September 30, 2001 was $32.6 million compared to $60.4 million at December 31, 2000. Net cash used in operating activities during the first nine months of 2001 was $8.1 million, due primarily to a net loss of $86.3 million which was partially offset by a $46.9 million charge for impaired assets (primarily goodwill), $11.9 million of deferred income taxes, $8.9 million of non-cash restructuring charges and a $5.4 million net increase in cash from working capital items. Net cash provided by investing activities in the first nine months of 2001 was $5.1 million, which was primarily attributable to $8.4 million of proceeds from the sale of the CPG business, which were partially offset by $2.9 million of property and equipment purchases. See notes to consolidated financial statements. Net cash used in financing activities in the first nine months of 2001 was $4.3 million, which was primarily attributable to $5.1 million of repayments of short-term borrowings. The matters discussed in the Loss of Significant Customers, Resulting Events and Going Concern section above, which will have a substantial adverse impact on the Company's cash position, raise substantial concern about the Company's ability to meet its future working capital obligations and raises substantial doubts 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 has taken and will continue to take action to reduce its cost structure as all options are explored in 19 the wake of these events. The options being considered include the sale of all or a portion of the Company and a reorganization and/or liquidation of the net assets of the Company which may be through bankruptcy proceedings. Since inception, the Company has financed its working capital and capital expenditure requirements through cash generated from operations, and investment and financing activities such as public and private sales of common and preferred stock, bank borrowings, asset sales and capital equipment leases. As a result of the precipitous drop in the value of the Company's common stock after the announcement of the loss of its two largest customers (see notes to consolidated financial statements), the Company has accelerated the recognition of contingent payment obligations arising from the acquisition of Simon Marketing in 1997. Consequently, a $5.0 million third quarter 2001 charge to stockholders' equity is included in accrued expenses and other current liabilities to reflect these commitments. Payments to be made under these commitments totaling approximately $5.8 million are due in June 2002. The Company currently has available several worldwide bank letters of credit and revolving credit facilities which expire at various dates beginning in May 2002. In June 2001, the Company secured a new primary domestic letter of credit facility of up to $21.0 million for the purpose of financing the importation of various products from Asia and for issuing standby letters of credit. Pursuant to the provisions of this facility, the Company had bank commitments to issue or consider issuing for product related letter of credit borrowings of up to $15.0 million and bank commitments to issue or consider issuing for standby letters of credit of up to $6.0 million through May 15, 2002. As a result of the loss of its McDonald's and Philip Morris business (see notes to consolidated financial statements) the Company no longer has the ability to issue a letter of credit under this facility without it being fully cash collateralized. As of September 30, 2001, the Company's borrowing capacity was $42.3 million, of which $1.6 million in letters of credit were outstanding. In addition, bank guarantees totaling $.3 million were outstanding at September 30, 2001. Borrowings under these facilities are collateralized by substantially all assets of the Company. Restricted cash consists of amounts deposited with lenders to satisfy the Company's obligations pursuant to its outstanding standby letters of credit. The outstanding standby letters of credit have maturities ranging from February 2002 through October 2002. The Company's second quarter 2001 restructuring action (see notes to consolidated financial statements) will have an adverse impact on the Company's cash position. Total cash outlays related to restructuring activities are expected to be approximately $11.3 million. 20 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Subsequent to August 21, 2001, numerous consumer class action and representative action lawsuits have been filed in multiple jurisdictions nationwide against the Company and Simon Marketing. Additionally, on October 23, 2001, Simon Marketing filed suit against McDonald's in California Superior Court for the County of Los Angeles. Also on October 23, 2001, the Company and Simon Marketing were named as defendants, along with a former employee of Simon Marketing, and certain other individuals unrelated to the Company or Simon Marketing, in a complaint filed by McDonald's in the United States District Court for the Northern District of Illinois. On November 13, 2001, the Company filed suit against Philip Morris in California Superior Court for the County of Los Angeles. The complaint, which alleges breach of contract, unjust enrichment and breach of the implied covenant of good faith and fair dealing, seeks to recover in excess of $4 million in damages resulting from the termination of the Company's relationship with Philip Morris. The above matters are more fully described in "Legal Actions Associated with the McDonald's Matter", above. