<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FEBRUARY 11, 1998
REGISTRATION NO. 333-42815
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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MEDIA ARTS GROUP, INC.
(Exact name of Registrant as specified in its charter)
<TABLE>
<S> <C> <C>
DELAWARE 3999 77-0354419
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
Incorporation or Organization) Classification Code Number) Identification Number)
</TABLE>
521 CHARCOT AVENUE
SAN JOSE, CALIFORNIA 95131
(408) 324-2020
(Address, including zip code, and telephone number of Registrant's principal
executive offices)
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JAMES F. LANDRUM, JR., ESQ.
MEDIA ARTS GROUP, INC.
521 CHARCOT AVENUE
SAN JOSE, CALIFORNIA 95131
(408) 324-2020
(Name, address, including ZIP code, and telephone number, including area code,
of agent for service)
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COPIES TO:
<TABLE>
<S> <C>
PETER F. KERMAN, ESQ. CARLA S. NEWELL, ESQ.
ORA T. FISHER, ESQ. SANJOY K. GOYLE, ESQ.
LATHAM & WATKINS GUNDERSON DETTMER STOUGH
75 WILLOW ROAD VILLENEUVE FRANKLIN & HACHIGIAN, LLP
MENLO PARK, CALIFORNIA 94025 155 CONSTITUTION DRIVE
(650) 328-4600 MENLO PARK, CALIFORNIA 94025
(650) 321-2400
</TABLE>
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after this Registration Statement becomes effective.
----------------
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. / /
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act of 1933, please check the
following box and list the Securities Act registration statement number of the
earlier effective registration statement for the same offering. / /
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act of 1933, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. / /
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. / /
----------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
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<PAGE>
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
<PAGE>
SUBJECT TO COMPLETION, DATED FEBRUARY 11, 1998
PROSPECTUS
2,409,500 SHARES
[LOGO]
COMMON STOCK
Of the 2,409,500 shares of Common Stock offered hereby, 1,500,000 shares are
being sold by the Company and 909,500 shares are being sold by the Selling
Stockholders. The Company will not receive any of the proceeds from the sale of
shares by the Selling Stockholders. Upon completion of the offering, the
Company's directors and executive officers will own beneficially an aggregate of
approximately 57.1% of the outstanding shares of the Company's Common Stock and
will be able to control the outcome of all matters requiring a stockholder vote,
including the election of directors. See "Principal and Selling Stockholders."
The Company's Common Stock is quoted on the Nasdaq Stock Market under the
symbol ARTS. On February 6, 1998, the last reported sale price of the Common
Stock was $13.125 per share. See "Price Range of Common Stock."
--------------
THE SHARES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" COMMENCING ON PAGE 5.
-------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PROCEEDS TO
PRICE TO UNDERWRITING PROCEEDS TO SELLING
PUBLIC DISCOUNT (1) COMPANY (2) STOCKHOLDERS
<S> <C> <C> <C> <C>
Per Share..................... $ $ $ $
Total (3)..................... $ $ $ $
</TABLE>
(1) See "Underwriting" for indemnification arrangements with the several
Underwriters.
(2) Before deducting expenses payable by the Company estimated at $1,100,000.
(3) Certain stockholders have granted to the Underwriters a 30-day option to
purchase up to 361,425 additional shares of Common Stock solely to cover
over-allotments, if any. If all such shares are purchased, the total Price
to Public, Underwriting Discount and Proceeds to Selling Stockholders will
be $ , $ , and $ , respectively. See "Underwriting."
--------------
The shares of Common Stock are offered by the several Underwriters subject
to prior sale, receipt and acceptance by them and subject to the right of the
Underwriters to reject any order in whole or in part and certain other
conditions. It is expected that certificates for such shares will be available
for delivery on or about February , 1998, at the office of the agent of
Hambrecht & Quist LLC in New York, New York.
HAMBRECHT & QUIST NATIONSBANC MONTGOMERY
SECURITIES LLC
, 1998
<PAGE>
EDGAR COLORWORK DESCRIPTIONS:
INSIDE FRONT COVER OF PROSPECTUS: Shows photo of Thomas Kinkade with framed
painting plus five other Thomas Kinkade images and a caption that reads as
follows:
Thomas Kinkade creates worlds which invite us all to experience peace,
family, community, nature and a simpler life. These worlds capture
romantic and familiar settings which include cities, cabins, gardens,
coastal scenes and cottages. Through a wide range of products that
feature these appealing images, the Thomas Kinkade lifestyle brand
focuses on creating warm and positive environments in which to live and
work.
INSIDE GATEFOLD (RIGHT): Contains two photos showing interior space of
Thomas Kinkade Stores and two photos showing interior space of Signature
Galleries with corresponding logos.
INSIDE GATEFOLD (LEFT): Contains photographs of 14 Thomas Kinkade products
including stationery, mugs, gift prints, books and other gift products and
corresponding descriptions; header at top states "Thomas Kinkade Products."
INSIDE BACK COVER OF PROSPECTUS: Contains one large Thomas Kinkade image
with label "Secondary Offering Prospectus Collector's Edition."
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING BY ENTERING STABILIZING BIDS OR EFFECTING SYNDICATE AND COVERING
TRANSACTIONS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS AND SELLING GROUP
MEMBERS (IF ANY) OR THEIR RESPECTIVE AFFILIATES MAY ENGAGE IN PASSIVE MARKET
MAKING TRANSACTIONS IN THE COMMON STOCK ON THE NASDAQ STOCK MARKET IN ACCORDANCE
WITH RULE 103 OF REGULATION M. SEE "UNDERWRITING."
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY, AND SHOULD BE READ IN
CONJUNCTION WITH, THE MORE DETAILED INFORMATION AND THE CONSOLIDATED FINANCIAL
STATEMENTS AND NOTES THERETO APPEARING ELSEWHERE IN THIS PROSPECTUS. THIS
PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE DISCUSSED IN
THE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING THOSE
SET FORTH IN "RISK FACTORS" AND ELSEWHERE IN THIS PROSPECTUS. SEE "CAUTIONARY
LANGUAGE REGARDING FORWARD-LOOKING STATEMENTS." ALL REFERENCES TO A PARTICULAR
"FISCAL YEAR" OF THE COMPANY REFER TO THE 12 MONTHS ENDED MARCH 31 OF THE YEAR
REFERENCED, UNLESS OTHERWISE NOTED.
THE COMPANY
Media Arts Group, Inc. is a leading designer, manufacturer, marketer and
branded retailer of art-based home decorative accessories, collectibles and gift
products based on the works of the award-winning artist Thomas Kinkade, Painter
of Light. The Company's primary products are canvas and paper lithographs that
feature Mr. Kinkade's unique use of light and his peaceful and inspiring themes.
The Company believes that the Thomas Kinkade lifestyle brand appeals to a wide
range of consumers because of its broad and inclusive message that celebrates
home, family, nature and traditions. The Company strives to reach a broad
consumer base by offering products at a variety of price points, controlling its
distribution through branded retail stores and galleries and developing
strategic marketing relationships with companies such as Hallmark Cards, Inc.
("Hallmark"), Avon Products, Inc. ("Avon") and QVC, Inc. ("QVC").
The Company believes that its focus on high quality products sold in Thomas
Kinkade branded retail environments has allowed it to increase sales and
profitability significantly. In the 12 month period ended December 31, 1997, the
Company recorded an increase in net sales of 49.7% over the comparable prior 12
month period to $68.7 million, with a gross margin of 67.1% and an operating
margin of 22.3%. In this same period, Thomas Kinkade Stores open for more than
12 months had average sales per square foot of $1,332. The Company's growth
strategy includes a continued focus on building the Thomas Kinkade brand,
building market awareness and increasing the number of Company owned Thomas
Kinkade Stores and independently owned Signature Galleries.
The Company distributes its products through a network of 17 Company owned
Thomas Kinkade Stores and 67 independently owned Signature Galleries that
exclusively sell Thomas Kinkade products. The Company plans to expand this
network by adding approximately 10 Thomas Kinkade Stores and approximately 100
Signature Galleries in fiscal 1999. This controlled distribution strategy
focuses on developing stores and galleries to provide warm and inviting shopping
environments that showcase Thomas Kinkade products as they might appear in a
customer's home. The Company also distributes its products through approximately
2,200 independent dealers that commit to varying levels of minimum purchases.
Furthermore, the Company has established licensing and/or distribution
arrangements with Hallmark for stationery items, ornaments and other gift
products; Avon for gift products; and QVC for paper lithographs and other gift
products.
The Company's products include limited edition canvas and paper lithographs,
open edition prints and gift products. The Company plans to introduce
approximately 10 new limited edition images per year and intends to leverage its
library of new images and over 160 existing Thomas Kinkade images into
additional products. The Company's retail price points range from $50 for small
gift prints to $150 to $15,000 for lithographs. The Company also offers a
variety of products at lower price points, including books, mugs, decorative
tins and gift baskets. The Company's canvas lithographs are manufactured at its
San Jose, California production facility using a proprietary manufacturing
process. Paper lithographs and most of the Company's gift items are manufactured
by third parties.
According to Packaged Facts, a consumer research organization, the home
decorative accessories and collectibles market is expected to grow from $6.9
billion in 1996 to $9.2 billion by the year 2001. The Company's goal is to
capitalize on the significant opportunity afforded by this market by developing
Thomas Kinkade into a leading art-based brand. The Company's key business
strategies include: (i) providing a wide array of branded home accessories; (ii)
expanding controlled distribution through Thomas Kinkade Stores and Signature
Galleries; (iii) expanding its dealer network and promoting existing dealers to
higher purchase levels; (iv) developing strategic business relationships to
expand consumer reach and product lines; and (v) providing high quality
products.
Media Arts Group, Inc. was incorporated in Delaware in 1993. The Company
maintains its executive offices at 521 Charcot Avenue, San Jose, California
95131. The Company's telephone number is (408) 324-2020.
The Company owns and uses a variety of trademarks, including the registered
trademarks MAGI-Registered Trademark', Media Arts Group,
Inc.-Registered Trademark- and Painter of Light-Registered Trademark-
(registered for use with respect to books and certain paper goods).
3
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered by the Company........... 1,500,000 shares
Common Stock offered by the Selling
Stockholders.................................. 909,500 shares
Common Stock to be outstanding after the
offering...................................... 12,583,042 shares (1)
Use of proceeds............................... The net proceeds to the Company from the
offering will be used to repay certain
indebtedness, to open new Thomas Kinkade Stores,
for other capital expenditures and for general
corporate purposes. See "Use of Proceeds."
Nasdaq National Market symbol................. ARTS
</TABLE>
SUMMARY CONSOLIDATED FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE DATA AND SELECTED OPERATING DATA)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
FISCAL YEAR ENDED MARCH 31, DECEMBER 31,
------------------------------- --------------------
1995 1996 1997 1996 1997
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF INCOME DATA: (2)
Net sales............................................................. $ 33,485 $ 39,752 $ 47,018 $ 35,512 $ 57,209
Operating income...................................................... 6,397 5,547 6,791 5,318 13,864
Income from continuing operations before extraordinary loss........... 4,014 2,455 2,644 1,967 8,393
Net income (loss)..................................................... $ 3,789 $ (673) $ (10,986) $ (11,663) $ 8,393
Income from continuing operations before extraordinary loss per share
(diluted) (3)....................................................... $ 0.42 $ 0.25 $ 0.26 $ 0.20 $ 0.73
Net income (loss) per share (diluted) (3)............................. $ 0.40 $ (0.07) $ (1.09) $ (1.17) $ 0.73
Shares used in per share calculations (3)............................. 9,479 9,906 10,108 9,930 11,532
SELECTED OPERATING DATA:
Number of Thomas Kinkade Stores (4)................................... 7 15 16 16 17
Retail sales per square foot (4)(5)................................... $ 993 $ 986 $ 1,109 $ 856 $ 1,078
Number of Signature Galleries......................................... -- -- 17 14 67
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997
--------------------------
ACTUAL AS ADJUSTED (6)
--------- ---------------
<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA: (2)
Cash and cash equivalents.................................................................... $ 5,099 $ 17,105
Working capital.............................................................................. 13,498 26,004
Total assets................................................................................. 33,199 45,205
Long-term debt less current portion (7)...................................................... 3,909 1,200
Total stockholders' equity................................................................... 14,445 25,071
</TABLE>
- ------------------------------
(1) Based on shares outstanding as of December 31, 1997. Excludes (i) 1,395,447
shares of Common Stock reserved for issuance under the Company's stock
option plans and other stock option agreements, of which 1,076,666 shares
were subject to outstanding options as of December 31, 1997 at a weighted
average exercise price of $3.85 per share, 563,584 of which were immediately
exercisable within 60 days of such date; (ii) 600,000 shares of Common Stock
reserved for issuance to Thomas Kinkade under an option agreement dated
December 3, 1997 at an exercise price of $12.375 per share, subject to
stockholder approval; and (iii) 633,432 shares issuable under warrants and
convertible notes at a weighted average exercise price of $7.54 per share.
(2) Restated to reflect (i) discontinuance of John Hine Limited during the year
ended March 31, 1997; and (ii) acquisitions of seven galleries during the
year ended March 31, 1996 which have been accounted for as poolings of
interests. See Notes 2 and 3 of Notes to Consolidated Financial Statements.
(3) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of the determination of shares used in computing earnings per share.
(4) In fiscal 1996, the Company acquired seven galleries which are included in
the number of Thomas Kinkade Stores commencing with the fiscal year ended
March 31, 1996. Since these galleries were acquired in transactions
accounted for as a pooling of interests, the operating results of these
galleries are included in the Company's Consolidated Statement of Income in
all prior periods.
(5) Includes sales by Thomas Kinkade Stores open for 12 or more months.
(6) Adjusted to reflect the sale by the Company of 1,500,000 shares of Common
Stock offered hereby at an estimated price of $13.125 per share and the
application of the estimated net proceeds therefrom as if such transaction
had occurred as of December 31, 1997. See "Use of Proceeds" and
"Capitalization."
(7) Actual amount is net of unamortized deferred debt discount of $2,191,000.
See Note 6 of Notes to Consolidated Financial Statements.
------------------------------
ALL REFERENCES TO THE "COMPANY" AND "MEDIA ARTS" MEAN MEDIA ARTS GROUP, INC.
AND ITS SUBSIDIARIES, UNLESS THE CONTEXT INDICATES OTHERWISE. EXCEPT AS
OTHERWISE NOTED, ALL INFORMATION IN THIS PROSPECTUS ASSUMES NO EXERCISE OF THE
UNDERWRITERS' OVER-ALLOTMENT OPTION.
4
<PAGE>
RISK FACTORS
THIS PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE DISCUSSED IN
THE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING THOSE
SET FORTH BELOW AND ELSEWHERE IN THIS PROSPECTUS. SEE "CAUTIONARY LANGUAGE
REGARDING FORWARD-LOOKING STATEMENTS." THE FOLLOWING RISK FACTORS SHOULD BE
CONSIDERED CAREFULLY IN ADDITION TO THE OTHER INFORMATION IN THIS PROSPECTUS
BEFORE PURCHASING THE SHARES OF COMMON STOCK OFFERED HEREBY.
DEPENDENCE ON THOMAS KINKADE; LACK OF PRODUCT REVENUE
DIVERSIFICATION. Thomas Kinkade, a founder and principal stockholder of the
Company, supplies all of the artwork for the Company's existing art-based home
decorative accessories, collectibles and gift products, and his artwork and
message form the foundation for the Company's business strategy. On December 3,
1997, the Company entered into a license agreement with Thomas Kinkade (the "New
License Agreement"). The New License Agreement gives the Company perpetual and
exclusive rights to each image produced by Mr. Kinkade under the New License
Agreement or prior thereto, subject to certain exceptions. The New License
Agreement requires Mr. Kinkade to deliver 150 paintings to the Company during
the period commencing December 3, 1997 and ending 15 years thereafter, with at
least 10 paintings to be delivered during each of the first five years. However,
the New License Agreement is terminable by Mr. Kinkade under certain
circumstances, including upon a change in control of the Company or a material
breach of the New License Agreement by the Company. Upon any such termination by
Mr. Kinkade, the Company would be prohibited from selling any products based
upon Mr. Kinkade's artwork, other than the Company's then existing product
inventory. If the New License Agreement were so terminated by Mr. Kinkade or if
he were unable or unwilling to produce new artwork for the Company for any
reason, the loss of Mr. Kinkade's services would have a material adverse effect
on the Company. Moreover, the Company's available remedies in the event of a
breach of the New License Agreement by Mr. Kinkade are limited to monetary
damages because the license is a personal service contract. Upon any loss by the
Company of Mr. Kinkade's services, the Company may seek to expand its products
based upon Mr. Kinkade's then existing images, to the extent Mr. Kinkade has not
terminated the Company's rights thereto, and/or develop relationships with other
artists and offer products based upon their work. However, the Company has not
developed relationships with other artists and there can be no assurance that
the Company will be able to identify other artists or sell products based upon
their work. In addition, the Company is dependent upon continued customer demand
for products based upon the artwork of Thomas Kinkade. Any decline in sales of
such products in existing markets or any failure of such products to gain
consumer acceptance as the Company expands its distribution would have a
material adverse effect on the Company. See "--Dependence on Consumer
Preferences," "Business--License with Thomas Kinkade" and "Management."
RISKS ASSOCIATED WITH EXPANSION OF DISTRIBUTION CHANNELS. The Company's
strategy includes aggressively expanding its distribution channels, and its
future operating results will depend, in large part, upon its ability to
effectively implement this strategy. The Company had 17 Company owned Thomas
Kinkade Stores and 67 independently owned Signature Galleries as of December 31,
1997. The Company currently plans to open two additional Thomas Kinkade Stores
during fiscal 1998 and approximately 10 in fiscal 1999 and to add 15 additional
Signature Galleries in fiscal 1998 and approximately 100 in fiscal 1999. If
successfully implemented, this expansion would result in significant increases
in the number of stores operated by the Company and the number of galleries that
sell Thomas Kinkade products exclusively. Build-out expenses for Thomas Kinkade
Stores are anticipated generally to range from $75,000 to $150,000 per store,
excluding inventory, and pre-opening costs are anticipated generally to range
from $50,000 to $75,000 per store. To the extent the Company cannot generate
sufficient funds internally to finance these expenses, the Company may have to
incur additional debt or issue additional equity securities which would result
in either increased leverage or dilution to existing stockholders.
The Company's planned expansion of its Thomas Kinkade Stores is dependent
upon a number of factors including the ability of the Company to locate and
obtain suitable store sites, negotiate acceptable lease terms, hire and train
employees, and adapt its management information systems and other systems to the
extent necessary to accommodate and facilitate such growth. The Company's
planned expansion of its Signature
5
<PAGE>
Gallery program is also dependent upon a number of factors, including the
ability of the Company to identify appropriate owners and integrate them into
the Company's dealership network, as well as the ability of such owners to
locate suitable store sites and effectively promote and sell the Company's
products. The Company intends to open Thomas Kinkade Stores and/or add Signature
Galleries in geographic markets where it has little or no experience and it may
encounter competitive challenges that it has not experienced to date. In
addition, the Company intends to open or license stores near existing Thomas
Kinkade Stores, Signature Galleries and independent dealers, which could result
in lower sales of the Company's products at such existing sites. There can be no
assurance that the Company will be able to open its planned Thomas Kinkade
Stores or that such stores will operate on a profitable basis. Furthermore,
there can be no assurance that the Company will be able to identify suitable
owners for its planned Signature Galleries expansion or that such owners will
become effective distributors for the Company's products. Failure by the Company
to achieve its planned expansion of Thomas Kinkade Stores and Signature
Galleries or to do so on a profitable basis could have a material adverse effect
on the Company. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations," "Business--Business Strategy" and "--Distribution."