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.1 Retention and Amendment Agreement dated as of August 29, 2001 between Simon Worldwide, Inc. and Allan I. Brown. 10.2 Form of Retention Agreement dated as of August 28, 2001 between Simon Worldwide, Inc. and each of George Golleher, Anthony Kouba and Joseph Bartlett. 99.1 Amended Cautionary Statement for Purposes of the "Safe Harbor" Provisions of the Private Securities Litigation Reform Act of 1995 (b) Reports on Form 8-K The Company filed a Report on Form 8-K dated August 21, 2001 with respect to the termination of its relationship with McDonalds and certain other customers and the resignation of two of its directors. The Company filed a Report on Form 8-K dated September 17, 2001 with respect to complaints filed against the registrant and its subsidiary Simon Marketing, Inc. The Company filed a Report on Form 8-K dated September 21, 2001 with respect to the reduction in force implemented by its subsidiary Simon Marketing, Inc. and which included an Amended Cautionary Statement as an exhibit. The Company filed a Report on Form 8-K dated October 30, 2001 with respect to a complaint filed by McDonald's Corporation against the registrant and its subsidiary Simon Marketing, Inc. and a complaint filed by Simon Marketing, Inc. and the registrant against McDonald's Corporation. 21 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: November 19, 2001 SIMON WORLDWIDE, INC. /s/Allan I. Brown Allan I. Brown President and Chief Executive Officer (principal executive officer) /s/Paul J. Meade Paul J. Meade Chief Accounting Officer (principal accounting officer) 22 EX-10.1 3 b40921swex10-1.txt RETENTION & AMENDMENT AGREEMENT Exhibit 10.1 RETENTION AND AMENDMENT AGREEMENT This Retention and Amendment Agreement, dated as of August 29, 2001 (this "Agreement") is entered into between Simon Worldwide, Inc., a Delaware corporation formerly known as Cyrk, Inc. (the "Corporation"), Simon Marketing, Inc., a Delaware corporation ("Simon"), and Allan Brown (the "Executive"). WHEREAS, the Corporation, the Executive and Simon, a wholly owned subsidiary of the Corporation, are parties to that certain Employment Agreement, dated as of September 1, 1999 (the "Employment Agreement"); and WHEREAS, the Executive has issued a Promissory Note and Pledge Agreement, dated July 10, 2000, in the principal amount of $1,000,000 to the Corporation (the "July Promissory Note"); and WHEREAS, the Executive has issued a Promissory Note and Pledge Agreement, dated October 18, 2000, in the principal amount of $1,000,000 payable to Simon (the "October Promissory Note"); and WHEREAS, the Corporation and Simon believe that it is vital to their interests to ensure the continued availability of Executive, especially in light of the recent notice from McDonald's Corporation, the largest customer of Simon, that McDonald's Corporation is terminating its relationship with Simon; and WHEREAS, the parties hereto desire to enter into certain agreements and amend in certain respects the Employment Agreement, the July Promissory Note and the October Promissory Note to induce Executive to remain an employee of the Corporation. NOW THEREFORE, the parties hereto agree as follows: 1. Special Severance. (a) The Corporation or Simon shall have the right to terminate Executive's employment with the Corporation or Simon without cause at any time, but in the event of any such termination, Executive shall be paid by the Corporation and Simon a lump sum payment of $750,000. Executive shall not be required to seek other employment or otherwise to mitigate his damages in the event of his discharge without cause. (b) Executive shall have the right to terminate his employment with the Corporation or Simon at any time for good reason. For purposes of this Agreement, "good reason" shall mean and be limited to a material breach by the Corporation or Simon of a material obligation of the Corporation or Simon under the Employment Agreement, which such material breach is not cured within thirty (30) days written notice to the Corporation or Simon. Upon termination of employment by Executive for good reason, Executive shall be entitled to receive the lump sum payment provided in Section 1(a) of this Agreement within five (5) days after Executive gives notice of termination hereunder. (c) Payments made by Corporation and Simon pursuant to Section 1(a) and (b) of this Agreement are entirely separate and distinct from the obligations of Corporation and Simon under the Employment Agreement. 2. In order to secure the payments of the amounts set forth in Sections 1(a) and (b) of this Agreement, Simon will deposit to an account at [to be selected] the sum of $750,000. Simon hereby grants to Executive a security interest in all of Simon's right, title and interest in that account, and Simon and Executive shall execute and deliver a Control Agreement substantially in the form attached hereto as Exhibit A providing that such account constitutes cash collateral to secure such obligations. Upon payment of the amounts set forth in Sections 1(a) and (b) of this Agreement, such cash collateral will be released to Simon. Alternatively at the request of Executive, a prepaid letter of credit may be substituted for the collateral account maintained pursuant to this Paragraph 2, if such a letter of credit can be obtained without imposing a material burden on Simon or the Corporation. 3. Section 1 of the July Promissory Note is hereby amended to add at the end thereof; "Notwithstanding anything herein to the contrary, this Note shall not accrue any interest on or after August 29, 2001." 4. Section 1 of the October Promissory Note is hereby amended to add at the end thereof; "Notwithstanding anything herein to the contrary, this Note shall not accrue any interest on or after August 29, 2001." 5. Section 11.2 of the Employment Agreement is hereby amended by deleting clause (iv) thereof and replacing it with the following: "(iv) will be due and payable on November 22, 2004, and" 6. Commencing September 1, 2001, for each month Executive is employed by the Corporation or Simon, the unpaid principal of and accrued interest on the July Promissory Note shall be reduced by $200,000 per month until it is reduced to zero, and thereafter the unpaid principal of and accrued interest on the October Promissory Note shall be reduced by $200,000 per month until it is reduced to zero; provided, however, in the event of Executive's termination of employment by the Corporation or Simon without cause or by Executive for good reason as defined in Paragraph 1(b) hereof, the remaining balance of the unpaid principal and interest on both the July Promissory Note and October Promissory Note shall be forgiven in full and Executive shall be relieved of any further liability thereon. Excepting the Special Severance obligations of the Corporation and Simon to Executive under Paragraphs 1 and 2 hereof, any forgiveness of debt under this Paragraph shall reduce, on a dollar for dollar basis, the Corporation's and Simon's remaining severance obligations to Executive under Executive's Employment Agreement. -2- 7. Except as otherwise expressly provided in this Agreement, the terms of the Employment Agreement, the July Promissory Note and the October Promissory Note shall remain in full force and effect. 8. The obligations of the Corporation and Simon under this Agreement are joint and several. This Agreement shall not confer any rights or remedies upon any person other than the parties and their respective successors and permitted assigns. 9. This Agreement shall be binding upon and inure to the benefit of the parties named herein and their respective successors and permitted assigns. No party may assign either this Agreement or any of his or its rights, interests, or obligations hereunder without the prior written approval of the Corporation and Executive; provided, however, that the Corporation may (i) assign any or all of its rights and interests hereunder to one or more of its affiliates; (ii) designate one or more of its affiliates to perform its obligations hereunder (in any or all of which cases the Corporation nonetheless shall remain responsible for the performance of all of its obligations hereunder); and (iii) assign its rights and interests hereunder to any entity into which the Corporation may be merged or which may succeed to substantially all of its assets or business. 10. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original but all of which together will constitute one and the same instrument. 11. This Agreement shall be governed by, and construed and enforced in accordance with, the laws of the State of California without giving effect to any choice or conflict of law provision or rule (whether of the State of California or any other jurisdiction) that would cause the application of the laws of any jurisdiction other than the State of California. 12. No amendment of any provision of this Agreement shall be valid unless the same shall be in writing and signed by Corporation and Executive. -3- 13. Any term or provision of this Agreement that is invalid or unenforceable in any situation in any jurisdiction shall not affect the validity or enforceability of the remaining terms and provisions hereof or the validity or enforceability of the offending term or provision in any other situation or in any other jurisdiction. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written. "THE CORPORATION" SIMON WORLDWIDE, INC. and "SIMON" SIMON MARKETING, INC. By: /s/ George Golleher ------------------------------- GEORGE GOLLEHER, Director "EXECUTIVE" /s/ Allan Brown ---------------------------------- ALLAN BROWN -4- EX-10.2 4 b40921swex10-2.txt FORM OF RETENTION AGREEMENT Exhibit 10.2 SIMON WORLDWIDE, INC. August 28, 2001 (Director's Name and Address) Dear ____________: As you are aware, Simon Worldwide, Inc. (the "Company") is at a critical stage. McDonald's Corporation, the largest client of the Company's subsidiary, Simon Marketing, Inc., has notified Simon that McDonald's is terminating its relationship with Simon. In addition, due to potential conflicts of interests arising as a result of the actions by McDonald's, the Company's Chairman of the Board and an outside Director have resigned. It is vital to the Company that it have available non-executive Directors with the experience and expertise of its present remaining non-executive Directors. Accordingly, to ensure that the Company has available to it your services as a Director, we have agreed that the Company will pay you a retention fee of $150,000, payable immediately. You have agreed to continue to serve as a Director of the Company for at least six months. If you resign as a Director before the end of the six-month period, you agree to refund to the Company the pro rata portion of the retention fee equal to the percentage of the six-month period you did not