ABILITY TO EFFECTIVELY MANAGE EXPANSION; NEED FOR ADDITIONAL MANUFACTURING
CAPACITY. The Company's recent rapid and substantial growth in its sales and
its strategy for introducing new products and expanding its distribution
channels could place a significant strain on its management and operations. The
Company has recently hired several key officers and employees to supplement its
management team. To manage any expansion effectively, the Company's management
will need to anticipate the changing demands of the Company's operations and to
adapt systems and procedures accordingly. There can be no assurance that the
Company will anticipate all of the demands that an expansion of operations will
impose on such systems and procedures. To support the planned expansion of the
Company's products and distribution channels, the Company will have to hire
additional manufacturing, sales and administrative personnel. There can be no
assurance that the Company will be able to hire such personnel, particularly due
to the competitive nature of current labor markets, or that the Company will be
able to train successfully and supervise such personnel if hired. In addition,
the Company may need to add shifts to its manufacturing operations or implement
other efficiencies to satisfy any significant future increase in production,
including implementing new automation processes. The failure of the Company to
increase its operational and manufacturing capacity in a timely and effective
manner while maintaining its product quality and customer service standards
could result in a failure to meet demand on a timely and satisfactory basis,
which would have a material adverse effect on the Company. Failure to continue
to upgrade operating and financial control systems or unexpected difficulties
encountered during expansion could materially adversely affect the Company.
There can be no assurance that such systems and controls will be adequate to
sustain and effectively monitor future growth. Moreover, in the event any
overproduction results from the Company's expansion activities, the oversupply
of product could, among other things, reduce the perceived value and
collectibility of the Company's products and therefore reduce demand for its
products, particularly its limited editions. Any reductions in sales or margins
resulting from a decrease in demand could have a material adverse effect on the
Company. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
DEPENDENCE UPON CONSUMER PREFERENCES. Sales of the Company's existing and
new products depend upon continued consumer demand for the Thomas Kinkade brand
and products. Demand for the Company's products can be affected generally by
consumer preferences, which are subject to frequent and unanticipated changes.
The Company is dependent on its ability to continue to produce appealing and
popular Thomas Kinkade art-based products that anticipate, gauge and respond in
a timely manner to changing consumer demands and preferences. Failure to
anticipate and respond to changes in consumer preferences could lead to, among
other things, lower sales, excess inventories, diminished consumer loyalty and
lower margins, all of which would have a material adverse effect on the Company.
There can be no assurance that the current level of demand for products based
upon Mr. Kinkade's artwork will be sustained or grow, and any decline in the
demand for such products or failure of demand to grow would have a material
adverse effect on the Company. See "Business--Business Strategy."
6
<PAGE>
SEASONALITY. The Company has experienced, and is expected to continue to
experience, significant seasonal fluctuations in net sales and net income. The
Company's net sales historically have been highest in the December quarter and
lower in the subsequent March and June quarters. Despite overall increases in
annual net sales in fiscal 1996, net sales in the December quarter were $12.2
million and net sales in the subsequent March and June quarters were $10.4
million and $8.7 million, respectively. In fiscal 1997 net sales in the December
quarter were $15.5 million and sales in the subsequent March and June quarters
were $11.5 million and $13.2 million, respectively. Management believes that
this seasonal effect is due primarily to customer buying patterns, particularly
with respect to holiday purchases, and is typical of the home decorative
accessories, collectibles and gift product industries. The Company expects these
seasonal trends to continue in the foreseeable future; therefore, quarterly
results are not necessarily indicative of results for an entire year and will
fluctuate significantly from quarter to quarter. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
FLUCTUATIONS IN OPERATING RESULTS. The Company's operating results have
fluctuated significantly in the past and may continue to fluctuate as a result
of numerous factors, including demand for the art of Thomas Kinkade and the
Company's Thomas Kinkade products (including new product categories and series),
the Company's ability to achieve its expansion plans, the timing, mix and number
of new product releases, the timing of opening of new Thomas Kinkade Stores and
the expensing of the associated pre-opening costs, the successful implementation
of the Signature Gallery program and expansion of distribution generally, the
Company's ability to implement strategic business alliances, the Company's
ability to hire and train new manufacturing, sales and administrative personnel,
continued implementation of manufacturing efficiencies, timing of product
deliveries and the incurrence of other operating costs. In addition, since a
significant portion of the Company's revenues are generated from orders received
in the quarter, sales in any quarter are substantially dependent on orders
booked in that quarter. The Company's results of operations may also fluctuate
based on extraordinary events. For example, in September 1996 the Company
recorded a $12.2 million charge as a result of the discontinuance of the
operations of John Hine Limited. In addition, as a result of the expected
repayment of the outstanding subordinated debt due to Levine Leichtman Capital
Partners, L.P. ("Levine Leichtman") of $5.4 million using the net proceeds of
the offering, the Company will record an extraordinary expense in the quarter
the debt is repaid as a result of the write-off of deferred debt discount
associated with that debt. The deferred debt discount was $2.2 million as of
December 31, 1997. See Note 6 of Notes to Consolidated Financial Statements.
Accordingly, the results of operations in any quarter will not necessarily be
indicative of the results that may be achieved for a full fiscal year or any
future quarter. As a result of the foregoing factors, it is likely that in some
future quarter or quarters the Company's operating results may be below the
expectation of public market analysts and investors. In such event, the trading
price of the Common Stock will be adversely affected. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
INTRODUCTION OF NEW PRODUCT LINES. A significant element of the Company's
strategy is to expand the Thomas Kinkade brand into new product lines.
Historically, substantially all of the Company's net sales from Thomas Kinkade
products have been generated through sales of limited edition wall art products.
The Company recently added open edition wall art products to its offerings and
intends to continue to broaden its line of Thomas Kinkade branded products to
include other home decorative accessories, collectibles and gift products. The
Company has little or no experience in the marketing and sale of certain of
these potential home accessory products. There can be no assurance that the
Company will be able to successfully market these potential new products or that
any of the new product lines will gain market acceptance, and such failure could
result in lower than anticipated sales for such products and affect adversely
the image and value of the Thomas Kinkade brand. See "Business--Business
Strategy."
RELIANCE ON THIRD PARTIES. The Company relies on third parties to
distribute a majority of its products, manufacture certain of its products and
supply certain materials and components for use in its own manufacturing
processes. The substantial majority of its product distribution, as well as its
interaction with the ultimate customer, is conducted by independent dealers,
including Signature Gallery owners whose stores may bear the
7
<PAGE>
Thomas Kinkade name. The Company is in the process of entering into formal
licensing agreements with Signature Gallery owners and there can be no assurance
that the Company will enter into such agreements with all of its current
Signature Gallery owners. The failure of these dealers to properly represent the
Company's products could damage the reputation of the Company or Thomas Kinkade
and adversely affect the ability of the Company to build the Thomas Kinkade
brand. Most of the Company's three-dimensional products and gift items are
manufactured by third parties under licensing or manufacturing arrangements. The
failure of any of these third party vendors to produce products that meet the
Company's specifications could result in lower sales or otherwise adversely
affect consumer perceptions of the Company's brand and products. In addition,
the Company relies on third party vendors to supply frames, paper, canvas, paint
and other materials and components for its limited edition and other wall art
products. Although the Company maintains relationships with several framing
suppliers, in the past it has experienced shortages in framing supplies. There
can be no assurance that the Company will not encounter similar shortages in the
future and any prolonged shortage in frames or other materials could have a
material adverse effect on the Company. See "Business--Distribution" and
"--Manufacturing and Production."
LIMITED OPERATING HISTORY; FUTURE OPERATING RESULTS. The Company commenced
operations in 1990 with the introduction of Thomas Kinkade lithograph products,
opened its first Thomas Kinkade Store in 1993 and formally launched the
Signature Gallery program in 1996. Since its inception in 1990, the Company has
experienced rapid and substantial growth in sales, as well as in the scope of
its operations generally. However, the Company remains vulnerable to a variety
of business risks generally associated with rapidly growing companies with
limited operating histories, including without limitation, risks associated with
expansion, risks associated with implementing new and enhanced systems and risks
associated with integrating new personnel, and there can be no assurance that
the Company will be able to sustain its sales growth, effectively manage its
operations or remain profitable in future periods. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
CHANGES IN ECONOMIC CONDITIONS AND CONSUMER SPENDING. The home decorative
accessories, collectibles and gift product industries are subject to cyclical
variations. Purchases of these products are discretionary for consumers and,
therefore, such purchases tend to decline during recessionary periods in the
national or regional economies and may also decline at other times. The success
of the Company depends in part upon a number of economic factors relating to
discretionary consumer spending, including employment rates, business
conditions, future economic prospects, interest rates and tax rates. In
addition, the Company's business is sensitive to consumer spending patterns and
preferences. Shifts in consumer discretionary spending away from home decorative
accessories, collectibles or gift products, as well as general declines in
consumer spending, could have a material adverse effect on the Company.
DEPENDENCE ON MANAGEMENT. The Company is dependent upon the efforts of its
executive officers and other key personnel and on its ability to continue to
attract and retain qualified personnel in the future. The loss of certain of the
Company's executive officers and key personnel or its inability to attract and
retain qualified personnel in the future could have a material adverse effect on
the Company. The Company currently maintains key man insurance on the lives of
Thomas Kinkade, Kenneth E. Raasch, Daniel P. Byrne and Raymond A. Peterson in
the amounts of $10.0 million, $2.0 million, $1.0 million and $1.0 million,
respectively. See "Management."
COMPETITION. The home decorative accessories, collectibles and gift
products industries are highly fragmented and competitive. The Company's
products compete with products marketed by numerous regional, national and
foreign companies that are distributed through a variety of retail formats
including department stores, mass merchants, art and gift galleries and frame
shops, bookstores, mall-based specialty retailers, direct response marketing
programs, catalogs and furniture and home decor stores. The number of marketers
and retail outlets selling home accessory and gift products has increased in
recent years and the entry of these companies into the market, together with the
lack of significant barriers to entry, may result in increased
8
<PAGE>
competition. The Company intends to open Thomas Kinkade Stores and/or add
Signature Galleries in geographic markets where it has little or no experience
and, as a result, it may encounter competitive challenges that it has not
experienced to date. Such competition could have a material adverse effect on
the Company. Some of the Company's competitors have substantially greater
resources than the Company, including name recognition and capital resources,
have more diversified product offerings and sell their products through broader
distribution channels than the Company. There can be no assurance that the
Company will be able to compete effectively in the future. See
"Business--Competition."
CONTROL BY EXISTING STOCKHOLDERS; CERTAIN TRANSACTIONS. After completion of
this offering, Messrs. Kinkade and Raasch will own beneficially an aggregate of
approximately 56.5% of the outstanding Common Stock (53.7% if the overallotment
option is exercised in full). See "Principal and Selling Stockholders" and
"Shares Eligible for Future Sale." As a result, Messrs. Raasch and Kinkade will
continue to be in a position to control the outcome of all actions requiring
stockholder approval, including the election of the entire Board of Directors,
thereby ensuring their ability to control the future direction and management of
the Company. Mr. Kinkade, the Company's principal artist, has been engaged and
will continue to be engaged in transactions with the Company. See
"Business--License with Thomas Kinkade," "Management--Employment and Change of
Control Arrangements" and "Certain Transactions."
PRICE VOLATILITY. The market price of the Common Stock has been and will
likely continue to be subject to significant fluctuations in response to
variations in quarterly operating results, changes in analysts' earnings
estimates and other factors specific to the Company or affecting the Company's
industry generally. In addition, the stock markets in recent years have
experienced extreme price and volume fluctuations that often have been unrelated
to or disproportionate to the operating performance of companies. These broad
fluctuations may adversely affect the market price of the Common Stock. See
"Price Range of Common Stock."
SHARES ELIGIBLE FOR FUTURE SALE. Sales of substantial amounts of Common
Stock in the public market following this offering (including shares issued upon
the exercise of stock options and warrants) by current holders of the Company's
Common Stock and stock options and warrants exercisable therefor, including
Kenneth E. Raasch, Thomas Kinkade and Levine Leichtman, who as of December 31,
1997 beneficially owned 3,851,875, 3,312,043 and 940,700 shares (of which
700,000 shares are expected to be sold in the offering), respectively, or the
perception that such sales might occur, could adversely affect the market price
of the Common Stock and the Company's ability to raise additional equity
capital. Certain of the Selling Stockholders, the Company's executive officers
and directors and certain additional stockholders have agreed with the
Underwriters not to offer to sell, contract to sell or otherwise sell (including
without limitation in a short sale) or dispose of, for a period of 90, 120 and
150 days after the effective date of the Registration Statement of which this
Prospectus is a part, (the "lock-up period") 100%, 66 2/3% and 33 1/3%,
respectively, of the shares of Common Stock of the Company or any options or
warrants to purchase any shares of Common Stock of the Company now owned or
thereafter acquired by them or with respect to which they have the power of
disposition, without the prior written consent of Hambrecht & Quist LLC.
Stockholders holding an aggregate of 8,970,193 shares of Common Stock or
securities exercisable or exchangeable for Common Stock as of December 31, 1997
are subject to the lock-up period. The Company has similarly agreed with the
Underwriters that it will not offer, subject to certain limited exceptions, to
sell, contract to sell or otherwise sell or issue any shares of the Company's
Common Stock for 120 days after the effective date of the Registration
Statement, of which this Prospectus is part, without the prior written consent
of Hambrecht & Quist LLC. See "Principal and Selling Stockholders" and "Shares
Eligible for Future Sale."
CERTAIN ANTI-TAKEOVER EFFECTS. The Company's Amended and Restated
Certificate of Incorporation and Bylaws, as well as Delaware corporate law,
contain certain provisions that could have the effect of delaying, deferring or
preventing a change of control of the Company that may be in the best interest
of stockholders. These provisions include the ability of the Company to issue up
to 1,000,000 shares of Preferred Stock having such designations, preferences and
rights as may be fixed by the Board of Directors, without stockholder approval.
Under certain conditions, Section 203 of the Delaware General Corporation Law
would prohibit the
9
<PAGE>
Company from engaging in a "business combination" with an "interested
stockholder" (in general, a stockholder owning 15% or more of the Company's
outstanding voting stock) for a period of time. See "Description of Capital
Stock." In addition, the New License Agreement enables Mr. Kinkade to terminate
the agreement in the event of certain changes in control. See "Business--License
with Thomas Kinkade."
CAUTIONARY LANGUAGE REGARDING FORWARD-LOOKING STATEMENTS
This Prospectus contains forward-looking statements within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act. Such
statements may be found in the material set forth under "Prospectus Summary,"
"Risk Factors," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business," as well as in the Prospectus generally
and are indicated by words or phrases such as "anticipate," "estimate,"
"project," "believe," "intend," "seek," "expect," "plan" and similar words or
phrases. Such statements are based on current expectations and are subject to
certain risks, uncertainties and assumptions, including but not limited to those
discussed in "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Risk Factors." Should one or more of these risks or
uncertainties materialize, or should underlying assumptions prove incorrect,
actual results may vary materially and adversely from those anticipated,
estimated or projected. These forward-looking statements are made as of the date
of this Prospectus, and the Company assumes no obligation to update such
forward-looking statements or to update the reasons why actual results could
differ materially from those anticipated in such forward-looking statements.
10
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 1,500,000 shares of
Common Stock offered hereby are estimated to be $17.4 million based upon an
assumed offering price per share of $13.125 after deducting the underwriting
discount and estimated offering expenses. The Company expects to use
approximately $5.4 million of the estimated net proceeds to repay the remaining
principal amount due under its note payable to Levine Leichtman; such note bears
interest at the rate of 13.5% and is subject to semi-annual repayments
commencing on December 28, 1998 and continuing through December 31, 2001. Levine
Leichtman beneficially owned 8.5% of the Company's Common Stock as of December
31, 1997 and is selling Common Stock in this offering. The Company also has
deferred debt discount costs in relation to that debt which are being amortized
over the repayment term resulting in an effective interest rate of 28.3%. As a
result of the expected repayment of this debt, the Company will record an
extraordinary expense relating to the write-off of deferred debt discount
associated with that debt. Deferred debt discount aggregated $2.2 million as of
December 31, 1997. The Company also expects to use approximately $5.0 million of
the net proceeds for capital expenditures through fiscal 1999 to open new Thomas
Kinkade Stores, for leasehold improvements and increased automation at its
manufacturing facilities and for upgrades to its management information systems.
The Company expects to use the remainder of the net proceeds for general
corporate purposes. Furthermore, from time to time the Company evaluates the
acquisitions of galleries and business operations which complement the Company's
business, for which a portion of the proceeds may be used. Currently, however,
the Company does not have any understandings, commitments or agreements with
respect to any such acquisitions. Pending use of the net proceeds for the above
purposes, they will be invested in short-term, interest bearing,
investment-grade securities. The Company will not receive any proceeds from the
sale of Common Stock by the Selling Stockholders.
PRICE RANGE OF COMMON STOCK
The Common Stock of the Company commenced trading publicly on the Nasdaq
Stock Market on August 3, 1994 and is traded under the symbol ARTS. The
following table sets forth for the periods indicated the high and low daily
closing prices for the Common Stock:
<TABLE>
<CAPTION>
HIGH LOW
--------- ---------
<S> <C> <C>
FISCAL YEAR ENDED MARCH 31, 1996
First Quarter............................................................................. $ 7.500 $ 5.625
Second Quarter............................................................................ 6.625 5.750
Third Quarter............................................................................. 5.000 2.625
Fourth Quarter............................................................................ 3.500 2.125
FISCAL YEAR ENDED MARCH 31, 1997
First Quarter............................................................................. $ 3.250 $ 2.625
Second Quarter............................................................................ 2.875 1.313
Third Quarter............................................................................. 2.875 1.438
Fourth Quarter............................................................................ 5.125 2.438
FISCAL YEAR ENDING MARCH 31, 1998
First Quarter............................................................................. $ 5.125 $ 3.750
Second Quarter............................................................................ 6.750 3.875
Third Quarter............................................................................. 17.000 6.500
Fourth Quarter (through February 6, 1998)................................................. 15.875 11.375
</TABLE>
On February 6, 1998, the last reported sale price of the Common Stock as
quoted on the Nasdaq Stock Market was $13.125 per share. As of December 31,
1997, there were 203 holders of record of the Common Stock.
DIVIDEND POLICY
The Company has not paid any cash dividends on its Common Stock since the
Company's initial public offering in 1994. Moreover, the Board of Directors of
the Company does not anticipate paying any cash dividends in the foreseeable
future. In addition, certain of the Company's financing agreements with lenders
prohibit payment of dividends. See Note 6 of the Notes to Consolidated Financial
Statements.
11
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of the Company as of
December 31, 1997 (i) on an actual basis; and (ii) as adjusted to give effect to
the sale by the Company of the 1,500,000 shares of Common Stock offered hereby
at an assumed offering price of $13.125 per share and the application of the
estimated net proceeds therefrom. This table should be read in conjunction with
the Consolidated Financial Statements and Notes thereto included elsewhere in
this Prospectus.
<TABLE>
<CAPTION>
DECEMBER 31, 1997
----------------------
ACTUAL AS ADJUSTED
--------- -----------
(IN THOUSANDS)
<S> <C> <C>
Short-term portion of long-term debt...................................................... $ 500 $ --
--------- -----------
Long-term debt, less current portion (1).................................................. 2,709 --
--------- -----------
Convertible notes......................................................................... 1,200 1,200
--------- -----------
Stockholders' equity:
Preferred Stock, $0.01 par value; 1,000,000 shares authorized; no shares outstanding
actual or as adjusted................................................................. -- --
Common Stock, $0.01 par value; 20,000,000 shares authorized; 11,083,042 shares issued
actual; 12,583,042 shares issued as adjusted for the offering (2)..................... 69 84
Additional paid-in capital.............................................................. 17,338 29,329
Retained earnings (accumulated deficit)................................................. (2,962) (4,342)
--------- -----------
Total stockholders' equity............................................................ 14,445 25,071
--------- -----------
Total capitalization................................................................ $ 18,854 $ 26,271
--------- -----------
--------- -----------
</TABLE>
- ------------------------
(1) Amount is net of unamortized deferred debt discount of $2,191,000. See Note
6 of Notes to Consolidated Financial Statements.
(2) Excludes (i) 1,395,447 shares of Common Stock reserved for issuance under
the Company's stock option plans and other stock option agreements, of which
1,076,666 shares were subject to outstanding options as of December 31, 1997
at a weighted average exercise price of $3.85 per share, 563,584 of which
were immediately exercisable within 60 days of such date; (ii) 600,000
shares of Common Stock reserved for issuance to Thomas Kinkade under an
option agreement dated December 3, 1997 at an exercise price of $12.375 per
share, subject to stockholder approval; and (iii) 633,432 shares issuable
under warrants and convertible notes at a weighted average exercise price of
$7.54 per share.
12
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data as of March 31, 1996 and
1997 and December 31, 1997 and for each of the three years in the period ended
March 31, 1997 and the nine months ended December 31, 1997 are derived from the
Consolidated Financial Statements of the Company audited by Price Waterhouse
LLP, independent accountants, which are included elsewhere in this Prospectus.