serve, unless you were asked to resign, the Company ceases to exist, or the Company fails to pay your compensation when due. In any of those events, no refund will be due. The Company also confirms to you its policy of paying Directors a fee of $2,000 per regular or special meeting of the Board of Directors or a committee thereof, whether you attend the meeting in person or by telephone. The Company also agrees to pay to you immediately all amounts due you for fees earned to date in your capacity as a Director. August 29, 2001 Page 2 In addition, you may provide additional services to the Company, in your capacity as a Director, over and above participating in Board meetings. If you provide additional services, the Company will pay you an additional fee of $750.00 per hour, plus reimburse you for your out-of-pocket expenses. You will also be entitled to this additional fee and reimbursement of expenses for any additional services you performed since August 21, 2001. You will provide an invoice and back-up for the hours spent and expenses incurred. If this letter accurately reflects our agreement, please execute the enclosed copy where indicated and return the executed copy to me. Very truly yours, SIMON WORLDWIDE, INC. By: _______________________ Allan I. Brown AGREED - --------------------------- (Director's Signature) EX-99.1 5 b40921swex99-1.txt AMENDED CAUTIONARY STATEMENT EXHIBIT 99.1 AMENDED CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 From time to time, Simon Worldwide, Inc. ("Simon Worldwide") may provide forward-looking information such as forecasts of expected future performance or statements about Simon Worldwide'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 Simon Worldwide. Simon Worldwide desires to take advantage of the "Safe Harbor" provisions of the Private Securities Litigation Reform Act of 1995 and is including this Exhibit 99.1 in this Form 10-Q in order to do so. Simon Worldwide wishes to caution readers that the following important factors, among others, in some cases have affected, and in the future could affect, Simon Worldwide's actual results and could cause Simon Worldwide's actual consolidated results for Simon Worldwide's current quarter and beyond to differ materially from those expressed in any forward-looking statements made by or on behalf of Simon Worldwide. DEPENDENCE ON PRINCIPAL CUSTOMERS WHICH HAVE TERMINATED THEIR RELATIONSHIPS WITH US In recent years, our business has been heavily dependent on purchases of promotional products by our key customers including Philip Morris Incorporated ("Philip Morris"). Additionally, the business of our subsidiary, Simon Marketing, Inc., has been heavily dependent on purchases of promotional products and services by McDonald's Corporation ("McDonald's") or its franchisees for which it receives an annual fee and other payments. As a result of the alleged fraudulent actions of a Simon Marketing, Inc. employee in connection with the McDonald's promotional games administered by Simon Marketing, Inc., both McDonald's and Philip Morris terminated their relationships with us. We have filed suit against McDonald's and Philip Morris in connection with their termination of our relationship, and McDonald's has brought suit against us. (See "Pending Litigation".) Our business, sales and results of operations have been and will continue to be materially adversely affected by the loss of Philip Morris and McDonald's. In addition, the absence of business from McDonald's and Philip Morris has adversely affected our relationship with and access to foreign manufacturing sources. UNCERTAIN OUTLOOK As a result of the loss of our two largest customers, McDonald's and Philip Morris, which represented approximately 88% of our sales base, we have terminated certain portions of our workforce, and expect to terminate in the near future a substantial portion of our worldwide workforce. Until the loss of our two largest customers and the pending litigation described below, we 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 our revenue was derived from the sale of products to consumer product and services companies seeking to promote their brand names and corporate identities and build brand loyalty. As a result of the loss of these major customers along with the resulting legal matters discussed further below, there is substantial doubt about our ability to continue as a going concern. We have taken and will continue to take action to reduce our cost structure while all options are explored in the wake of these events. We are considering various alternatives regarding our future, including a sale of all or a portion of the Company and a reorganization and/or liquidation of the net assets of the Company which may be through bankruptcy proceedings. The loss of these customers, and the pending litigation described below, raise substantial doubt about our ability to continue as a going concern. PENDING LITIGATION We and/or our subsidiary Simon Marketing, Inc. ("Simon Marketing") have been named as defendants in numerous consumer class action and representative action lawsuits (hereafter variously referred to as, "actions", "complaints" or "lawsuits") which have been filed in multiple jurisdictions nationwide. Plaintiffs in these actions assert diverse causes of action, including negligence, breach of contract, fraud, restitution, unjust enrichment, misrepresentation, false advertising, breach of warranty, unfair competition and violation of various state consumer fraud statutes. A complaint filed in federal court in New Jersey also alleges a pattern of racketeering. Plaintiffs in many of these actions allege, among other things, that defendants, including us, Simon Marketing, and McDonald's, misrepresented that plaintiffs had a chance at winning certain high-value prizes when in fact the prizes were stolen by one rogue employee of Simon Marketing in connection with the McDonald's promotional games administered by us. Plaintiffs seek various forms of relief, including restitution of monies paid for McDonald's food, disgorgement of profits, recovery of the "stolen" game prizes, other compensatory damages, attorney's fees, punitive damages and injunctive relief. We may be named as a defendant or co-defendant in additional actions which may be filed alleging similar claims. These lawsuits are all in the very early stages and discovery has yet to commence in any of these proceedings. Simon Marketing and other co-defendants are seeking to consolidate the various actions. We are unable to predict the outcome of any or all of these lawsuits and the ultimate effect, if any, on our financial condition, results of operations or net cash flows. On October 23, 2001, we and Simon Marketing filed suit against McDonald's in California Superior Court for the County of Los Angeles. The complaint includes allegations of fraud, defamation and breach of contract in connection with the termination of Simon Marketing's relationship with McDonald's. Also on October 23, 2001, we and Simon Marketing were named as defendants, along with a former employee of Simon Marketing, and certain other individuals unrelated to us or Simon Marketing, in a complaint filed by McDonald's in the United States District Court for the Northern District of Illinois. The complaint alleges that Simon Marketing has engaged in fraud, breach of contract, breach of fiduciary obligations and civil conspiracy and alleges that McDonald's is entitled to indemnification and damages of an unspecified amount. On November 13, 2001, we filed suit against Philip Morris in California Superior Court for the County of Los Angeles. The complaint, which alleges breach of contract, unjust enrichment and breach of the implied covenant of good faith and fair dealing, seeks to recover in excess of $4 million in damages resulting from the termination of our relationship with Philip Morris. We are unable to predict the outcome of the McDonald's complaint, or of our suit against McDonald's or Philip Morris, and their ultimate effects, if any, on our financial condition, results of operations or net cash flows. DEPENDENCE ON KEY PERSONNEL We are dependent on several key personnel, including our outside directors. In light of the loss of our principal customers and the pending litigation against us, there is not assurance that our key personnel can be retained. The loss of the services of our key personnel could harm our business. LIMITED CUSTOMER COMMITMENTS Generally, our agreements with promotional product customers do not require them to make a certain level of purchases. Instead, purchase commitments are represented by purchase orders placed by the customers from time to time during the course of a promotion. The actual level of purchases by promotional products customers depends on a number of factors, including the duration of the promotion and consumer redemption rates. Purchase orders are generally subject to cancellation with limited penalty. Consequently, our level of net sales is difficult to predict accurately and can fluctuate greatly from quarter to quarter. PROMOTIONAL PRODUCT AND MARKETING SPENDING Our business is driven by the spending of companies to promote and market their corporate identities and brand name products. If the demand for brand name products diminishes or if our customers decrease their use of promotional product programs or reduce their marketing spend to promote their corporate identities and brands, our business will be materially adversely affected. In addition, our relationship with certain of our promotional products customers has been limited to the sourcing of products being offered or sold by the customer in connection with a single promotional program. There can be no assurance that such customers will continue to use us to source products for future promotional programs. COMPETITION The promotional products industry is highly fragmented and competitive, and some of our competitors have substantially greater financial and other resources than we do. We also compete with the services of in-house advertising, promotional products and purchasing departments and with designers and vendors of single or multiple product lines. Certain of our customers seek competitive bid for their promotional programs. Our profit margin depends, to a great extent, on our competitive position when bidding and our ability to continually decrease product costs after being awarded bids. Competition is not expected to abate and thus will continue to exert pressure on our profit margin in the future. ASIAN ECONOMIC PROBLEMS The majority of our net sales in recent years have been attributable to products manufactured by subcontractors located in Asia. We have no long-term contracts with these manufacturing sources and often compete with other companies for production facilities and import quota capacity. In addition, many Asian manufacturers require that a letter of credit be posted at the time a purchase order