The consolidated statement of income data for the fiscal years ended December
31, 1992 and 1993, the three months ended March 31, 1994 and the consolidated
balance sheet data at December 31, 1992 and 1993 and March 31, 1995 are derived
from the Company's consolidated financial statements that were also audited by
Price Waterhouse LLP and which are not included herein. The selected
consolidated financial data for the nine months ended December 31, 1996 are
derived from the unaudited consolidated financial statements of the Company
which, in the opinion of management of the Company, reflect all adjustments,
consisting only of normal recurring adjustments, that the Company considers
necessary for a fair presentation of the financial position and results of
operations for these periods.
<TABLE>
<CAPTION>
FISCAL YEAR THREE MONTHS NINE MONTHS
ENDED DECEMBER ENDED FISCAL YEAR ENDED MARCH ENDED
31, MARCH 31, 31, DECEMBER 31,
--------------- ------------ -------------------------- -----------------
1992 1993 1994 1995 1996 1997 1996 1997
------ ------- ------------ ------- ------- -------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA AND SELECTED OPERATING DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF INCOME DATA: (1)
Net sales......................................... $7,123 $16,705 $6,258 $33,485 $39,752 $ 47,018 $ 35,512 $57,209
Cost of sales..................................... 2,633 5,531 2,166 10,330 13,343 16,760 12,982 18,812
------ ------- ------ ------- ------- -------- -------- -------
Gross profit...................................... 4,490 11,174 4,092 23,155 26,409 30,258 22,530 38,397
Operating expenses
Selling and marketing expenses.................. 1,263 3,904 1,571 6,685 10,028 12,784 9,631 13,103
General and administrative expenses............. 1,016 3,234 1,473 10,073 10,834 10,683 7,581 11,430
Bonuses to S Corporation stockholders........... 878 1,256 -- -- -- -- -- --
------ ------- ------ ------- ------- -------- -------- -------
Total operating expenses........................ 3,157 8,394 3,044 16,758 20,862 23,467 17,212 24,533
------ ------- ------ ------- ------- -------- -------- -------
Operating income.................................. 1,333 2,780 1,048 6,397 5,547 6,791 5,318 13,864
Interest expense.................................. -- (163) (389) (870) (1,447) (2,348) (1,749) (1,438)
Gain on sale and leaseback........................ -- -- (53) -- -- -- -- 997
Foreign exchange losses........................... -- -- -- -- (42) (31) (208) (93)
------ ------- ------ ------- ------- -------- -------- -------
Income before income taxes........................ 1,333 2,617 606 5,527 4,058 4,412 3,361 13,330
Provision for income taxes........................ 37 109 75 1,513 1,603 1,768 1,394 4,937
------ ------- ------ ------- ------- -------- -------- -------
Income from continuing operations before
extraordinary loss............................... 1,296 2,508 531 4,014 2,455 2,644 1,967 8,393
Discontinued operations........................... -- -- (30) (53) (3,128) (13,630) (13,630) --
Extraordinary loss................................ -- -- -- (172) -- -- -- --
------ ------- ------ ------- ------- -------- -------- -------
Net income (loss)................................. $1,296 $ 2,508 $ 501 $ 3,789 $ (673) $(10,986) $(11,663) $ 8,393
------ ------- ------ ------- ------- -------- -------- -------
------ ------- ------ ------- ------- -------- -------- -------
Income from continuing operations before
extraordinary loss per share:
Basic (2)....................................... $ 0.44 $ 0.25 $ 0.26 $ 0.20 $ 0.76
Diluted (2)..................................... $ 0.42 $ 0.25 $ 0.26 $ 0.20 $ 0.73
Net income (loss) per share:
Basic (2)....................................... $ 0.42 $ (0.07) $ (1.10) $ (1.18) $ 0.76
Diluted (2)..................................... $ 0.40 $ (0.07) $ (1.09) $ (1.17) $ 0.73
Pro forma income from continuing operations before
extraordinary loss (3)........................... $ 2,302 $ 312
------- ------
------- ------
Pro forma income from continuing operations before
extraordinary loss per share:
Basic (3)....................................... $ 0.30 $ 0.04
Diluted (3)..................................... $ 0.28 $ 0.04
------- ------
------- ------
Shares used in per share calculations:
Basic (2)....................................... 7,795 8,026 9,130 9,756 9,991 9,867 11,049
------- ------ ------- ------- -------- -------- -------
------- ------ ------- ------- -------- -------- -------
Diluted (2)..................................... 8,183 8,464 9,479 9,906 10,108 9,930 11,532
------- ------ ------- ------- -------- -------- -------
------- ------ ------- ------- -------- -------- -------
Pro forma supplemental income from continuing
operations before extraordinary loss per share:
Basic (4)....................................... $ 0.32 $ 0.23 $ 0.79
Diluted (4)..................................... $ 0.31 $ 0.23 $ 0.76
SELECTED OPERATING DATA:
Number of Thomas Kinkade Stores (5)............... -- 5 7 7 15 16 16 17
Retail sales per square foot (5)(6)............... -- -- -- $ 993 $ 986 $ 1,109 $ 856 $ 1,078
Number of Signature Galleries..................... -- -- -- -- -- 17 14 67
</TABLE>
13
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
--------------- ---------------------------------- DECEMBER 31,
1992 1993 1994 1995 1996 1997 1997
------ ------- ------- ------- ------- ------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA: (1)
Cash and cash equivalents................. $ 539 $ 801 $ 847 $ 1,552 $ 382 $ 374 $ 5,099
Working capital (7)....................... 1,417 4,442 (2,229) 4,239 3,891 6,982 13,498
Total assets.............................. 2,315 12,871 18,764 31,271 36,658 23,061 33,199
Long-term debt less current portion (8)... -- 5,216 3,326 3,166 9,610 5,809 3,909
Total stockholders' equity................ 1,442 3,998 2,562 18,033 15,578 5,890 14,445
</TABLE>
- ------------------------------
(1) Restated to reflect (i) discontinuance of John Hine Limited during the year
ended March 31, 1997; and (ii) acquisitions of seven galleries during the
year ended March 31, 1996 which have been accounted for as poolings of
interests. See Notes 2 and 3 of Notes to Consolidated Financial Statements.
(2) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of the determination of shares used in computing earnings per share.
(3) Pro Forma Statement of Income Data reflects the historical statement of
income data for the year ended December 31, 1993 and the three months ended
March 31, 1994 as if (i) certain subsidiaries of the Company had ceased to
be treated as S Corporations for income tax purposes on January 1, 1993;
and (ii) the Company had paid principal stockholders distributions in the
form of annual executive compensation aggregating no more than $720,000. On
April 1, 1994, the Company changed its fiscal year end from December 31 to
March 31.
(4) The supplemental pro forma income from continuing operations before
extraordinary loss per share is based on income from continuing operations
before extraordinary loss, increased to give effect to the reduction of
interest expense, assuming a portion of the net proceeds from the offering
were used to repay notes payable aggregating $5.4 million on April 1, 1996,
and the number of shares used in the calculation of income from continuing
operations before extraordinary loss per share, increased by the estimated
number of shares required to be sold by the Company to repay such notes
payable.
(5) In fiscal 1996, the Company acquired seven galleries which are included in
the number of Thomas Kinkade Stores commencing with the fiscal year ended
March 31, 1996. Since these galleries were acquired in transactions
accounted for as a pooling of interests, the operating results of these
galleries are included in the Company's Consolidated Statement of Income in
all prior periods.
(6) Includes sales by Thomas Kinkade Stores open for 12 or more months.
(7) Excludes net assets of discontinued operations.
(8) Amount is net of unamortized deferred debt discount. See Note 6 of Notes to
Consolidated Financial Statements.
14
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH
"SELECTED CONSOLIDATED FINANCIAL DATA" AND THE COMPANY'S CONSOLIDATED FINANCIAL
STATEMENTS AND NOTES THERETO INCLUDED ELSEWHERE IN THIS PROSPECTUS. THIS
PROSPECTUS CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE DISCUSSED IN
THE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING THOSE
SET FORTH IN "RISK FACTORS" AND ELSEWHERE IN THIS PROSPECTUS. SEE "CAUTIONARY
LANGUAGE REGARDING FORWARD-LOOKING STATEMENTS."
OVERVIEW
The Company was founded in 1990 primarily to manufacture, market and
distribute paper lithographs of Thomas Kinkade's artwork. The Company's net
sales have grown rapidly as a result of growing consumer awareness and
acceptance of Thomas Kinkade's paintings, the Company's penetration of the gifts
and collectibles retail distribution channels and the introduction of the framed
canvas lithograph. In 1993, the Company acquired John Hine Limited, a producer
of miniature collectible English cottages and figurines. In September 1996, as a
result of declining sales, the Company decided to discontinue the operations of
John Hine Limited and focus on further development of the Thomas Kinkade product
line. As a result, in the quarter ended September 30, 1996, the Company incurred
a loss from discontinuance totaling $12.2 million.
The Company has continued to expand its Thomas Kinkade product line to
include home decorative accessories, collectibles and gift products featuring
the art of Thomas Kinkade. The Company's principal products currently include
limited and open edition canvas and paper lithograph reproductions of the art of
Thomas Kinkade. In addition, the Company offers a line of gift and home
accessory products. In the first nine months of fiscal 1998, limited edition
canvas and paper lithograph sales accounted for 68.3% of the Company's revenues.
See "Risk Factors--Dependence on Thomas Kinkade; Lack of Product Revenue
Diversification."
Since its inception, the Company has focused on controlled distribution. The
Company currently distributes its products through Thomas Kinkade Stores,
independently owned Signature Galleries and other independent dealers. In 1993,
the Company initiated the development of Company owned Thomas Kinkade Stores,
which exclusively sell Thomas Kinkade products. The Company currently has 17
Thomas Kinkade Stores located in California, Hawaii, Minnesota, Missouri and
Illinois, and currently plans to open two additional Thomas Kinkade Stores in
fiscal 1998 and approximately 10 stores in fiscal 1999 in strategic mall
locations, downtown shopping areas and high tourist traffic areas. Thomas
Kinkade Stores generally range in size from 1,000 square feet to 2,200 square
feet. Build-out expenses are anticipated generally to range from approximately
$75,000 to $150,000 per store, excluding inventory. In addition, pre-opening
costs are anticipated generally to range from $50,000 to $75,000 per store. It
is the Company's policy to expense pre-opening costs as they are incurred. As a
result, quarterly operating results may fluctuate as a result of the number of
Thomas Kinkade Stores opened during a given quarter. In the first nine months of
fiscal 1998, Thomas Kinkade Stores accounted for 28.0% of the Company's net
sales, compared to 33.1% in fiscal 1997. There can be no assurance that the
Company will be able to open its planned Thomas Kinkade Stores or that such
stores will operate on a profitable basis. See "Risk Factors--Risks Associated
with Expansion of Distribution Channels."
In 1996, in an effort to accelerate expansion of distribution, the Company
initiated its Thomas Kinkade Signature Gallery program. These independently
owned and operated Signature Galleries are modeled on Thomas Kinkade Stores and
exclusively sell Thomas Kinkade products. As of December 31, 1997, there were 67
Signature Galleries. The Company currently plans to add 15 additional Signature
Galleries, including through the conversion of existing independent dealers,
through the end of fiscal 1998 and approximately 100 in fiscal 1999. Since
Signature Galleries are independently owned, the Company does not incur any
build-out expense in connection with their opening. Signature Galleries are
required to make an initial advance purchase of inventory of between $25,000 and
$75,000, as well as annual minimum purchases of $100,000 per location. In the
first nine months of fiscal 1998, sales to Signature Galleries accounted for
21.5% of the Company's net sales, compared to
15
<PAGE>
6.7% in fiscal 1997. There can be no assurance that the Company will be able to
identify suitable owners for its planned Signature Galleries expansion or that
such owners will become effective distributors for the Company's products. See
"Risk Factors--Risks Associated with Expansion of Distribution Channels."
The Company also markets its products through approximately 2,200
independent dealers organized into various incentive and commitment levels and
through QVC, a cable television shopping network. Additionally, the Company has
established key strategic alliances with major retailers such as Avon and
Hallmark to expand brand recognition and generate revenues.
The Company's cost of sales consists primarily of raw material and component
costs, manufacturing and supervisory labor, manufacturing overhead costs and
royalties. Although the Company may realize economies of scale as unit volumes
increase, cost of sales may increase as a percentage of net sales as the Company
expands its open edition products, which historically have had lower gross
margins than limited edition products.
Selling and marketing expenses consist primarily of salaries and
commissions, as well as advertising and promotional expenses. General and
administrative expenses consist primarily of salaries and bonuses, rent and
professional services such as legal and accounting fees. The Company expects
that efforts to expand distribution will result in increased selling and
marketing and general and administrative expenses. See "Risk Factors--
Fluctuations in Operating Results."
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
relationship of certain items from the Company's statement of operations to net
sales (restated to reflect the discontinuance of John Hine Limited):
<TABLE>
<CAPTION>
PERCENTAGE OF NET SALES
-----------------------------------------------------
NINE MONTHS
FISCAL YEAR ENDED ENDED
MARCH 31, DECEMBER 31,
------------------------------- --------------------
1995 1996 1997 1996 1997
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Net sales......................................................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales..................................................... 30.8 33.6 35.6 36.6 32.9
--------- --------- --------- --------- ---------
Gross margin...................................................... 69.2 66.4 64.4 63.4 67.1
Operating expenses:
Selling and marketing expenses.................................. 20.0 25.2 27.2 27.1 22.9
General and administrative expenses............................. 30.1 27.3 22.7 21.3 20.0
--------- --------- --------- --------- ---------
Total operating expenses...................................... 50.1 52.5 49.9 48.4 42.9
--------- --------- --------- --------- ---------
Operating income.................................................. 19.1 13.9 14.5 15.0 24.2
Interest expense.................................................. (2.6) (3.6) (5.0) (4.9) (2.5)
Gain on sale and leaseback........................................ -- -- -- -- 1.7
Foreign exchange losses........................................... -- (0.1) (0.1) (0.6) (0.1)
--------- --------- --------- --------- ---------
Income before income taxes........................................ 16.5 10.2 9.4 9.5 23.3
Provision for income taxes........................................ 4.5 4.0 3.8 4.0 8.6
--------- --------- --------- --------- ---------
Income from continuing operations before extraordinary loss....... 12.0 6.2 5.6 5.5 14.7
Discontinued operations........................................... (0.2) (7.9) (29.0) (38.3) --
Extraordinary loss................................................ (0.5) -- -- -- --
--------- --------- --------- --------- ---------
Net income (loss)................................................. 11.3% (1.7)% (23.4)% (32.8)% 14.7%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
16
<PAGE>
COMPARISON OF NINE MONTHS ENDED DECEMBER 31, 1996 AND 1997
NET SALES. Net sales increased 61.1% from $35.5 million in the first nine
months of fiscal 1997 to $57.2 million in the first nine months of fiscal 1998.
Net sales to wholesale customers increased 74.6% from $23.6 million in the first
nine months of fiscal 1997 to $41.2 million in the first nine months of fiscal
1998. Net sales to wholesale accounts include sales to Signature Galleries,
sales to other independent dealers, sales to QVC and revenue generated from
licensing arrangements. Increased sales to Signature Galleries accounted for
$10.0 million of the increase in wholesale sales. The remainder of the increase
was primarily due to an increase in the number of other independent dealers and,
to a lesser extent, increased sales to existing accounts. Retail sales through
Thomas Kinkade Stores increased 34.3% from $11.9 million in the first nine
months of fiscal 1997 to $16.0 million in the first nine months of 1998. The
increase in retail sales was primarily due to an increase in the number of units
sold and, to a lesser extent, to a shift in the retail product mix towards
higher priced editions and the opening of two retail stores during the first six
months of fiscal 1998.
GROSS MARGIN. Gross margin increased from 63.4% in the first nine months of
fiscal 1997 to 67.1% for the first nine months of fiscal 1998 primarily due to
efficiencies resulting from increased sales volumes, as well as improved
management of labor and manufacturing processes resulting from the hiring of
more experienced management. Gross margin also improved as a result of the
outsourcing of the manufacturing of certain open edition products.
SELLING AND MARKETING EXPENSES. Selling and marketing expenses increased
36.1% from $9.6 million in the first nine months of fiscal 1997 to $13.1 million
in the first nine months of fiscal 1998 but decreased as a percentage of net
sales from 27.1% in the first nine months of fiscal 1997 to 22.9% in the first
nine months of fiscal 1998. The increase in absolute selling and marketing
expenses was due primarily to higher compensation costs associated with higher
sales levels and higher advertising and promotion costs. The decrease of selling
and marketing expenses as a percentage of net sales was due primarily to the
fact that a significant portion of the compensation of the Company's sales force
is fixed and, as a result, selling and marketing expenses increased at a slower
rate than net sales.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 50.8% from $7.6 million in the first nine months of fiscal 1997 to
$11.4 million in the first nine months of fiscal 1998, but decreased as a
percentage of net sales from 21.3% in the first nine months of fiscal 1997 to
20.0% in the first nine months of fiscal 1998. The decrease in general and
administrative expenses as a percentage of net sales was due to the leveraging
of relatively fixed general and administrative expenses over a higher sales
base. This decrease was offset primarily by payments under incentive
compensation plans as a result of higher profitability and other costs related
to expansion, such as increased headcount and rent costs.
INTEREST EXPENSE. Interest expense decreased from $1.7 million in the first
nine months of fiscal 1997 to $1.4 million in the first nine months of fiscal
1998. This decrease was due to a reduction in the Company's borrowings under
lines of credit and secured notes, offset by an increase in non-cash
amortization of debt issuance costs resulting from the refinancing of the
Company's long-term debt in February 1997.
SALE AND LEASEBACK. In July 1997, the Company exercised an option to
purchase its leased San Jose, California facility. The Company subsequently sold
the facility and entered into a four year lease agreement with the purchaser.
The gain on the sale and leaseback of the facility, after transaction costs of
$110,000 and deferral of $650,000 to offset future rent increases as compared to
the previous lease, aggregated $997,000.
PROVISION FOR INCOME TAXES. The provision for income taxes as a percentage
of income before income taxes decreased from 41.5% in the first nine months of
fiscal 1997 to 37.0% in the first nine months of fiscal 1998.
COMPARISON OF YEARS ENDED MARCH 31, 1996 AND 1997
NET SALES. Net sales increased 18.3% from $39.8 million in fiscal 1996 to
$47.0 million in fiscal 1997. Net sales to wholesale customers increased 20.9%
from $26.0 million in fiscal 1996 to $31.5 million in fiscal 1997.
17
<PAGE>
Increased sales to Signature Galleries accounted for $2.8 million of the
increase in wholesale sales. The remainder of the increase was primarily due to
an increase in the number of other wholesale accounts and, to a lesser extent,
increased sales to existing wholesale accounts. Retail sales through Thomas
Kinkade Stores increased 13.2% from $13.7 million in fiscal 1996 to $15.5
million in fiscal 1997. The increase in retail sales was primarily due to an
increase in the number of units sold and, to a lesser extent, to an increase in
product prices during fiscal 1997.
GROSS MARGIN. Gross margin declined from 66.4% in fiscal 1996 to 64.4% in
fiscal 1997 as a result of the introduction of lower priced, lower margin open
edition products as part of the Company's strategy to expand the range of prices
of available products and leverage its library of Thomas Kinkade images. Gross
margin in fiscal 1997 was also adversely affected by a temporary loss of
efficiency during the consolidation of the Company's administrative functions
with the manufacturing facility in San Jose. These additional costs were partly
offset by efficiencies gained from increased sales volumes.
SELLING AND MARKETING EXPENSES. Selling and marketing expenses increased
27.5% from $10.0 million in fiscal 1996 to $12.8 million in fiscal 1997 and
increased as a percentage of net sales from 25.2% in fiscal 1996 to 27.2% in
fiscal 1997. The increase in selling and marketing expenses in fiscal 1997 was
due to higher compensation costs associated with the Company's efforts to expand
sales volumes through an increase in the number of customers as well as through
new channels of distribution. In addition, the Company experienced
inefficiencies when it reduced its in-house sales force subsequent to the
discontinuance of John Hine Limited in September 1996. During fiscal 1997, the
Company also incurred additional marketing costs as part of the development of
the Signature Gallery program.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
decreased from $10.8 million in fiscal 1996 to $10.7 million in fiscal 1997 and
decreased as a percentage of net sales from 27.3% in fiscal 1996 to 22.7% in
fiscal 1997. The decrease in general and administrative expenses was a result of
various cost cutting programs, such as the consolidation of the Company's
administrative operations in San Jose in fiscal 1997, partially offset by
increased costs due to the Company's expanding level of activity. Fiscal 1996
expenses also included approximately $450,000 of charges related to a reduction
in headcount.