is placed. There can be no assurance that we will continue to have the necessary credit facilities in order to post such letters of credit. Our business is subject to the risks normally associated with conducting business abroad, such as: - foreign government regulations; - political unrest; - disruptions or delays in shipments; - fluctuations in foreign currency exchange rates; and - changes in economic conditions in countries in which our manufacturing sources are located. If any such factors were to render the conduct of our business in a particular country undesirable or impractical, or if our current foreign manufacturing sources were to cease doing business with us for any reason, our business, sales and operating results could be materially adversely affected. IMPORTS AND IMPORT RESTRICTIONS The importation of products manufactured in Asia is subject to the constraints imposed by bilateral agreements between the United States and substantially all of the countries from which we import goods. These agreements impose quotas that limit the quantity of certain types of goods, including textile products imported by us, which can be imported into the United States from those countries. These agreements also allow the United States to impose, under certain conditions, restraints on the importation of categories of merchandise that, under the terms of the agreements, are not subject to specified limits. Our continued ability to source products through imports may be harmed by: - additional bilateral and multilateral agreements; - unilateral trade restrictions; - significant decreases in import quotas; - the disruption of trade from exporting countries as a result of political instability; or - the imposition of additional duties, taxes and other charges or restrictions on imports. Products imported by us from China currently receive the same preferential tariff treatment accorded goods from countries granted permanent "normal trade relations". However, the annual renewal by Congress of normal trade relations with China has been a contentious political issue for several years and there can be no assurance that such relations will be continued. If China were to lose its grant of normal trade relations with the U.S., goods imported from China would be subject to significantly higher duty rates which would increase the cost of goods from China and could materially harm our business. EFFECT OF INDUSTRY CONDITIONS FACING SIMON WORLDWIDE'S CUSTOMERS Our business is heavily dependent on the promotional budgets of our customers, which in turn are influenced by industry conditions and other factors. SALE OF CPG AND NEW CORPORATE STRUCTURE In December 2000, we decided to sell our CPG division and, in February 2001, we announced that we had sold our CPG division, which was comprised principally of two of our subsidiaries, Tonkin, Inc. and Cyrk Acquisition Corp. The sale is described in our report filed on Form 8-K dated February 15, 2001 which is incorporated herein by reference. In connection with the sale, we agreed not to compete in the CPG business in the United States for a period of five years after the closing of the sale. There can be no assurance that the sale of the CPG division will result in long term benefits. We are effecting a new corporate structure enabled by the sale of the CPG division that will operate globally. This corporate structure is primarily comprised of the operations of our Simon Marketing subsidiary and certain legacy custom product clients. In connection with this new structure, certain of our executive officers resigned in June 2001 as described in our report filed on Form 8-K dated June 15, 2001. There is no assurance that this new structure will be successfully effected in a manner that will have a positive impact on our business, sales or operating results. ACQUISITIONS, INVESTMENTS, STRATEGIC ALLIANCES OR OTHER ALTERNATIVES We may acquire or invest in other businesses which are complementary to our business or entered into strategic alliances with such businesses, or explore other strategic alternatives for Simon Worldwide. In addition, we have made and may continue to make venture investments. There can be no assurance that any current or future acquisition, strategic or venture investment or strategic alliance or strategic alternative will result in long-term benefits. If we are not successful in our acquisitions, investments or alliances or any other financial or strategic alternatives, our business and operating results in the future may be harmed. Our Internet venture investments are subject to all the risks inherent in the Internet marketplace including the growth of the number of users, concerns about systems and transaction security, continued development of technological infrastructure, increasing government regulation of the Internet, rapid technology changes rendering existing technology obsolete, the possibility of system downtime and/or failure due to technological or other factors beyond our control, and the fact that legal standards relating to intellectual property rights in Internet-related business are uncertain and evolving, and are further subject to valuation volatility of this sector within the investment community. In addition, the early stage Internet companies have a high degree of dependence on ready access to the capital markets and, as such, are highly vulnerable to the pace and scale of change in the capital markets. -----END PRIVACY-ENHANCED MESSAGE-----