INTEREST EXPENSE. Interest expense increased from $1.4 million in fiscal
1996 to $2.3 million in fiscal 1997 due to higher interest rates on the
Company's long-term debt due to covenant defaults, as well as to an increase in
the amount of amortization of debt discount.
PROVISION FOR INCOME TAXES. The provision for income taxes as a percentage
of income before income taxes was 39.5% in fiscal 1996 and 40.1% in fiscal 1997.
DISCONTINUED OPERATIONS. In September 1996, the Company decided to
discontinue the operations of John Hine Limited and recorded a loss of $12.2
million, including a tax benefit of $2.4 million and a write-off of intangible
assets with a net book value of $8.4 million.
COMPARISON OF YEARS ENDED MARCH 31, 1995 AND 1996
NET SALES. Net sales increased 18.7% from $33.5 million in fiscal year 1995
to $39.8 in fiscal 1996. Net sales to wholesale customers increased 7.6% from
$24.2 million in fiscal year 1995 to $26.0 million in fiscal year 1996 due to an
increase in the number of units sold and an increase in product prices in fiscal
1996. Unit volume increased in fiscal 1996 as a result of an increase in the
edition size of limited edition releases. Retail sales through Thomas Kinkade
Stores increased 47.7% from $9.3 million in fiscal 1995 to $13.7 million in
fiscal 1996 due to increased sales productivity as retail stores matured.
GROSS MARGIN. Gross margin declined from 69.2% in fiscal 1995 to 66.4% in
fiscal 1996 due to inefficient manufacturing labor practices, a temporary loss
of efficiency during the consolidation of the Company's manufacturing operations
into one facility in fiscal 1996, as well as increased overhead costs resulting
from investments in manufacturing infrastructure. These factors were partly
offset by increased sales volumes.
18
<PAGE>
SELLING AND MARKETING EXPENSES. Selling and marketing expenses increased
50.0% from $6.7 million in fiscal 1995 to $10.0 million in fiscal 1996 and
increased as a percentage of net sales from 20.0% in fiscal 1995 to 25.2% in
fiscal 1996. This increase was due to the expansion of the Company's sales and
marketing staff, including recruiting and training expenses associated with a
change from the use of independent sales representatives to an exclusively
in-house sales force as well as higher promotional costs associated with the
Company's efforts to expand its product range. Selling and marketing expense
also increased due to the recognition of approximately $340,000 of commission
expense during the phase-out of the independent sales force in addition to the
relatively fixed salary costs of the new in-house sales force.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 7.6% from $10.1 million in fiscal 1995 to $10.8 million in fiscal
1996, due primarily to severance costs related to a reduction in head count, but
decreased as a percentage of net sales from 30.1% in fiscal 1995 to 27.3% in
fiscal 1996 due to an increase in net sales.
INTEREST EXPENSE. Interest expense increased from $870,000 in fiscal 1995
to $1.4 million in fiscal 1996. The increase in interest expense in fiscal 1996
was due to an increase in the amount and interest rate of the Company's
long-term debt which was used in part to retire shorter term debt that had a
lower interest rate.
PROVISION FOR INCOME TAXES. The provision for income taxes as a percentage
of income before income taxes increased from 27.4% in fiscal 1995 to 39.5% in
fiscal 1996. The lower income tax rate for fiscal 1995 was attributable to the
recognition of a nonrecurring deferred tax benefit of $638,000 when the Company
acquired certain of its subsidiaries which then ceased to be treated as S
corporations. The effective income tax rate for fiscal 1995, excluding the
deferred tax benefit, would have been 38.0%.
EXTRAORDINARY ITEM. In August 1994, the Company recorded a write-off of
deferred debt discount of $172,000 (net of deferred income tax benefit of
$96,000) as an extraordinary item on the repayment of John Hine Limited
acquisition-related debt using proceeds from the Company's initial public
offering.
SELECTED QUARTERLY RESULTS OF OPERATIONS
The Company's business has experienced, and is expected to continue to
experience, significant seasonal fluctuations in sales and net income. The
Company's net sales generally are highest in the December quarter and
historically have been lower in the subsequent March and June quarters. Despite
overall increases in annual net sales in fiscal 1996, net sales in the December
quarter were $12.2 million, and net sales in the subsequent March and June
quarters were $10.4 million and $8.7 million, respectively. In fiscal 1997, net
sales in the December quarter were $15.5 million, and sales in the subsequent
March and June quarters were $11.5 million and $13.2 million, respectively.
Management believes that the seasonal effect is due primarily to customer buying
patterns, particularly in holiday purchases, and is typical of the home
decorative accessories, collectibles and gift products industries. The Company
expects these seasonal trends to continue in the foreseeable future; therefore,
quarterly results are not necessarily indicative of results for an entire year
and will fluctuate significantly from quarter to quarter. See "Risk
Factors--Seasonality."
The following table sets forth certain unaudited statement of operations
data for the eight quarters ended December 31, 1997 (restated to reflect the
discontinuance of John Hine Limited), as well as such data expressed as a
percentage of the Company's total net sales for the periods indicated. This data
has been derived from unaudited financial statements that, in the opinion of
management, include all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of such information when read in
conjunction with the Company's annual audited consolidated statements and notes
thereto.
19
<PAGE>
<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
1996 1996 1996 1996 1997 1997 1997 1997
--------- -------- --------- -------- --------- -------- --------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net sales............................. $10,397 $ 8,718 $ 11,323 $ 15,471 $11,506 $ 13,189 $17,224 $ 26,796
Cost of sales......................... 3,525 3,697 4,057 5,228 3,778 4,208 5,684 8,920
--------- -------- --------- -------- --------- -------- --------- --------
Gross profit.......................... 6,872 5,021 7,266 10,243 7,728 8,981 11,540 17,876
Operating expenses
Selling and marketing expenses...... 3,131 3,098 3,031 3,502 3,153 3,342 4,424 5,337
General and administrative
expenses.......................... 2,217 2,274 2,474 2,833 3,102 2,794 3,120 5,516
--------- -------- --------- -------- --------- -------- --------- --------
Total operating expenses.......... 5,348 5,372 5,505 6,335 6,255 6,136 7,544 10,853
--------- -------- --------- -------- --------- -------- --------- --------
Operating income (loss)............... 1,524 (351) 1,761 3,908 1,473 2,845 3,996 7,023
Interest expense...................... (601) (516) (564) (669) (599) (688) (475) (275)
Gain on sale and leaseback............ -- -- -- -- -- -- 997 --
Foreign exchange gains (losses)....... 120 (62) -- (146) 177 (61) 45 (77)
--------- -------- --------- -------- --------- -------- --------- --------
Income (loss) before income taxes..... 1,043 (929) 1,197 3,093 1,051 2,096 4,563 6,671
Provision for income taxes............ 412 (365) 470 1,289 374 765 1,690 2,482
--------- -------- --------- -------- --------- -------- --------- --------
Income (loss) from continuing
operations before extraordinary
loss................................ 631 (564) 727 1,804 677 1,331 2,873 4,189
Discontinued operations............... (1,226) (791) (12,839) -- -- -- -- --
--------- -------- --------- -------- --------- -------- --------- --------
Net income (loss)..................... $ (595) $(1,355) $ (12,112) $ 1,804 $ 677 $ 1,331 $ 2,873 $ 4,189
--------- -------- --------- -------- --------- -------- --------- --------
--------- -------- --------- -------- --------- -------- --------- --------
Income (loss) from continuing
operations before extraordinary loss
per share (diluted)................. $ 0.06 $ (0.06) $ 0.07 $ 0.18 $ 0.06 $ 0.12 $ 0.25 $ 0.35
--------- -------- --------- -------- --------- -------- --------- --------
--------- -------- --------- -------- --------- -------- --------- --------
Net income (loss) per share
(diluted)........................... $ (0.06) $ (0.14) $ (1.23) $ 0.18 $ 0.06 $ 0.12 $ 0.25 $ 0.35
--------- -------- --------- -------- --------- -------- --------- --------
--------- -------- --------- -------- --------- -------- --------- --------
Shares used in computation of earnings
per share........................... 9,992 9,867 9,992 9,932 10,639 11,294 11,298 12,004
--------- -------- --------- -------- --------- -------- --------- --------
--------- -------- --------- -------- --------- -------- --------- --------
</TABLE>
<TABLE>
<CAPTION>
PERCENTAGE OF NET SALES
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net sales........................................ 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales.................................... 33.9 42.4 35.8 33.8 32.8 31.9 33.0 33.3
-------- ------- -------- ------- -------- ------- -------- -------
Gross margin..................................... 66.1 57.6 64.2 66.2 67.2 68.1 67.0 66.7
Operating expenses
Selling and marketing expense.................. 30.1 35.5 26.8 22.6 27.4 25.3 25.7 19.9
General and administrative expense............. 21.3 26.1 21.8 18.3 27.0 21.2 18.1 20.6
-------- ------- -------- ------- -------- ------- -------- -------
Total operating expenses..................... 51.4 61.6 48.6 40.9 54.4 46.5 43.8 40.5
-------- ------- -------- ------- -------- ------- -------- -------
Operating income (loss).......................... 14.7 (4.0) 15.6 25.3 12.8 21.6 23.2 26.2
Interest expense................................. (5.8) (5.9) (5.0) (4.3) (5.2) (5.2) (2.8) (1.0)
Gain on sale and leaseback....................... -- -- -- -- -- -- 5.8 --
Foreign exchange gains (losses).................. 1.2 (0.7) -- (0.9) 1.5 (0.5) 0.3 (0.3)
-------- ------- -------- ------- -------- ------- -------- -------
Income (loss) before income taxes................ 10.1 (10.6) 10.6 20.1 9.1 15.9 26.5 24.9
Provision for income taxes....................... 4.0 (4.2) 4.2 8.3 3.3 5.8 9.8 9.3
-------- ------- -------- ------- -------- ------- -------- -------
Income (loss) from continuing operations before
extraordinary loss............................. 6.1 (6.4) 6.4 11.8 5.8 10.1 16.7 15.6
Discontinued operations.......................... (11.8) (9.1) (113.4) -- -- -- -- --
-------- ------- -------- ------- -------- ------- -------- -------
Net income (loss)................................ (5.7)% (15.5)% (107.0)% 11.8% 5.8% 10.1% 16.7% 15.6%
-------- ------- -------- ------- -------- ------- -------- -------
-------- ------- -------- ------- -------- ------- -------- -------
</TABLE>
Net sales during the quarter ended March 31, 1996 included the shipment of a
number of orders which the Company had originally scheduled for the following
quarter. In addition, the Company accelerated the production of some
higher-priced products during that quarter. This resulted in lower sales for the
June 1996 quarter as the Company had shipped most of its backlog in the previous
quarter. As a result, cost of sales, selling and
20
<PAGE>
marketing expenses and general and administrative expenses all increased
significantly as a percentage of sales as compared to other quarters.
The Company discontinued the operations of John Hine Limited during the
quarter ended September 30, 1996, resulting in an after-tax loss of $12.2
million in addition to net losses of discontinued operations of $594,000 for
that quarter.
The Company's quarterly operating results have fluctuated significantly in
the past and may continue to fluctuate as a result of numerous factors,
including demand for the art of Thomas Kinkade and the Company's Thomas Kinkade
products (including new product categories and series), the Company's ability to
achieve its expansion plans, the timing, mix and number of new product releases,
the timing of the opening of new Thomas Kinkade Stores and the expensing of the
associated pre-opening costs, the successful implementation of the Signature
Gallery program and expansion of distribution generally, the Company's ability
to implement strategic business alliances, the Company's ability to hire and
train new manufacturing, sales and administrative personnel, continued
implementation of manufacturing efficiencies, timing of product deliveries and
the incurrence of other operating costs. The Company's results of operations may
also fluctuate based on extraordinary events, such as the discontinuance of the
operations of John Hine Limited. As a result of the expected repayment of the
outstanding subordinated debt due to Levine Leichtman of $5.4 million using the
net proceeds of this offering, the Company will record an extraordinary expense
in relation to the write-off of deferred debt discount associated with that
debt. Deferred debt discount aggregated $2.2 million as of December 31, 1997.
Accordingly, the results of operations in any quarter will not necessarily be
indicative of the results that may be achieved for a full fiscal year or any
future quarter. In addition, since a significant portion of the Company's
revenues are generated from orders received in the quarter, sales in any quarter
are substantially dependent on orders booked in that quarter.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds have been from the issuance of stock,
incurrence of debt and more recently, from its operations. The Company had
working capital of $13.5 million at the end of December 1997 compared to $7.9
million at the end of March 1997.
Net cash provided by operations for the nine months ended December 31, 1997
was $11.6 million consisting of $10.7 million provided by continuing operations
and $890,000 provided by discontinued operations. Net cash provided by
continuing operations consisted primarily of income from continuing operations
adjusted by increases in income taxes payable and accrued compensation costs and
receipt of an income tax refund partly offset by an increase in accounts
receivable and inventory. Net cash provided by operations for the nine months
ended December 31, 1996 was $2.7 million consisting of $4.9 million provided by
continuing operations which was partly offset by $2.2 million used in
discontinued operations. Net cash provided by continuing operations consisted
primarily of income from continuing operations adjusted by an increase in income
taxes refundable and a decrease in accrued royalties. Net cash provided by
operations for fiscal 1997 was $3.2 million consisting of $785,000 provided by
continuing operations and $2.4 million provided by discontinued operations. Net
cash provided by continuing operations consisted primarily of income from
continuing operations and adjusted by an increase in accounts receivable partly
offset by increases in prepaid expenses and income tax assets. Net cash used in
operations for fiscal 1996 was $6.9 million consisting of $388,000 used in
operations and $6.5 million used in discontinued operations. Net cash used in
continuing operations consisted primarily of adjustments for increases in
accounts receivable and payments to related parties which were offset in part by
income from continuing operations.
Net cash used in investing activities was $222,000 and $473,000 for the nine
months ended December 31, 1997 and 1996, respectively, and was $719,000 and
$364,000 in fiscal 1997 and 1996, respectively. The Company's investing
activities have primarily related to capital expenditures for property and
equipment. For the nine months ended December 31, 1997, the Company also
received net proceeds of $1.6 million under a sale and leaseback transaction.
The Company anticipates that total capital expenditures in fiscal 1998 will be
21
<PAGE>
approximately $3.0 million, and will relate to continued manufacturing and
infrastructure investments as well as to the opening of new retail locations and
upgrades to management information systems.
Net cash used in financing activities was $6.6 million and $2.5 million in
the nine months ended December 31, 1997 and 1996, respectively and $2.5 million
in fiscal 1997. Net cash provided by financing activities was $6.1 million in
fiscal 1996. Cash used in financing activities has been primarily for the
repayment of borrowings under credit lines and notes payable, while cash
provided by financing activities has been primarily from the issuance of $5.4
million in subordinated notes and borrowings of $1.8 million in credit lines.
The Company has a $10.0 million secured line-of-credit facility with CIT
Group/Business Credit, Inc. (the "Senior Debt"). Borrowing capacity under the
Senior Debt is based on eligible accounts receivable and inventory and
aggregated $10.0 million as of December 31, 1997. The Company's indebtedness
under bank lines of credit was $2.7 million as of March 31, 1997. As of December
31, 1997, the Company had $24,000 of outstanding borrowings under the Senior
Debt and had cash on hand of $5.1 million. In February 1997, the Company
renegotiated and issued a $7.4 million secured note payable to Levine Leichtman
(the "Subordinated Debt"), $2.0 million of which was repaid as of July 31, 1997.
The Company expects to use a portion of the proceeds from this Offering to repay
the remaining outstanding Subordinated Debt of $5.4 million, which will result
in a write-off of deferred debt discount associated with that debt as an
extraordinary expense in the quarter in which it is repaid. Deferred debt
discount aggregated $2.2 million as of December 31, 1997. As of December 31,
1997, the Company had repaid $1.6 million of debt to a former shareholder of
John Hine Limited.
The Company's working capital requirements in the foreseeable future will
change depending on the rate of the Company's expansion, the Company's operating
results and any other adjustments in its operating plan as needed in response to
competition, acquisition opportunities or unexpected events. The Company
believes that existing borrowing capacity under lines of credit, together with
the proceeds from the offering and revenues from operations, will be sufficient
to meet the Company's working capital requirements through fiscal 1999. However,
there can be no assurance that the Company will not seek additional capital in
the future as a result of expansion or otherwise.
INFLATION
The Company does not believe that inflation has had a material adverse
effect on net sales or results of operations. However, there can be no assurance
that the Company's business will not be affected by inflation in the future.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
See Note 1 of Notes to Consolidated Financial Statements for a discussion of
the impact of new accounting pronouncements.
22
<PAGE>
BUSINESS
OVERVIEW
Media Arts is a leading designer, manufacturer, marketer and branded
retailer of art-based home decorative accessories, collectibles and gift
products based upon the works of the artist Thomas Kinkade, Painter of Light.
The Company's primary products are canvas and paper lithographs that feature Mr.
Kinkade's unique use of light and his peaceful and inspiring themes. The Company
believes the Thomas Kinkade lifestyle brand appeals to a wide range of consumers
because its message celebrates home, family, nature and traditions and its
products help to create positive environments in which to live and work. The
Company strives to reach a broad consumer base by offering products at a variety
of price points, controlling its distribution through its branded Company owned
retail stores ("Thomas Kinkade Stores") and independently owned and operated
Thomas Kinkade Signature Galleries ("Signature Galleries") and developing
strategic marketing relationships with companies such as Hallmark, Avon and QVC.
The Company's products generally sell at retail price points ranging from $50
for small gift prints to between $150 and $15,000 for paper and canvas
lithographs. The Company distributes Thomas Kinkade products through an
extensive distribution network which as of December 31, 1997 included 17 Thomas
Kinkade Stores, 67 Signature Galleries and approximately 2,200 other independent
gift and collectible retailers and through strategic relationships with
companies such as Hallmark, Avon and QVC. The Company believes that this broad
distribution network has allowed it to develop Thomas Kinkade into a leading
art-based brand.
INDUSTRY OVERVIEW
The home decorative accessories and collectibles market is a multi-billion
dollar industry which includes products such as artwork, vases, trays, mugs,
picture frames and ornaments sold by specialty stores, art and gift galleries,
department stores and catalog retailers. This market is expected to grow 33%
from $6.9 billion in 1996 to $9.2 billion by the year 2001, according to a
January 1997 report on the U.S. giftware market (the "Report") by Packaged
Facts, a consumer research organization. The Company believes that key drivers
of this growth may include an increase in the homeowner population and an
accompanying trend towards enhancing the home environment, or "nesting."
According to the U.S. Census Bureau, while the population of homeowners is
expected to increase by 4.4 million from 1997 to 2001, the population of
homeowners ages 35-64 is expected to grow 4.8 million from 55.4 million in 1997
to 60.2 million by the year 2001. Typically, homeowners have a greater sense of
permanency and are more interested in purchasing household goods and decorating
than those who view their living arrangements as temporary. The Report also
notes that collectibles, which generally focus on positive themes with
sentimental appeal, are growing in popularity both as an investment and as a way
of creating a warm living environment. Consumers tend to purchase decorative
accessories, collectibles, and other giftware from specialty stores. The Report
states that in 1997, specialty stores accounted for 65% of retail sales for the
overall giftware market, with department stores and mass merchants accounting
for only 25% of such sales. The Company believes that the increased demand for
decorative and collectible products and the preference of consumers to purchase
giftware through specialty retail stores present a significant business
opportunity.
BUSINESS STRATEGY
The Company's goal is to develop Thomas Kinkade into a leading art-based
brand with widespread consumer appeal. To achieve this goal, the Company has
adopted the following strategy:
PROVIDE A WIDE ARRAY OF BRANDED ART-BASED HOME ACCESSORIES. The Company
seeks to increase awareness of the Thomas Kinkade brand and lifestyle message by
creating products that appeal to a broad range of consumers. The Company's
Thomas Kinkade images are released first in its higher margin limited edition
lithographs and are the foundation of its product lines. By leveraging these new
images and its existing library of over 160 Thomas Kinkade images into a wide
array of art-based home accessories with accessible price points, the Company
hopes to reach a broad consumer base and to build brand awareness.
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EXPAND CONTROLLED DISTRIBUTION THROUGH DEDICATED STORES AND GALLERIES. The
Company seeks to enhance the Thomas Kinkade brand by developing its network of
Company owned Thomas Kinkade Stores and independently owned Signature Galleries,
which exclusively sell Thomas Kinkade products. This controlled distribution
strategy enables the Company to have its products presented in environments
designed to showcase the Thomas Kinkade brand and convey the Thomas Kinkade
lifestyle message. Furthermore, many Thomas Kinkade Store managers and Signature
Gallery owners have completed a sales, marketing and management program at
Thomas Kinkade University, the Company's training facility. In the first nine
months of fiscal 1998, sales through Thomas Kinkade Stores and Signature
Galleries accounted for approximately 49.5% of net sales compared to 39.8% in
fiscal 1997. The Company intends to continue to expand its network of Thomas
Kinkade Stores and Signature Galleries.
EXPAND DEALER NETWORK AND PROMOTE EXISTING DEALERS. The Company seeks to
increase sales and build brand awareness by continuing to expand its dealer
network and promoting existing dealers to higher incentive and commitment
levels. The Company currently distributes its products through approximately
2,200 independent dealers organized into four dealer levels with minimum
purchase requirements ranging from a $500 minimum initial purchase requirement
to a $15,000 minimum annual purchase requirement. As dealers upgrade to higher
levels, they receive increasing benefits such as access to a wider range of the
Company's products. In the first nine months of fiscal 1998, the Company added
over 140 new independent dealers.
DEVELOP STRATEGIC BUSINESS RELATIONSHIPS TO EXPAND PRODUCT LINES AND
AUDIENCE REACH. The Company intends to continue to develop strategic business
relationships with leading consumer marketing companies in order to build brand
awareness and generate additional sales and to leverage the expertise of these
companies in sales and marketing, manufacturing and distribution. The Company
currently has such strategic business relationships with Hallmark for stationery
items, ornaments and other gift products; Avon for gift products; and QVC for
paper lithographs and other gift products.
PROVIDE HIGH QUALITY PRODUCTS. The Company believes that manufacturing high
quality products is essential to enhancing the Thomas Kinkade brand image. While
the Company expects demand for these products to increase, the Company remains
committed to providing high quality products. Accordingly, the Company plans to
continue to improve quality control, increase capacity and shorten production
time by automating certain of its manufacturing processes.
PRODUCTS
The Company's products include collectible framed canvas and paper
lithographs, books, stationery items and other home accessories and gift
products that feature Mr. Kinkade's unique use of light and his peaceful, warm
and inspiring themes. Mr. Kinkade's subjects often include gardens, cityscapes,
cottages, lighthouses and country villages. The following paragraphs describe
the Company's product categories, product strategy and creative process.
PRODUCT CATEGORIES. The Company's products are categorized generally as
limited editions or open editions. Limited editions are high quality canvas and
paper lithographs produced in limited quantities, each of which is accompanied
by a certificate of authenticity stating the size of the edition. Open editions
are products that may be produced in greater quantities and sold by the Company
indefinitely. In fiscal 1997, limited editions and open editions represented
72.3% and 21.4% of the Company's net sales, respectively.
The limited edition product line currently consists of canvas and paper
lithographs. Canvas lithographs are paper prints transferred to canvas and
hand-highlighted to have the appearance of an original oil painting. The
Company's paper lithographs are high quality lithographs reproduced on acid-free
paper. Both canvas and paper lithographs feature Thomas Kinkade's signature,
applied in DNA-infused ink through a double authentication signing process. The
Company markets its limited edition canvas lithographs in eight sub-editions and
its paper lithographs in seven sub-editions with various edition sizes and
attributes to provide levels of collectibility at multiple price points. When
determining edition sizes, the Company seeks to balance anticipated market
demand and the desire to maintain collectibility.
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The Company's open edition products include gift prints, gift products and
home accessories based on popular Thomas Kinkade images. Gift prints are smaller
versions of previously released images, reproduced in a number of formats with
varying sizes and attributes. The Company's current gift and home accessory
products include books, ceramic mugs, mini-prints on easels, magnets, small
framed inspirational prints, decorative tins, gift baskets, photograph frames,
candles and stationery items. The Company plans to introduce new products which
may include craft and activity kits, decorative home accessories and home
textiles. The Company's gift and home accessory products are produced primarily
by third party manufacturers under license agreements with the Company.
PRODUCT STRATEGY. The Company's product strategy focuses on creating high
perceived value by limiting edition sizes and creating collectibility. The
Company's strategy also includes providing a broad range of products at a
variety of price points. The following paragraphs describe the key elements of
this strategy.
- CREATE HIGH PERCEIVED VALUE THROUGH LIMITED EDITIONS. The Company seeks to
create high perceived value by producing its lithographs in numbered
limited editions accompanied by certificates of authenticity.
Historically, secondary market prices for the Company's sold-out editions
have exceeded original offering prices. Although the Company does not
promote the potential economic advantages of purchasing its limited
edition artwork, the Company believes that the existence of this secondary
market is an important consideration for some of its customers.
- CREATE COLLECTIBILITY THROUGH PRODUCT SERIES. The Company seeks to promote
collectibility and successive purchases by consumers by introducing many
of its products in series rather than as single offerings. Most of Mr.
Kinkade's works are marketed as part of a series, such as the series of
cabin and wilderness scenes entitled "End of A Perfect Day." The Company
has found that releasing pieces in series has allowed it to generate
pre-release orders from retailers anticipating collector demand.
- LEVERAGE THOMAS KINKADE IMAGES INTO A BROAD ARRAY OF PRODUCTS. The Company
plans to leverage its library of Thomas Kinkade images, particularly its
most successful limited edition releases, into a wide array of home
accessories and gift products. Through this strategy, the Company seeks to
reach a broad consumer base, to build brand awareness and to increase
demand for Thomas Kinkade products.
- TIERED PRICING. In order to appeal to a broad range of consumers with
varying budgets and address the needs of different retail formats, the
Company offers its products at a variety of price points. Retail prices
for reproductions of Thomas Kinkade wall art range from $50 to $250 for a
small framed gift print, $175 to $300 for an unframed paper lithograph,
$300 to $1,200 for a canvas lithograph, $1,500 to $6,000 for a canvas
lithograph hand signed by Thomas Kinkade and $5,000 to $15,000 for a
canvas lithograph hand signed and highlighted by Thomas Kinkade. The
Company's gift and home accessory products generally sell for under $50.
CREATIVE PROCESS. The Company's products are based on the artwork of Thomas
Kinkade, who has won multiple awards from The National Association of Limited
Edition Dealers, including Artist of the Year and Graphic Artist of the Year.
Mr. Kinkade paints in his Northern California studio and on location while
traveling. Mr. Kinkade is known for his unique use of light and the manner in
which his paintings reflect changes in the intensity of the ambient lighting.
Under the terms of the New License Agreement, Mr. Kinkade will provide 150
paintings to the Company during the period commencing December 3, 1997 and
ending 15 years thereafter, with at least 10 paintings to be delivered during
each of the first five years. The Company also has perpetual and exclusive
rights to produce and sell additional products based on an existing library of
over 160 Thomas Kinkade images. In particular, the Company has the exclusive
right to produce, sell, distribute and promote reproductions of Mr. Kinkade's
artwork in any form and the right to use the name and likeness of the artist in
promoting the sale of its products and development of any brand name associated
with Mr. Kinkade. See "--License with Thomas Kinkade." The Company has an active
product development department that works with Mr. Kinkade, dealers of the
Company's products, the Company's in-house sales force and strategic business
partners to create new products. The Company seeks to gauge demand for proposed
new products by pre-marketing prior to product introductions. The Company is
dependent upon continued customer demand for products based upon the artwork of
Thomas Kinkade. Any decline in sales of such products in existing markets or any
failure of such
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products to gain consumer acceptance as the Company expands its distribution
would have a material adverse effect on the Company. See "Risk
Factors--Dependence on Thomas Kinkade; Lack of Product Revenue Diversification"
and "--Dependence on Consumer Preferences."
DISTRIBUTION
The Company currently distributes its products through Thomas Kinkade
Stores, Signature Galleries, a network of other independent dealers consisting
of gift and collectible retailers and strategic relationships with Hallmark,
Avon and QVC. The Company seeks to strengthen its brand and increase sales by
expanding its network of Thomas Kinkade Stores and Signature Galleries,
promoting independent dealers to higher incentive and commitment levels and
expanding distribution through strategic business relationships.
THOMAS KINKADE STORES. Thomas Kinkade Stores provide warm and inviting
environments that convey Thomas Kinkade's lifestyle message and display Thomas
Kinkade lithographs and other products as they might appear in a customer's
home. Strategically located rheostatic lighting enables the retail staff to
showcase Mr. Kinkade's unique use of light and the effect of varying ambient
lighting on the appearance of the artwork. Thomas Kinkade Stores range in size
generally from 1,000 to 2,200 square feet and generated average sales of $1,109
per square foot in fiscal 1997. Sales through Thomas Kinkade Stores were
approximately $15.5 million in fiscal 1997. As of December 31, 1997, the Company
owned and operated 17 Thomas Kinkade Stores in California, Hawaii, Illinois,
Minnesota and Missouri, all of which exclusively sell Thomas Kinkade products.
The Company is seeking to expand this network of Thomas Kinkade Stores through
the opening of new stores and possibly through the selective acquisition of
certain of its independent dealers. The Company plans to locate its new Thomas
Kinkade Stores in strategic mall locations, downtown shopping areas and high
traffic tourist areas to reach the greatest number of consumers and build brand
awareness. The Company currently plans to open two additional Thomas Kinkade
Stores in fiscal 1998 and approximately 10 new Thomas Kinkade Stores in fiscal
1999. There can be no assurance that the Company will be able to open its
planned Thomas Kinkade Stores or that such stores will operate on a profitable
basis. See "Risk Factors--Risks Associated with Expansion of Distribution
Channels."
SIGNATURE GALLERIES. In 1996, the Company initiated its Signature Gallery
program, a network of stores owned and operated by individual entrepreneurs that
exclusively sell Thomas Kinkade products. The Company believes that the
Signature Gallery program enables it to benefit from the regional knowledge of
local Signature Gallery owners, strengthen the Thomas Kinkade brand and broaden
the Company's distribution network, all without significant investment by the
Company. As of December 31, 1997, 67 Signature Galleries had been opened or
converted from existing independent dealers. Sales to Signature Galleries were
approximately $3.1 million in fiscal 1997. The Company intends to expand the
Signature Gallery program aggressively and has identified target areas within
its United States sales districts for potential placement of Signature
Galleries. The Company identifies new Signature Gallery owners through referrals
generated by its in-house sales force, direct inquiries and referrals from
existing dealers and Signature Gallery owners. The Company currently plans to
add 15 additional Signature Galleries in fiscal 1998 and approximately 100 in
fiscal 1999.
Potential Signature Gallery owners must submit a comprehensive business plan
and satisfy certain financial criteria including minimum start-up capital and
net worth requirements in order to qualify for the Signature Gallery program.
Signature Gallery owners agree to, among other things, purchase at least
$100,000 in Company products annually, maintain minimum inventory of $25,000 per
location and display a broad collection of Thomas Kinkade images. Signature
Gallery owners have the opportunity to attend comprehensive training programs at
Thomas Kinkade University. In return, the Company allows Signature Gallery
owners to sell Thomas Kinkade products in environments similar to those of the
Company's Thomas Kinkade Stores and grants Signature Gallery owners limited use
of the Thomas Kinkade name. Signature Galleries also receive automatic shipment
of each new limited edition release and have rights to purchase certain limited
edition inventory otherwise available only to Thomas Kinkade Stores. There can
be no assurance that the Company will be able to identify suitable owners for
its planned Signature Galleries expansion or that such owners will become
effective distributors for the Company's products. See "Risk Factors--Risks
Associated with Expansion of Distribution Channels."
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The following map shows the locations of each of the 17 Thomas Kinkade
Stores and 67 Signature Galleries as of December 31, 1997:
[Graphic art map showing U.S. States which have stores or galleries are shaded
and an arabic number indicates number of store sites in each state.]
<TABLE>
<S> <C> <C>
CALIFORNIA (26, *12) CONNECTICUT (1) Charlotte
Bakersfield Farmington Raleigh
Brea HAWAII (*2) OHIO (1)
Burlingame Lahaina, Maui (*2) Cincinnati
Calistoga ILLINOIS (*1) OREGON (3)
Cambria Schaumberg Ashland
Capitola INDIANA (1) Newburg
Carmel (*3) Zionsville Portland
Catalina MAINE (1) SOUTH CAROLINA (2)
Costa Mesa Kennebunkport Charleston
Escondido MASSACHUSETTS (1) Columbia
Folsom Mashpee TENNESSEE (2)
Fresno MICHIGAN (1) Cleveland
MontClair Birmingham Nashville
Monterey (*4) MINNESOTA (*1) TEXAS (6)
Morro Bay Bloomington Arlington
Newport MISSOURI (1,*1) Dallas
Northridge Kansas City (*1) Fort Worth
Palm Springs St. Louis Houston (2)
Pleasanton NEBRASKA (2) Lewisville
Riverside Omaha (2) UTAH (2)
Sacramento (2) NEVADA (2) Park City
San Diego Carson City Salt Lake
San Francisco (*2) Henderson WASHINGTON (5)
San Rafael NEW JERSEY (2) Bonnylake
Santa Barbara (*1) Cape May Edmonds
Santa Clara (*1) Stone Harbor La Conner (2)
Santa Rosa NORTH CAROLINA (3) Tacoma
Sonoma Asheville WISCONSIN (2)
Tracy Greendale
Walnut Creek (*1) Hales Corners
Yontville
COLORADO (3)
Aspen
Denver (2)
</TABLE>
* indicates Thomas Kinkade Stores
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OTHER INDEPENDENT DEALERS. The Company's products currently are sold to
approximately 2,200 independent dealers, including independent gift retailers,
collectible retailers, art galleries and frame stores located principally in the
United States and, to a lesser extent, in Canada. The Company has organized
these dealers into four levels designed to encourage dealers to increase
purchase commitments by offering increased benefits such as access to a wider
range of the Company's products, automatic shipments of new product releases and
other benefits not available to lower level dealers. Dealer levels range from
Open Edition Accounts, which are authorized to purchase only open edition
products and for which only a $500 initial purchase is required, to Showcase
Dealers, which are stores-within-stores committed to purchase a minimum of
$15,000 annually in limited edition canvas products. By promoting lower level
dealers to higher incentive and commitment levels, the Company believes it is
able to strengthen its dealer network, increase sales and build brand awareness
by leveraging productive dealers. The Company also has been able to identify
potential Signature Gallery owners through its dealer program. As of December
31, 1997, there were approximately 180 Showcase Dealers, 380 Premier Dealers,
930 Authorized Dealers and 710 Open Edition Accounts.
The substantial majority of the Company's product distribution, as well as
its interaction with the ultimate customer, is conducted by independent dealers,
including Signature Gallery owners, whose stores may bear the Thomas Kinkade
name. The Company is in the process of entering into formal licensing agreements
with Signature Gallery owners. Failure by the Company to achieve its planned
expansion of its distribution through Thomas Kinkade Stores, Signature Galleries
and other independent dealers or to do so on a profitable basis could have a
material adverse effect on the Company. In addition, the failure of these
dealers to properly represent the Company's products could damage the reputation
of the Company or Thomas Kinkade and adversely affect the ability of the Company
to build the Thomas Kinkade brand. See "Risk Factors--Risks Associated with
Expansion of Distribution Channels" and "--Reliance on Third Parties."
STRATEGIC BUSINESS RELATIONSHIPS
The Company has entered into agreements with leading consumer marketing
companies to build brand awareness, to generate additional sales by reaching a
larger audience of consumers and to leverage the expertise of these companies in
sales and marketing, manufacturing and distribution. For example, the Thomas
Kinkade brand has received substantial publicity under a strategic licensing
agreement with Hallmark, including in-store promotion and a feature in
Hallmark's Christmas 1997 television and print advertising campaign. The Company
also sells Thomas Kinkade brand products through direct marketing on QVC and
through direct mail catalogs, such as Avon. The Company's paper lithographs,
open edition gift prints and other home accessory and gift products were
featured on QVC shows totaling 12 hours in 1996 and 15 hours in 1997. The
Company intends to continue to develop strategic business relationships with
leading consumer marketing companies in the United States and abroad.
SALES AND MARKETING
The Company's sales and marketing efforts include an in-house sales force
that sells to and services wholesale accounts, training programs for in-house
and retail sales personnel and Signature Gallery owners through Thomas Kinkade
University, marketing and promotional programs and a consumer-oriented Thomas
Kinkade Collectors' Society, each of which is described below.
IN-HOUSE SALES FORCE. As of December 31, 1997 the Company's sales force
consisted of a Vice President supported by four Regional Sales Directors, a
Director of Sales Operations and 28 District Sales Managers. The sales force is
generally compensated on a salary plus commission basis. Many of these sales
personnel are experienced in both the gift and collectibles and direct sales
industries. District Sales Managers call on Signature Galleries, the Company's
independent dealers and other potential dealers. Certain of the Company's
in-house sales personnel support the Signature Gallery program through review
and approval of applications and ongoing on-site and telephone support to
Signature Gallery owners.
TRAINING. The Company conducts training programs for its in-house sales
personnel, retail consultants and other Company employees, as well as Signature
Gallery owners, at Thomas Kinkade University, a training
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facility located in Monterey, California. Thomas Kinkade University consists of
a week-long training program that emphasizes product knowledge and selling
techniques, marketing, accounting, inventory management and administration. All
District Sales Managers and Thomas Kinkade Store managers attend training
sessions at Thomas Kinkade University and participate in an annual national
sales meeting and quarterly regional sales meetings.
MARKETING PROGRAMS. Each Thomas Kinkade Store keeps a customer list from
which it targets direct mailings, including postcards introducing new product
releases. The Company designs and sells promotional materials including
postcards, catalogs and videotapes to Signature Galleries and independent
dealers for sale or direct marketing to consumers. In addition, the Company
produces print advertising available to Signature Galleries on a co-op basis.
Signature Galleries and other high level independent dealers may pay to
participate in regional events (including appearances by Thomas Kinkade)
organized by the Company from time to time. In addition, the Company benefits
from advertising funded by its strategic business partners, such as Hallmark's
Christmas 1997 television and print advertising campaign and a number of
exclusive shows on QVC.
THOMAS KINKADE COLLECTORS' SOCIETY. The Company sponsors and operates a
collector's club for consumers of Thomas Kinkade products. As of December 31,
1997, the Thomas Kinkade Collectors Society had over 17,500 members. Members pay
an annual membership fee of $45 and receive quarterly newsletters that keep them
informed about Mr. Kinkade's artwork, including upcoming releases and events.
Members also have the opportunity to purchase "members only" product offerings.
MANUFACTURING AND PRODUCTION
The Company manufactures canvas lithographs and assembles, warehouses and
ships its lithograph products from its production facility in San Jose,
California. Most of the Company's three-dimensional products and gift items, as
well as its paper lithographs, are manufactured by third parties under
manufacturing or licensing arrangements.
The Company's proprietary manufacturing process for a canvas lithograph
begins with an original Thomas Kinkade painting. An independent photographer
photographs the painting and produces a transparency. The transparency then goes
to a digitizing facility for the creation of a color separation. The color
separation is reviewed and approved by Thomas Kinkade, who works with an
independent printer and the Company's artistic team, to develop a paper
lithograph that best represents the original painting. The paper lithographs are
then printed and sent to the Company's warehouse facilities, where they are sent
through a double authentication signing process, inspected, transferred to
canvas and hand-highlighted. The manufacturing process takes approximately five
days to complete. The Company then frames and ships finished canvas lithographs
in accordance with order specifications. Third party vendors supply the frames,
paper, canvas, paint and other raw materials and components used by the Company
in its lithograph production process. The failure of any of these third party
vendors to produce products that meet the Company's specifications could result
in lower sales or otherwise adversely affect consumer perceptions of the
Company's brand and products. There can be no assurance that the Company will
not encounter shortages in the future, and any prolonged shortage in frames or
other materials could have a material adverse effect on the Company. See "Risk
Factors--Reliance on Third Parties" and "--Ability to Effectively Manage
Expansion; Need for Additional Manufacturing Capacity."
The Company is committed to assuring that its products meet its quality
standards and continually evaluates its manufacturing processes to maintain
quality control. Systematic quality control procedures are in place at various
points in the manufacturing process, including spot inspections and regular
inspection check stations. In order to improve quality control, shorten
production time and increase capacity, the Company intends to automate certain
portions of its production process, invest in packaging, conveyance, barcoding
and MIS equipment and develop further improvements in the lithograph
manufacturing process. In addition, the Company is considering vertically
integrating certain of its manufacturing processes. The majority of the
Company's inventory is comprised of paper lithographs and frames.
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SYSTEMS
The Company uses JD Edwards software on an IBM AS/400 computer system in
order to provide integrated order processing, production, manufacturing,
financial management and distribution functions for the Company's business. The
Company plans to upgrade its JD Edwards software application suite within the
next six months. In addition, the Company recently began installation of a new
retail management software system in its Thomas Kinkade Stores to process
point-of-sale transactions, provide real-time information and enhance inventory
and office management.
BACKLOG
Because the Company generally ships its products within a short period after
receipt of an order, the Company does not have a material backlog of unfilled
orders, and sales in any quarter are substantially dependent on orders booked in
that quarter.
LICENSE WITH THOMAS KINKADE
The Company entered into the New License Agreement with Thomas Kinkade,
effective as of December 3, 1997, the material terms of which are discussed
below. Under the New License Agreement Thomas Kinkade granted the Company
perpetual and exclusive rights to each image produced by Mr. Kinkade under the
New License Agreement, as well as to the library of over 160 existing Thomas
Kinkade images, subject to certain exceptions. In particular, the Company has
the exclusive right to produce, sell, distribute and promote reproductions of
Mr. Kinkade's artwork in any form and the right to use the name and likeness of
the artist in promoting the sale of its products and development of any brand
name associated with Mr. Kinkade. The New License Agreement requires Mr. Kinkade
to deliver 150 paintings to the Company during the period commencing December 3,
1997 and ending 15 years thereafter, with at least 10 paintings to be delivered
during each of the first five years. Mr. Kinkade has the right to approve the
Company's products based upon his artwork, as well as promotional materials,
business plans and strategic relationships relating to such products or the use
of his name or likeness. Mr. Kinkade retains ownership of the original paintings
he produces.
The New License Agreement permits Mr. Kinkade to reproduce up to two pieces
annually to raise money for the City of Placerville, California. Mr. Kinkade
also retained the right to use his name, likeness and certain artwork in
association with non-profit organizations. In addition, Mr. Kinkade retained the
right to use his name in connection with for-profit ventures with the Company's
prior consent, provided that he first offers the opportunity to the Company. Mr.
Kinkade is otherwise subject to a non-compete agreement with the Company under
the New License Agreement.
The principal terms of the New License Agreement are as follows: Mr. Kinkade
is entitled to 4.5% of the Company's net sales through May 8, 2000, and 5.0% of
the Company's net sales thereafter, provided that if the Company's net sales
should exceed $500 million, Mr. Kinkade would also be entitled to receive 1.0%
of any excess amount. To encourage timely delivery of paintings, commencing
April 1, 1998, Mr. Kinkade will receive 25.0% of the Company's consolidated
operating margin in excess of 23.0%, if any, if Mr. Kinkade delivers all
paintings at least 12 weeks ahead of the applicable scheduled release date
during the subject fiscal year. Mr. Kinkade also will receive 65.0% of the
wholesale gross profit margin of any Studio Proof products through May 8, 2000
and 35.0% of such margin thereafter. In addition, Mr. Kinkade is entitled to
receive 50.0% of the retail value of any Masters Edition products. The Company
must pay Mr. Kinkade $25,000 for each new painting and pay for his studio rent
and office support. The Company receives all of the licensing income from the
licensing of products that incorporate Thomas Kinkade's images. Subject to
stockholder approval, to be sought after the date of this Prospectus, Mr.
Kinkade was granted a 15-year option to purchase 600,000 shares of Common Stock
at $12.375, the closing price of the Common Stock on December 3, 1997.
The New License Agreement is terminable by either party after failure by the
other party for 90 days to cure a material breach of the agreement. In addition,
Mr. Kinkade may terminate the New License Agreement in the event of the
Company's insolvency or upon a change of control of the Company. A change in
control is defined to occur on the date when any person or group (as defined in
Rule 13(d)(3) under the Securities
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<PAGE>
Exchange Act of 1934) beneficially owns (as defined in such Rule) a number of
shares of Common Stock in excess of the number of shares then beneficially owned
by Mr. Kinkade. The computation excludes stockholders as of December 3, 1997 to
the extent of their beneficial holdings of Common Stock as of such date. The
right of termination may not be invoked by Mr. Kinkade if it is triggered as a
result of Mr. Kinkade's transfer of shares. After December 3, 2012, the
perpetual nature of the New License Agreement may be terminated by Mr. Kinkade
if the Company engages in any material business enterprises unrelated to his
work or brand name to which he objects. Upon any termination of the New License
Agreement by Mr. Kinkade, the Company would be prohibited from selling any
products based upon Mr. Kinkade's artwork, other than the Company's then
existing product inventory.
The New License Agreement superseded the Company's previous license and
royalty arrangements with Mr. Kinkade. Had the New License Agreement been in
effect for fiscal 1997 and the nine months ended December 31, 1997, Mr. Kinkade
would have earned $3.0 million and $4.0 million, respectively, compared to $1.8
million and $2.9 million, respectively, under the previous arrangements. Mr.
Kinkade is also compensated as the Company's Creative Director. See
"Management--Employment and Change in Control Agreements" and "Certain
Transactions."
COMPETITION
The art-based home decorative accessories, collectibles and gift products
industries are highly fragmented and competitive. Participants in these
industries compete generally on the basis of product and brand appeal, quality,
price and service. The Company's products compete with products marketed by
numerous regional, national and foreign companies that are distributed through a
variety of retail formats including department stores, mass merchants, art and
gift galleries and frame shops, bookstores, mall-based specialty retailers,
direct response marketing programs, catalogs, and furniture and home decor
stores. The number of marketers and retail outlets selling home decorative
accessories, collectibles and gift products has increased in recent years, and
the entry of these companies together with the lack of significant barriers to
entry may result in increased competition. The Company intends to open Thomas
Kinkade Stores and/or add Signature Galleries in geographic markets where it has
little or no experience and, as a result, it may encounter competitive
challenges that it has not experienced to date. Such competition could have a
material adverse effect on the Company. Some of the Company's competitors have
substantially greater resources than the Company, including name recognition and
capital resources, have more diversified product offerings and sell their
products through broader distribution channels than the Company. The Company's
business depends substantially on its ability to produce on an ongoing basis a
wide variety of products that appeal to a broad range of consumers who can gain
ready access to such products. See "Risk Factors--Competition."
EMPLOYEES
As of December 31, 1997, the Company had 336 full-time and 68 part-time and
temporary employees, including 120 in manufacturing and distribution, 110 in
sales and marketing, 120 in retail sales and administration and 54 in corporate
administration. The Company believes that its labor relations are satisfactory
and has never experienced a work stoppage.
PROPERTIES
The Company's manufacturing, distribution, sales and marketing,
administration and executive offices are located in four leased facilities in
San Jose and Monterey, California with an aggregate of 113,000 square feet. As
of December 31, 1997, the Company's retail operations were located in 18 leased
sites throughout the United States ranging from 144 to 2,700 square feet, with
an aggregate of approximately 19,000 square feet. In addition, in January 1998,
the Company leased approximately 22,000 square feet of manufacturing and office
space, and expects to enter into leases for new retail sites prior to the end of
fiscal 1998. The Company otherwise believes that its properties are adequate to
support the Company's needs through fiscal 1998.
LEGAL PROCEEDINGS
The Company is not a party to any legal proceedings which, individually or
in the aggregate, are believed to be material to the Company's business.
31
<PAGE>
MANAGEMENT
DIRECTORS AND OFFICERS
Directors and officers of the Company, and their ages as of December 31,
1997, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITIONS
- ----------------------------------------- --- ----------------------------------------------------------------
<S> <C> <C>
Kenneth E. Raasch........................ 37 Chairman
Thomas Kinkade........................... 39 Creative Director and Director
Craig A. Fleming......................... 42 President and Chief Executive Officer
Raymond A. Peterson...................... 52 Senior Vice President and Chief Financial Officer
John Lackner............................. 57 Senior Vice President and Chief Operating Officer
Daniel P. Byrne.......................... 35 Senior Vice President of Product Development and Marketing
Greg H. L. Nash.......................... 38 Corporate Controller and Principal Accounting Officer
James F. Landrum, Jr..................... 33 Vice President, General Counsel and Corporate Secretary
Dean O. Bard............................. 47 Vice President of Human Resources
Richard F. Barnett....................... 44 Vice President of Retail Development
Harry B. Boyd............................ 58 Vice President of Operations
G. Eric Kuskey........................... 35 Vice President of Licensing
Brian P. Mahoney......................... 41 Vice President of Sales
Kevin M. Sacher.......................... 37 Vice President of Marketing
Michael L. Kiley (1)..................... 53 Director, Vice Chairman and Independent Consultant
Norman T. Mahoney (2).................... 68 Director
Norman A. Nason (1)(2)................... 57 Director
</TABLE>
- ------------------------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
Directors of the Company are elected annually and serve until their
successors are elected and qualified or until their earlier resignation or
removal. The Company has agreed to use its best efforts to cause a nominee
designated by the underwriters of its initial public offering to be elected to
the Board of Directors until August 1998; such right had not been exercised with
respect to the Company's current directors. Officers of the Company are
appointed annually and serve at the discretion of the Company's Board of
Directors. There are no family relationships among the officers and directors of
the Company, except that Brian P. Mahoney, Vice President of Sales, is the son
of Norman T. Mahoney, a director.
KENNETH E. RAASCH co-founded the Company in 1990 and has been the Chairman
of the Board of the Company since its inception in March 1990. In addition, he
was President of the Company from March 1990 to May 1997 and Chief Executive
Officer from March 1996 until October 1997. Mr. Raasch's responsibilities as
Chairman include formulating and executing the Company's strategic plan,
developing new strategic business relationships and representing the Company to
the financial community, among other things. Prior to joining the Company, he
was the President and majority shareholder of First Med Corp., Inc., a medical
billing and management company, from August 1988 until January 1990 when it was
sold to Medaphis Corp., a public company.
32
<PAGE>
THOMAS KINKADE co-founded the Company and has been the Creative Director and
a member of the Board of Directors of the Company since its inception in March
1990. Mr. Kinkade has provided artwork to the Company for its productions since
the Company's inception. In addition, Mr. Kinkade's role includes providing
strategic vision for the Thomas Kinkade brand, assisting in product development
and communicating the Company's brand message through public appearances and
books. Prior to March 1990, Mr. Kinkade was a self-employed artist.
CRAIG A. FLEMING has been the President of the Company since May 1997 and
the President and Chief Executive Officer since October 1997 and was Vice
President of Sales for the Company from November 1996 to May 1997. Prior to
joining the Company, Mr. Fleming was an independent consultant from March 1996
to October 1996, as well as the Executive Vice President of Sales for Home Cable
Concepts, Inc., a direct TV satellite dish company from October 1995 to March
1996. Prior to employment with Home Cable Concepts, Mr. Fleming was the Vice
President of Sales for Dorling Kindersley Family Library, a direct seller of
children's books, from July 1994 through October 1995. Prior thereto, Mr.
Fleming was Director of Sales for Melaleuca, Inc., a direct selling
organization, from June 1992 to July 1994.
RAYMOND A. PETERSON has been Senior Vice President and Chief Financial
Officer of the Company since May 1993. He was the Chief Executive Officer of
Peterson, Sense & Company, a certified public accounting firm, for the previous
15 years, during which time he provided accounting, tax and financial planning
services for the Company. Prior thereto, Mr. Peterson was the Corporate Tax
Manager for Raychem Corporation, multi-national manufacturing corporation and a
Senior Tax Accountant with Peat Marwick & Mitchell (currently KPMG Peat
Marwick).
JOHN LACKNER has been the Senior Vice President and Chief Operating Officer
of the Company since October 1997. Prior to joining the Company, Mr. Lackner was
employed for over 25 years with the Kirby Company, an established manufacturer
and retailer of quality vacuum cleaners. His most recent position with the Kirby
Company was as Senior Vice President of Research, Product Development and
Technology, which position he had held since 1990. Mr. Lackner also served as a
Vice President in manufacturing and production for the Kirby Company from 1981
to 1990.
DANIEL P. BYRNE has been the Senior Vice President of Product Development
and Marketing of the Company since June 1996. He was the Vice President of
Marketing of the Company from March 1993 to June 1996. Prior thereto, he was a
Vice President with Commemorative Press, an art retailing company co-founded by
Kenneth E. Raasch and Thomas Kinkade. He was employed as Manager of Product
Development and Manager of Concept Development by the Bradford Exchange, Ltd.,
an established manufacturer and marketer of collectible giftware, from October
1988 until February 1992. Mr. Byrne also served as the Product Manager of
Precious Moments Collection, a multi-million dollar product line of Enesco
Corporation, a subsidiary of Stanhome Inc., for a period of three years.
GREG H. L. NASH has been the Corporate Controller of the Company since May
1995 and also has been Principal Accounting Officer since November 1997. From
August 1988 until April 1995 he was employed by Price Waterhouse LLP, most
recently as an Audit and Business Services Manager. Prior to August 1988 he held
various management positions with companies in the investment and retail
industries.
JAMES F. LANDRUM, JR. has been the General Counsel for the Company since
February 1995 and was appointed Vice President and Corporate Secretary on April
30, 1997. He was self employed as an attorney and business consultant for two
years prior to joining the Company.
DEAN O. BARD has been the Vice President of Human Resources for the Company
since August 1997. From September 1993 to May 1996, he was the Manager of
Benefit Planning at Occidental Petroleum, an energy and chemical corporation.
Prior thereto, Mr. Bard was the Director of Compensation and Benefits at Island
Creek Coal, a coal mining company.
RICHARD F. BARNETT has been Vice President of Retail Development for the
Company since October 1995. Prior thereto, Mr. Barnett owned a number of
galleries which sold Thomas Kinkade products.
33
<PAGE>
HARRY B. BOYD has been the Vice President of Operations for the Company
since August 1996. Prior thereto, he was the Vice President of Operations for
Diversey Tech, a chemical pumping company, from July 1988 to August 1996.
G. ERIC. KUSKEY has been the Vice President of Licensing for the Company
since January 1997 and was the Director of Licensing for the Company from
September 1995 to January 1997. Prior to joining the Company, from January 1994
to September 1995 Mr. Kuskey worked as an independent agent negotiating
licensing, product development and distribution agreements for publishers and
intellectual property owners in the United States and abroad. From January 1990
to January 1994, he was the Licensing Director at Pemberton & Oakes, an art
publishing company.
BRIAN P. MAHONEY has been the Vice President of Sales for the Company since
July 1997. Prior to joining the Company, from August 1994 to July 1997, Mr.
Mahoney was the Vice President of Sales for Natural World, a direct sales
company. From July 1992 to August 1994 he was a Region Vice President for
Melaleuca, Inc., a direct sales company. For the 13 years prior to that, he was
an independent contractor for the Kirby Company, serving as a sales person,
Assistant Divisional Supervisor and Factory Distributor.
KEVIN M. SACHER has been with the Company since October 1993 and has been
Vice President of Marketing since April 1996. Prior thereto, Mr. Sacher was Vice
President of the Company's Entertainment Division from April 1995 to April 1996,
and Senior Product Manager from October 1993 to April 1995. Prior to joining the
Company, he was a Product Manager at Franklin Mint, a direct response seller of
collectibles, from October 1992 to October 1993.
MICHAEL L. KILEY has been a director of the Company since January 1997 and
Vice Chairman of the Board since June 1997. Mr. Kiley has been an independent
consultant to the Company since April 1997. In 1978, he founded Home Church and
has served as Pastor since that time. Prior to founding Home Church, Mr. Kiley
co-owned Business Exchange, Inc., a cooperative buying company servicing over
400 business owners.
NORMAN T. MAHONEY has been a director of the Company since March 1997. From
1988 to 1995 he served as a consultant to Scott Fetzer Corporation, a
diversified manufacturer whose product lines include Kirby brand vacuum
cleaners, encyclopedias and educational materials. Mr. Mahoney was previously
President and CEO of the Kirby Company, a division of Scott Fetzer Corporation.
NORMAN A. NASON has been a director of the Company since April 1993. Mr.
Nason is President of Saratoga Commercial Real Estate Brokerage Corporation and
Saratoga Management Corporation, companies that he founded in 1976.
DIRECTOR COMPENSATION
Board members other than the Company's outside directors receive no
compensation for attending Board meetings, except for reimbursement of certain
expenses in connection with attendance at Board meetings and Committee meetings.
The Company's outside directors receive $2,000 per meeting as compensation for
their services as Directors. In addition, one of the outside directors, Norman
A. Nason, received $15,000 for serving as a member of the Board in fiscal 1997.
The Company's outside directors also have various consulting agreements with the
Company. See "Certain Transactions."
In addition to cash compensation, the Company's nonemployee directors are
entitled to participate in the Company's Directors' Stock Option Plan. The Board
of Directors and the stockholders of the Company approved the Directors' Stock
Option Plan on February 15, 1994 and reserved 50,000 shares of Common Stock for
issuance thereunder. On the approval date of the Directors' Stock Option Plan,
the Company's then current nonemployee directors received an initial grant of an
option to purchase 7,909 shares of Common Stock at an exercise price of $7.11
per share. After the approval date of the Directors' Stock Option Plan, any new
nonemployee director is entitled to receive on the first business day following
such director's appointment an initial grant of an option to purchase 5,000
shares of Common Stock under the Directors' Stock Option Plan. Following an
initial grant, on the business day following each annual meeting of the
Company's stockholders,
34
<PAGE>
each nonemployee director who will then have served at least one year as a
director of the Company is entitled to receive a grant of an option to purchase
an additional 1,500 shares of Common Stock. All options granted under the
Directors' Stock Option Plan are non-qualified and have an exercise price per
share equal to the fair market value of the Common Stock, as determined pursuant
to the Directors' Stock Option Plan. The options are immediately and fully
exercisable as of their respective grant dates and terminate upon the earlier of
(i) the tenth anniversary of the grant date; (ii) the expiration of the
three-month period following the termination of the participant's services as a
director for any reason other than disability or death; (iii) the first
anniversary of the termination of the participant's service by reason of
disability; or (iv) the first anniversary of the participant's death. Directors'
options expire upon a merger or consolidation of the Company with or into
another corporation or acquisition by another corporation or person of all or
substantially all of the Company's assets or at least 51% of the Company's then
outstanding voting stock or a liquidation or dissolution of the Company. Options
are not transferable except by will or descent and distribution.
EXECUTIVE COMPENSATION
The following table sets forth information concerning the compensation of
the Chief Executive Officer of the Company and the other highly compensated
executive officers of the Company whose salary and incentive compensation
exceeded $100,000 for the year ended March 31, 1997. Since March 31, 1997, Craig
A. Fleming has replaced Kenneth E. Raasch as President and Chief Executive
Officer, with Mr. Raasch remaining as Chairman, and John Lackner has joined the
Company as Chief Operating Officer.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION AWARDS
ANNUAL COMPENSATION ---------------------
------------------------ SHARES UNDERLYING
NAME AND PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) OPTIONS (#)
- ----------------------------------------------------------- --------- ----------- ----------- ---------------------
<S> <C> <C> <C> <C>
Kenneth E. Raasch, Chairman 1997 427,586 -- --
1996 381,119 -- --
1995 363,075 89,850 --
Thomas Kinkade, Creative Director 1997 373,893(1) -- --
1996 373,908(1) -- --
1995 364,781(1) -- --
Daniel P. Byrne, Senior Vice President of Marketing 1997 163,816 6,798 --
1996 162,542 -- --
1995 136,992 -- --
Raymond A. Peterson, Chief Financial Officer and Senior 1997 133,995 6,798 25,000
Vice President 1996 129,080 10,000 5,000
1995 122,917 -- --
</TABLE>
- ------------------------
(1) Does not include $1,323,977, $1,258,633 and $366,672 earned by Thomas
Kinkade in 1997, 1996 and 1995, respectively, pursuant to certain licensing,
royalty and other arrangements with the Company. See "Certain Transactions."
35
<PAGE>
OPTION GRANTS
The following table provides specific information concerning grants of
options to purchase the Company's Common Stock made during the fiscal year ended
March 31, 1997 to the persons named in the Summary Compensation Table.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
NUMBER OF ANNUAL RATES OF
SECURITIES STOCK PRICE
UNDERLYING % OF TOTAL APPRECIATION FOR
OPTIONS OPTIONS GRANTED EXERCISE OPTION TERM (3)
GRANTED TO EMPLOYEES IN PRICE EXPIRATION --------------------
NAME (1) (#) FISCAL YEAR (2) ($/ SH) DATE 5% ($) 10% ($)
- ------------------------------------------ ----------- ----------------- ----------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Kenneth E. Raasch......................... -- -- -- -- -- --
Thomas Kinkade............................ -- -- -- -- -- --
Daniel P. Byrne........................... -- -- -- -- -- --
Raymond A. Peterson....................... 25,000 17% 2.437 2/3/07 38,315 97,099
</TABLE>
- ------------------------
(1) Generally, the right to exercise an option under the Employees Stock Option
Plan vests as to one-fifth of the shares subject to the option on each
anniversary of the date of grant. The Employees Stock Option Plan permits
the grant of both incentive stock options within the meaning of Section 422
of the Internal Revenue Code, as amended and nonstatutory stock options. The
exercise price of incentive stock options and non-qualified stock options
must at least equal the fair market value of the Common Stock of the Company
on the date of grant. The exercise price of incentive stock options or
non-qualified stock options granted to any person who at the time of grant
owns stock representing more than 10% of the voting power of all classes of
stock of the Company or any parent or subsidiary corporations must be at
least 110% of the fair market value of the Common Stock of the Company on
the date of grant and the term of such options cannot exceed five years or
five years and one day, respectively.
(2) The option was granted based upon market value on the date of grant as
determined by the Company.
(3) Potential gains are net of exercise price, but before taxes associated with
exercise. These amounts represent certain assumed rates of appreciation
only, based on the Securities and Exchange Commission rules. Actual gains if
any, on stock option exercises are dependent on the future performance of
the Common Stock, overall market conditions and the option-holder's
continued employment through the vesting period. The amounts reflected in
this table may not necessarily be achieved.
36
<PAGE>
The following table provides the specified information concerning options
held as of March 31, 1997, by the persons named in the Summary Compensation
Table. No persons named in the Summary Compensation Table exercised options
during the fiscal year ended March 31, 1997 and no stock appreciation rights
were outstanding at March 31, 1997.
AGGREGATE OPTION EXERCISES AND FISCAL YEAR-END VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES UNDERLYING
UNEXERCISED OPTIONS HELD AT MARCH 31, VALUE OF UNEXERCISED IN-THE-MONEY
1997 OPTIONS AT MARCH 31, 1997 (2)
------------------------------------- -----------------------------------
EXERCISABLE UNEXERCISABLE (1) EXERCISABLE UNEXERCISABLE (1)
NAME (1)(#) (#) ($) ($)
- ------------------------------------- ---------------- ------------------- -------------- -------------------
<S> <C> <C> <C> <C>
Kenneth E. Raasch.................... 15,000 -- -- --
Thomas Kinkade....................... -- -- -- --
Daniel P. Byrne...................... 107,725 -- 235,201 --
Raymond A. Peterson.................. 103,725 32,000 236,041 65,600
</TABLE>
- ------------------------
(1) Company stock options generally vest one-fifth on the first anniversary of
the date of grant and one-fifth per year thereafter. These options are
exercisable only to the extent vested.
(2) The value of the unexercised in-the-money options is based on the closing
price of the Company's Common Stock on March 31, 1997 ($4.875 per share) and
is net of the exercise price of such options.
EMPLOYMENT AND CHANGE IN CONTROL AGREEMENTS
The Company has entered into employment agreements with certain of its
executive officers. In January 1994, the Company entered into a five-year
Employment Agreement with Kenneth E. Raasch to serve as Chairman of the Board,
President and Chief Executive Officer of the Company. This agreement, as amended
in March 1997, provides for an annual base salary of $360,000. In addition, Mr.
Raasch is entitled to receive incentive bonuses based upon (i) annual growth in
earnings per share; (ii) past enhanced performance (with penalties for poor
performance); (iii) operating income generated by new business ventures; and
(iv) early retirement of the Company's subordinated debt. In May 1997, he
relinquished the position of President and became Chairman and Chief Executive
Officer of the Company; in October 1997, Mr. Raasch also relinquished the
position of Chief Executive Officer.
In the event Mr. Raasch's employment is terminated by the Company prior to a
"Change in Control" other than for cause or disability (as defined in the
agreement), he is entitled to (i) receive salary, bonus and vested benefits for
the remaining term of the agreement at his then current compensation; and (ii)
continuation of indemnification and insurance coverage in effect at the time of
the termination, until any possible law suit against him is time barred by the
statute of limitation.
Mr. Kinkade was engaged by the Company as Art Director (later changed to
Creative Director) for a period of five years at an annual base salary of
$60,000, pursuant to Mr. Kinkade's January 1, 1994 employment agreement with the
Company. In addition to his base salary, Mr. Kinkade is entitled to receive a
bonus each year which bears the same pro rata relationship to his base salary as
the Company's pre-tax operating income for the year bears to the forecast amount
reflected in the Company's business plan of that year. Mr. Kinkade is also
entitled to certain royalties and other payments in connection with his artwork.
See "Business--License with Thomas Kinkade" and "Certain Transactions."
Mr. Peterson was engaged by the Company as Chief Financial Officer effective
January 1, 1994 for a period of five years at an annual base salary of $100,000
($150,000 effective January 1, 1997) pursuant to Mr. Peterson's employment
agreement with the Company. Mr. Peterson is also eligible to participate in the
Company's bonus plan adopted for the benefit of senior executives.
37
<PAGE>
Mr. Lackner was engaged by the Company pursuant to a written employment
agreement as Senior Vice President, Chief Operating Officer effective October 1,
1997. His employment agreement is effective for a period of five years at an
annual base salary of $175,000. In addition to his base salary, Mr. Lackner is
entitled to an art allowance of $5,000, a temporary living allowance, relocation
and moving expense payments, participation in the Company's bonus plan adopted
for the benefit of senior executives and other benefits. The agreement also
provides that Mr. Lackner will receive a bonus payment of $25,000 in 1998. The
Company granted to Mr. Lackner pursuant to the agreement an option to purchase
15,000 shares of the Company's Common Stock on the date of agreement and an
option to purchase 26,000 shares of the Company's Common Stock at fair market
value on October 29, 1997.
Mr. Fleming, President and Chief Executive Officer of the Company, entered
into a three-year employment agreement with the Company effective as of May 8,
1997 that supersedes a prior employment agreement. The agreement provides for an
annual base salary of $225,000, the opportunity to participate in any bonus plan
adopted for the benefit of senior executives, a monthly living allowance through
December 1997, a $10,000 art allowance, a relocation expense payment and a
twelve-month living allowance in the event of relocation of Mr. Fleming's
immediate family to Santa Clara County, California, in addition to other
benefits. The Company also granted to Mr. Fleming pursuant to the agreement an
option to purchase 50,000 shares of the Company's Common Stock at fair market
value on the date of formal Board approval of such options; an option to
purchase 25,000 shares of the Company's Common Stock at fair market value on
July 1, 1998; and an option to purchase 25,000 shares of the Company's Common
Stock at fair market value on July 1, 1999.
Mr. Byrne was engaged by the Company as Vice President of Marketing for a
period of three years (with an automatic two year renewal) effective January 1,
1994 at an annual base salary of $138,000 ($181,560 effective April 1, 1997)
pursuant to Mr. Byrne's employment agreement with the Company. Mr. Byrne is also
eligible to participate in the Company's bonus plan adopted for the benefit of
senior executives.
The employment agreements of Messrs. Raasch, Peterson, Kinkade, Byrne and
Fleming each provide for the officer to receive all salary and bonus payments
that would have been payable to him for the remaining term of the agreement
after a "Change in Control" which provides "Good Reason" for the officer to
terminate his employment. "Good Reason" is defined to include, among other
things, the assignment to the officer of duties inconsistent with his senior
executive status, a reduction in his base salary, a relocation of the officer or
the Company's principal office and the termination of any compensation or other
employee benefits plans in which he was eligible to participate.
38
<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information as of December 31, 1997,
with respect to the Common Stock beneficially owned by (i) each person known by
the Company to be the beneficial owner of more than 5% of the shares of Common
Stock; (ii) each stockholder who is selling Common Stock in this offering (the
"Selling Stockholders"); (iii) each director individually; (iv) certain named
executive officers individually; and (v) all directors and executive officers as
a group.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED PRIOR TO OFFERING OWNED AFTER THE
(1) SHARES OFFERING (1)(2)(3)
----------------------- OFFERED -----------------------
NUMBER PERCENT (3) NUMBER PERCENT
---------- ----------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C>
NAME AND ADDRESS OF 5% STOCKHOLDERS
- ---------------------------------------------------------
Kenneth E. Raasch (3)(4)(5) ............................. 3,851,875 34.2% -- 3,851,875 30.2%
521 Charcot Avenue
San Jose, CA 95131
Thomas Kinkade (3)(6) ................................... 3,312,043 29.9% -- 3,312,043 26.3%
521 Charcot Avenue
San Jose, CA 95131
Levine Leichtman Capital Partners, L.P. (7) ............. 940,700 8.5% 700,000 240,700 1.9%
345 North Maple Drive, Suite 304
Beverly Hills, CA 90210
CERTAIN OTHER EXECUTIVE OFFICERS AND DIRECTORS
- ---------------------------------------------------------
Raymond A. Peterson (8).................................. 122,725 1.1% 20,000 102,725 *
Daniel P. Byrne (9)...................................... 108,725 1.0% 15,000 93,725 *
Michael L. Kiley (10).................................... 76,500 * -- 76,500 *
Norman A. Nason (11)..................................... 32,682 * -- 32,682 *
Norman T. Mahoney (12)................................... 7,500 * -- 7,500 *
All directors and executive officers as a group (11
persons) (13).......................................... 7,536,250 64.8% 37,500 7,498,750 57.1%
OTHER SELLING STOCKHOLDERS
- ---------------------------------------------------------
Robert Wallace........................................... 200,370 1.8% 160,000 40,370 *
Other Selling Stockholders (4 persons or entities)
holding less than 1% of the Common Stock outstanding
prior to the offering.................................. 43,072 * 14,500 28,572 *
</TABLE>
- ------------------------
* Less than 1%.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission which generally attribute beneficial
ownership of securities to persons who possess sole or shared voting power
and/or investment power with respect to those securities and includes shares
of common stock issuable pursuant to the exercise of stock options that are
immediately exercisable or exercisable within 60 days. Unless otherwise
indicated, the persons or entities identified in this table have sole voting
and investment power with respect to all shares shown as beneficially owned
by them. Percentage ownership calculations prior to and after the offering
are based on 11,083,042 shares and 12,583,042 shares, respectively, of
Common Stock outstanding.
(2) Gives effect to the issuance of a total of 1,500,000 shares sold in the
offering.
39
<PAGE>
(3) In the event that the Underwriters exercise the over-allotment option, up to
an additional 361,425 shares of Common Stock may be sold as follows: Kenneth
E. Raasch, 189,748 shares; Thomas Kinkade, 171,677 shares. In the event that
the over-allotment option is exercised in full, Mr. Raasch will own
beneficially approximately 28.7% and Mr. Kinkade will own beneficially
approximately 25.0% of the Common Stock outstanding upon the completion of
the offering.
(4) The shares owned by Mr. Raasch are held by Kenneth E. Raasch and Linda
Louise Raasch, as Trustees of the Raasch Family Trust, May 18, 1993.
(5) Includes 165,517 shares of Common Stock which may be acquired upon the
conversion of a $1,200,000 promissory note issued to Linda Raasch, the wife
of Mr. Raasch, on June 30, 1995. Also includes 15,000 shares subject to
options held by Mr. Raasch.
(6) Does not include an option to purchase 600,000 shares of the Company's
Common Stock granted as of December 3, 1997 in connection with the New
License Agreement, subject to stockholder approval.
(7) The general partner of the named stockholder is LLCP California Equity
Partners, L.P.
(8) Includes 119,725 shares subject to options held by Mr. Peterson, of which
20,000 will be sold in the offering.
(9) Includes 107,725 shares subject to options held by Mr. Byrne, of which
15,000 will be sold in the offering.
(10) Includes 76,500 shares subject to options held by Mr. Kiley.
(11) Includes 27,682 shares subject to options held by Mr. Nason.
(12) Includes 6,500 shares subject to options held by Mr. Mahoney.
(13) Includes an aggregate of 374,532 shares subject to options held by the
directors and executive officers, of which an aggregate of 37,500 will be
sold in the offering, and 165,517 shares that may be acquired beneficially
by Mr. Raasch upon the conversion of a promissory note.
40
<PAGE>
CERTAIN TRANSACTIONS
LICENSE AGREEMENT WITH THOMAS KINKADE. Effective December 3, 1997, the
Company entered into the New License Agreement with Thomas Kinkade, a director,
employee and principal stockholder of the Company. See "Business--License with
Thomas Kinkade." The New License Agreement supersedes a previous license
agreement under which Mr. Kinkade received a flat fee of $18,750 per painting
delivered to the Company for reproduction, a royalty agreement pursuant to which
the Company paid Mr. Kinkade a royalty of 5.0% of net sales of Company-owned
stores using his name and certain other arrangements. In addition, Mr. Kinkade
earned approximately $932,000 in fiscal 1997 under an arrangement with the
Company for personally hand finishing master editions and supervising the hand
finishing of studio proof editions, services for which Mr. Kinkade is now
compensated under the New License Agreement. Mr. Kinkade is also employed by the
Company as Creative Director. See "Management--Employment and Change of Control
Arrangements." Mr. Kinkade and Mr. Raasch have an understanding whereby Mr.
Kinkade has in the past and will through May 8, 2000 pay to Mr. Raasch 50.0% of
royalty payments payable to Mr. Kinkade by the Company from the sale of studio
proofs. In fiscal 1997, Mr. Kinkade and Mr. Raasch shared approximately $795,000
in royalty payments from the sale of studio proofs.
MANAGEMENT AGREEMENT. Under the Amended and Restated Management Agreement
dated as of April 1, 1994, the Company had the right to receive 50.0% of the
gross revenues received by Mr. Kinkade from third party licensing activity. For
the year ended March 31, 1997, the Company received $362,000 pursuant to this
arrangement. The New License Agreement has superseded this arrangement.
OWNERSHIP AND SALE OF THOMAS KINKADE GALLERY, VALLEY FAIR. On June 30,
1995, the Company purchased the Thomas Kinkade Gallery, Valley Fair from Linda
L. Raasch, spouse of Kenneth E. Raasch, President, Chairman and Chief Executive
Officer of the Company, for an aggregate purchase price of approximately
$1,500,000, of which $1,200,000 was paid in the form of an 8.0% subordinated
convertible promissory note due October 10, 2002. The note is convertible into
Common Stock of the Company at a price of $7.25 per share. The entire principal
amount of the note is due at maturity, unless converted prior to maturity. Prior
to the consummation of the sale transaction, an independent appraisal of the
gallery was performed and the terms of the purchase were approved by a special
committee of the Board of Directors.
COMERICA BANK--CALIFORNIA. Lowell W. Morse, a director of the Company from
December 31, 1993 to August 29, 1996, is also a director of Comerica
Bank--California. All of the commercial banking facilities of the Company,
excluding its former subsidiary John Hine Limited, were provided by Comerica
Bank--California from the Company's inception until February 1997.
LEVINE LEICHTMAN. Effective July 26, 1995, Levine Leichtman entered into a
credit agreement with the Company pursuant to which Levine Leichtman purchased
$8.0 million principal amount of promissory notes of the Company due June 30,
2002, $3.0 million of which was convertible into Common Stock at a conversion
price of $6.25 per share, and a warrant to purchase 400,000 shares of Common
Stock at $5.9375 per share exercisable until June 30, 2002. As a result, Levine
Leichtman became a beneficial owner of 880,000 shares of Common Stock, making it
a greater than five percent stockholder of the Company. Effective March 13,
1996, the Company entered into an agreement with Levine Leichtman for the
restructuring of the $8.0 million notes held by Levine Leichtman. Under the
agreement, the interest rate on the debt was raised to 13.5% effective October
1, 1995, and Levine Leichtman received a subordinated security interest in the
Company's assets. Of the $8.0 million principal amount, $960,000 was convertible
into Common Stock at a conversion price of $2.00 per share and $810,000 was
convertible into Common Stock at a conversion price of $3.00 per share. The
exercise price of Levine Leichtman's warrant for 400,000 shares of Common Stock
was reduced to $2.00 per share. As a result of the restructuring agreement,
Levine Leichtman became the beneficial owner of 1,150,000 shares of Common
Stock. In addition, Levine Leichtman waived all defaults then existing under the
credit agreement and certain financial ratios and other covenants were modified.
Effective February 21, 1997, the Company renegotiated the credit agreement
to restructure its obligation to Levine Leichtman, totaling $7.4 million after a
payment of $592,500 pursuant to the restructuring. The interest
41
<PAGE>
rate on the debt remained at 13.5%. As part of the renegotiation, the warrant
price was amended to $0.01 per share and Levine Leichtman fully exercised these
warrants through a cashless exercise, resulting in the issuance of 398,693
shares of Common Stock. The conversion rights initially provided under the $3.0
million note were amended to provide that $7,500 of principal amount would be
convertible into Common Stock at a conversion price of $0.01 per share, and such
amount was converted into 750,000 shares of Common Stock. As of December 31,
1997, Levine Leichtman owned 940,700 shares of Common Stock. See "Principal and
Selling Stockholders." In addition, Levine Leichtman waived all defaults then
existing under the credit agreement and certain financial ratios and other
covenants were modified pursuant to the restructuring.
On September 10, 1996, the Company entered into an Investment Monitoring
Agreement with Levine Leichtman Capital Partners, Inc., an affiliate of Levine
Leichtman, pursuant to which Levine Leichtman Capital Partners, Inc., agreed to
monitor Levine Leichtman's investment in the Company in exchange for a
monitoring fee of $12,500 per month. The agreement is terminable by the Company
or Levine Leichtman Capital Partners, Inc., upon 30 days written notice at any
time from and after March 31, 1998. The Investment Monitoring Agreement was
amended as of February 21, 1997 in connection with the renegotiation of the
credit agreement between the Company and Levine Leichtman to provide for a
reduced monthly monitoring fee of $11,500 beginning February 28, 1997. The
Company's obligation to pay monthly monitoring fees to Levine Leichtman Capital
Partners, Inc., terminated on July 31, 1997 as a result of the outstanding
principal balance of the Company's note payable to Levine Leichtman being
reduced to $5.4 million.
In addition, the Company has agreed to reimburse Levine Leichtman for up to
$600,000 for any underwriting discounts and commissions relating to Levine
Leichtman's sale of 700,000 shares of Common Stock in this offering
notwithstanding the actual amount thereof, provided that if the number of shares
of Common Stock sold by Levine Leichtman in the offering is less than 700,000,
the payment shall be proportionately reduced.
OTHER AGREEMENTS WITH DIRECTORS. Steve Gordon, a director of the Company
until March 18, 1997, was engaged part-time by the Company as Head of Operations
(resigned June 30, 1997) at an annual base salary of $21,000 effective December
15, 1995. In addition to his base salary, Mr. Gordon was entitled to receive a
$50,000 bonus contingent upon the achievement of certain criteria. Effective
July 1, 1996, Mr. Gordon agreed to increase his duties to the Company and to
forego the $50,000 bonus in exchange for an increase in his annual base salary
to $60,000. In addition, TFS Limited, a consulting firm in which Mr. Gordon has
a 50.0% interest, was engaged on December 15, 1995 to provide certain strategic
advice to the Company for approximately one year for a monthly fee of $12,500.
On April 1, 1997, the Company entered into a one-year Consulting Agreement
with Michael L. Kiley, a director of the Company. Pursuant to the Consulting
Agreement, Mr. Kiley agreed to act as a liaison between Thomas Kinkade and the
Company and to provide various other consulting services in exchange for a fee
of $6,000 per month and an option to purchase 25,000 shares of the Company's
Common Stock priced at the then-fair market value of the shares. Effective
August 1, 1997, the Consulting Agreement was amended to provide for consulting
fees of $10,000 per month. In June 1997 and September 1997, the Company granted
to Mr. Kiley options to purchase 20,000 and 30,000 shares of Common Stock,
respectively, at the then-fair market value of the Common Stock. In October
1997, the Board of Directors awarded Mr. Kiley a consulting bonus of $90,000
(payable in the amount of $45,000 immediately and $45,000 in April 1998) in
connection with various consulting services provided by Mr. Kiley.
In fiscal 1998 to date, the Company paid Norman A. Nason, a director of the
Company, $13,750 for serving as a member of the Compensation Committee and
performing various other services. In July 1997, the Company paid a $35,000
commission to Mr. Nason for his services in negotiating a sale and leaseback of
the Company's San Jose, California facilities. In addition, in September 1997,
the Company granted to Mr. Nason an option to purchase 15,000 shares of Common
Stock for his various services.
42
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, the Company will have 12,583,042 shares of
Common Stock outstanding, based on shares outstanding at December 31, 1997. Of
these shares, 6,996,201 are held by "affiliates" of the Company as that term is
used under the Securities Act, and are subject to restriction under Rule 144
under the Securities Act (the "Restricted Shares"). In addition, certain of such
affiliates also hold options, convertible notes and warrants to purchase an
aggregate of 1,413,049 shares of Common Stock.
Stockholders holding an aggregate of 8,970,193 shares or securities
exercisable or exchangeable therefor have agreed with the Underwriters that they
will not, without the prior written consent of Hambrecht & Quist LLC, offer to
sell, contract to sell or otherwise sell (including without limitation in a
short sale) or otherwise dispose of, for a period of 90, 120 and 150 days after
the effective date of the Registration Statement of which this Prospectus is a
part (the "lock-up period"), 100%, 66 2/3% and 33 1/3%, respectively, of the
shares of Common Stock of the Company or any options or warrants to purchase any
shares of Common Stock of the Company owned or thereafter acquired by them or
with respect to which they have the power of disposition. The Company has also
agreed with the Underwriters that it will not, without the prior written consent
of Hambrecht & Quist LLC, (i) sell, offer, contract to sell, make any short
sale, pledge, sell any option or contract to purchase, purchase any option or
contract to sell, grant any option, right or warrant to purchase, or otherwise
transfer or dispose of, any share of Common Stock or any securities convertible
into or exercisable or exchangeable for or any rights to purchase or acquire
Common Stock; or (ii) enter into any swap or similar arrangement that transfers,
in whole or in part, any of the economic consequences of ownership of the Common
Stock, whether any such transaction described in the above clause (i) or (ii) is
to be settled by delivery of such Common Stock or such other securities, in cash
or otherwise, during the 120 days after the effective date of this Registration
Statement of which this Prospectus is part, other than (a) the sale by the
Company to the Underwriters of the shares of Common Stock pursuant to the
Underwriting Agreement; (b) the issuance by the Company of shares of Common
Stock upon exercise of warrants or options granted pursuant to the Company's
stock plans or otherwise, in each case as outstanding or reserved for issuance
on the date of this Prospectus; and (c) options to purchase Common Stock granted
under the Company's stock plans and reserved for such purpose on the date of
this Prospectus. Upon the expiration of the lock-up period (or earlier upon the
consent of Hambrecht & Quist LLC), such shares and shares issuable upon
exercise, conversion or exchange of certain of such securities will become
eligible for sale in the open market under Rule 144 or otherwise.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated) who has beneficially owned shares for at least one
year (including the holding period of certain prior owners) is entitled to sell
in "brokers' transactions" or to market makers, within any three-month period, a
number of shares that does not exceed the greater of: (i) 1% of the number of
shares of Common Stock then outstanding (approximately 125,719 shares
immediately after this offering); or (ii) the average weekly trading volume in
the Common Stock during the four calendar weeks preceding the required filing of
a Form 144 with respect to such sale. Sales under Rule 144 are subject to the
availability of current public information about the Company.
The Company has filed registration statements on Form S-8 under the
Securities Act to register shares of Common Stock reserved for issuance under
the Company's stock option plans, including, in some cases, shares for which an
exemption under Rule 144 would also be available, thus permitting the resale of
shares issued under those plans or options by non-affiliates in the public
market without restriction under the Securities Act. At December 31, 1997, stock
options to purchase an aggregate of 1,676,666 shares of Common Stock were
outstanding.
Certain security holders of the Company have the right to cause the Company
to register the sale of their shares of Common Stock or shares underlying their
warrants under the Securities Act. If such registration rights are exercised,
the shares can be sold without any holding period or sales volume limitation.
See "Description of Capital Stock--Registration and Other Rights."
Sales of substantial amounts of Common Stock in the public market following
this offering (including shares issued upon the exercise of stock options) by
current holders of large share blocks of the Company's Common Stock and stock
options or warrants exercisable therefor, or the perception that such sales
might occur, could adversely affect the market price of the Common Stock and the
Company's ability to raise additional equity capital.
43
<PAGE>
DESCRIPTION OF CAPITAL STOCK
As of December 31, 1997, the authorized capital stock of the Company
consisted of 20,000,000 shares of Common Stock, $0.01 par value per share, of
which 12,583,042 shares will be outstanding upon the completion of this offering
based upon shares outstanding as of December 31, 1997, and 1,000,000 shares of
preferred stock, $0.01 par value per share (the "Preferred Stock"), none of
which will be outstanding. The following description of the capital stock of the
Company and certain provisions of the Company's Amended and Restated Certificate
of Incorporation and Bylaws are qualified in their entirety by reference to such
documents, copies of which have been filed with the Securities and Exchange
Commission. As of December 31, 1997, the Company's Common Stock was held of
record by 203 stockholders.
COMMON STOCK
Each holder of Common Stock is entitled to one vote per share in the
election of Directors and for all other purposes. All shares of Common Stock are
entitled to participate pro rata in distributions and in such dividends as may
be declared by the Board of Directors out of funds legally available therefor,
subject to any preferential dividend rights of outstanding shares of Preferred
Stock. Subject to the prior rights of creditors, all shares of Common Stock are
entitled in the event of liquidation to participate ratably in the distribution
of all the remaining assets of the Company after distribution in full of
preferential amounts, if any, to be distributed to holders of Preferred Stock.
The rights, preferences and privileges of holders of Common Stock are subject
to, and may be adversely affected by, the rights of any series of Preferred
Stock which the Company may designate and issue in the future. Each outstanding
share of Common Stock is fully paid and non-assessable.
PREFERRED STOCK
The Preferred Stock is divisible into and issuable in one or more series.
The rights and preferences of the different series may be established by the
Board of Directors without further action by the stockholders. The Board of
Directors is authorized with respect to each series to fix and determine, among
other things, (i) its dividend rate; (ii) its liquidation preference; (iii)
whether or not such shares will be convertible into, or exchangeable for, any
other securities; and (iv) whether or not such shares will have voting rights,
and, if so, the conditions under which such shares will vote as a separate
class.
The Company believes that the Board of Directors' ability to issue Preferred
Stock on such a wide variety of terms will enable the Preferred Stock to be used
for important corporate purposes, such as financing acquisitions or raising
additional capital. However, were it inclined to do so, the Board of Directors
could issue all or part of the Preferred Stock with (among other things)
substantial voting power or advantageous conversion rights. Such stock could be
issued to persons deemed by the Board of Directors likely to support current
management in a contest for control of the Company, either as a precautionary
measure or in response to a specific takeover threat. The Company has no current
plans to issue Preferred Stock for any purpose.
REGISTRATION AND OTHER RIGHTS
The Company currently has five registration rights agreements in effect.
Under its Registration Rights Agreement with Hyprom, S.A., with respect to a
warrant to purchase 298,952 shares of Common Stock issued to Hyprom S.A. on
August 10, 1994, the holder has the right (a "demand right"), exercisable on two
occasions, to cause the Company to file a registration statement to register
such shares. In addition, in connection with the first two filings of a
registration statement by the Company after its initial public offering, Hyprom,
S.A. has the right to include its shares in the subject offering (a "piggyback
right"), in each case subject to certain limitations. The rights of Hyprom, S.A.
expire when its shares may be sold pursuant to Rule 144(k) promulgated under the
Securities Act. Under the Company's Registration Rights Agreement with Levine
Leichtman, which as of December 31, 1997 held 940,700 shares of Common Stock,
700,000 of which are expected to be sold in this offering, such stockholder has
two demand rights and unlimited piggyback rights with respect to such shares, in
each case subject to certain limitations; these rights expire on July 26, 2002.
Under the Company's Registration Rights Agreement with Richard Barnett, a vice
president of the Company, and his wife Lori Barnett, the
44
<PAGE>
Company granted Mr. and Mrs. Barnett piggyback rights with respect to 444,483
shares of Common Stock, subject to certain limitations; these rights expire on
March 31, 1998. Under the Company's Underwriter's Warrant Agreement executed on
August 10, 1994 in connection with its initial public offering of its Common
Stock, the holders of warrants exercisable for an aggregate of 125,000 shares of
Common Stock were granted the holders one demand right and unlimited piggyback
rights; these rights expire on August 2, 1999. Under the Company's Registration
Rights Agreement with a series of bridge investors with respect to warrants to
purchase an aggregate of 27,353 shares of Common Stock, the Company granted the
investors one demand right; this right will expire when the shares subject to
the warrants may be sold under Rule 144(k).
The underwriters in the Company's initial public offering of its Common
Stock in August 1994 received the right to appoint a nominee to the Company's
Board of Directors. This right will terminate on August 10, 1998.
Under the terms of the Company's Credit Agreement with Levine Leichtman,
such lender has a right of first refusal with respect to any private placements
of equity securities by the Company for cash to the extent necessary for the
lender to maintain its fully diluted equity interest in the Company. The Company
expects to repay all remaining debt outstanding under the Credit Agreement using
the proceeds of this offering, whereupon the lender's right of first refusal
will terminate.
CERTAIN CERTIFICATE OF INCORPORATION, BYLAW AND STATUTORY PROVISIONS AFFECTING
STOCKHOLDERS
STOCKHOLDER MEETINGS. Advance notice of stockholder nominations and any
other matter to be brought before a meeting of stockholders is required to be
given in writing to the Secretary of the Company within the time periods set
forth in the Bylaws. The Bylaws provide that Special Meetings of Stockholders of
the Company may be called by the Chairman or Vice Chairman of the Board of
Directors, the President, any Vice President, the Secretary or any Assistant
Secretary. In addition, Special Meetings of Stockholders may be called by any
such officer at the request in writing of a majority of the Board of Directors
or at the request in writing of stockholders owning a majority of the capital
stock that is entitled to vote. Any action required or permitted to be taken at
any Annual or Special Meeting of the Stockholders may be taken without a
meeting, without prior notice and without a vote, if signed consent is given by
the holders of outstanding stock having not less than the minimum number of
votes that would be necessary to authorize or take such action at a meeting at
which all shares entitled to vote thereon were present and voted.
SECTION 203 OF DELAWARE CORPORATION LAW. The Company is a Delaware
corporation and is subject to Section 203 of the Delaware General Corporation
Law, which generally prohibits a publicly held Delaware corporation from
engaging in a "business combination" with an "interested stockholder" for a
period of three years after the time that the person became an interested
stockholder, unless (i) prior to such time the Board of Directors of the
corporation approved either the business combination or the transaction in which
the person became an interested stockholder; (ii) upon consummation of the
transaction that resulted in the stockholder becoming an interested stockholder,
the interested person owns at least 85% of the voting stock of the corporation
outstanding at the time the transaction commenced, excluding shares owned by
persons who are directors and also officers of the corporation and by certain
employee stock plans; or (iii) at or after such time the business combination is
approved by the Board of Directors of the corporation and authorized at an
annual or special meeting of stockholders, and not by written consent, by the
affirmative vote of at least 66 2/3% of the outstanding voting stock of the
corporation that is not owned by the interested stockholder. A "business
combination" generally includes mergers, asset sales and similar transactions
between the corporation and the interested stockholder, and other transactions
resulting in a financial benefit to the stockholder. An "interested stockholder"
is a person who, together with affiliates and associates, owns 15% or more of
the corporation's outstanding voting stock or who is an affiliate or associate
of the corporation and, together with his or her affiliates and associates, has
owned 15% or more of the corporation's outstanding voting stock within three
years.
TRANSFER AGENT AND REGISTRAR
ChaseMellon Shareholder Services is the transfer agent and registrar for the
Common Stock.
45
<PAGE>
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
underwriters named below (the "Underwriters"), through their representatives
Hambrecht & Quist LLC and NationsBanc Montgomery Securities LLC (the
"Representatives"), have severally agreed to purchase from the Company and the
Selling Stockholders the following respective number of shares of Common Stock:
<TABLE>
<CAPTION>
NUMBER OF
NAME SHARES
- ------------------------------------------------------------------------------------------ ------------
<S> <C>
Hambrecht & Quist LLC.....................................................................
NationsBanc Montgomery Securities LLC.....................................................
------------
Total..................................................................................... 2,409,500
------------
------------
</TABLE>
The Underwriting Agreement provides that the obligations of the Underwriters
are subject to certain conditions precedent, including the absence of any
material adverse change in the Company's business and the receipt of certain
certificates, opinions and letters from the Company and its counsel and
independent auditors. The nature of the Underwriters' obligations is such that
they are committed to purchase all shares of Common Stock offered hereby if any
of such shares are purchased.
The Underwriters propose to offer the shares of Common Stock directly to the
public at the public offering price set forth on the cover page of this
Prospectus and to certain dealers at such price less a concession not in excess
of $ per share. The Underwriters may allow, and such dealers may allow, a
concession not in excess of $ per share to certain other dealers. After the
public offering of the shares, the offering price and other selling terms may be
changed by the Representatives.
Certain other Selling Stockholders have granted to the Underwriters an
option, exercisable no later than 30 days after the date of this Prospectus, to
purchase up to an aggregate of 361,425 shares of Common Stock at the public
offering price, less the underwriting discount set forth on the cover page of
this Prospectus. To the extent that the Underwriters exercise such option, each
of the Underwriters will have a firm commitment to purchase approximately the
same percentage thereof which the number of shares of Common Stock to be
purchased by it shown in the above table bears to the total number of shares of
Common Stock offered hereby. Such Selling Stockholders will be obligated,
pursuant to the option, to sell such shares to the Underwriters to the extent
the option is exercised. The Underwriters may exercise such option only to cover
over-allotments made in connection with the sale of shares of Common Stock
offered hereby.
The offering of the shares is made for delivery when, as and if accepted by
the Underwriters and subject to prior sale and to withdrawal, cancellation or
modification of the offering without notice. The Underwriters reserve the right
to reject an order for the purchase of shares in whole or in part.
The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act, and to contribute to payments the Underwriters may be required
to make in respect thereof.
The Company's executive officers and directors and certain of the Selling
Stockholders have agreed that they will not, without the prior written consent
of Hambrecht & Quist LLC, offer to sell, contract to sell or otherwise sell
(including without limitation in a short sale) or otherwise dispose of, for a
period of 90, 120 and 150 days after the effective date of the Registration
Statement of which this Prospectus is a part, 100%, 66 2/3% and 33 1/3%,
respectively, of the shares of Common Stock of the Company or any options or
warrants to purchase any shares of Common Stock of the Company owned or
thereafter acquired by them or with respect to which
46
<PAGE>
they have the power of disposition. The Company has also agreed with the
Underwriters that it will not, without the prior written consent of Hambrecht &
Quist LLC, (i) sell, offer, contract to sell, make any short sale, pledge, sell
any option or contract to purchase, purchase any option or contract to sell,
grant any option, right or warrant to purchase, or otherwise transfer or dispose
of, any share of Common Stock or any securities convertible into or exercisable
or exchangeable for or any rights to purchase or acquire Common Stock; or (ii)
enter into any swap or similar arrangement that transfers, in whole or in part,
any of the economic consequences of ownership of the Common Stock, whether any
such transaction described in the above clause (i) or (ii) is to be settled by
delivery of such Common Stock or such other securities, in cash or otherwise,
during the 120 days after the effective date of the Registration Statement of
which this Prospectus is part, other than (a) the sale by the Company to the
Underwriters of the shares of Common Stock pursuant to the Underwriting
Agreement; (b) the issuance by the Company of shares of Common Stock upon
exercise of warrants or options granted pursuant to the Company's stock plans or
otherwise, in each case as outstanding or reserved for issuance on the date of
this Prospectus; and (c) options to purchase Common Stock granted under the
Company's stock plans and reserved for such purpose on the date of this
Prospectus.
In general, the rules of the Securities and Exchange Commission (the
"Commission") will prohibit the Underwriters from making a market in the
Company's Common Stock during the "cooling-off" period immediately preceding the
commencement of sales in this offering. The Commission has, however, adopted
exemptions from these rules that permit passive market making under certain
conditions. These rules permit an Underwriter to continue to make a market
subject to the conditions among others, that its bid not exceed the highest bid
by a market maker not connected with this offering and that its net purchases on
any one trading day not exceed prescribed limits. Pursuant to these exemptions,
certain Underwriters, selling group members (if any) or their respective
affiliates intend to engage in passive market making in the Common Stock during
the "cooling-off" period.
Certain persons participating in this offering may overallot or effect
transactions which stabilize, maintain or otherwise affect the market price of
the Common Stock at levels above those which might otherwise prevail in the open
market, including by entering stabilizing bids or effecting syndicate covering
transactions. A stabilizing bid means the placing of any bid or effecting of any
purchase, for the purpose of pegging, fixing or maintaining the price of the
Common Stock. A syndicate covering transaction means the placing of any bid on
behalf of the underwriting syndicate or the effecting of any purchase to reduce
a short position created in connection with the offering. Such transactions may
be effected on the Nasdaq Stock Market, in the over-the-counter market, or
otherwise. Such stabilizing, if commenced, may be discontinued at any time.
The Underwriters do not intend to confirm sales to accounts over which they
exercise discretionary authority.
LEGAL MATTERS
The validity of the Common Stock being offered hereby will be passed upon
for the Company by Latham & Watkins, Menlo Park, California. Certain legal
matters will be passed upon for the Underwriters by Gunderson Dettmer Stough
Villeneuve Franklin & Hachigian, LLP, Menlo Park, California.
EXPERTS
The Consolidated Financial Statements of the Company as of March 31, 1996
and 1997 and December 31, 1997 and for each of the three years in the period
ended March 31, 1997 and for the nine month period ended December 31, 1997
included in this Prospectus and the Registration Statement have been included
and incorporated in reliance upon the reports of Price Waterhouse LLP,
independent accountants, given on authority of said firm as experts in auditing
and accounting.
47
<PAGE>
AVAILABLE INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") in Washington, D.C., a Registration Statement on Form S-1 under
the Securities Act with respect to the shares of Common Stock offered by this
Prospectus. This Prospectus does not contain all the information set forth in
the Registration Statement, certain portions of which are omitted as permitted
by the rules and regulations of the Commission. For further information with
respect to the Company and the shares offered by this Prospectus, reference is
made to the Registration Statement, including the exhibits and schedules filed
therewith. Statements contained in this Prospectus regarding the contents of any
contract or any other document referred to herein or therein are not necessarily
complete, and in each instance reference is made to the copy of such contract or
document filed as an exhibit to the registration statement or such other
document, each such statement being qualified in all respects by such reference.
Copies of the Registration Statement (of which this Prospectus is a part),
together with such exhibits and schedules, may be obtained upon payment of the
fee prescribed by the Commission or may be examined without charge at the office
of the Commission.
The Company is subject to the informational requirements of the Exchange
Act, and in accordance therewith, files annual and quarterly reports, proxy
statements and other information with the Commission. The Registration
Statement, including the exhibits thereto, as well as such reports and other
information filed by the Company with the Commission, can be inspected and
copied at the public reference facilities maintained by the Commission at 450
Fifth Street, N.W., Room 1024, Washington, D.C. 20549; 7 World Trade Center, New
York, New York 10048 and 500 West Madison Street, Suite 1400, Chicago, Illinois
60661. Copies of such material may also be obtained from the Public Reference
Section of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549 at
prescribed rates. The Commission also maintains a site on the World Wide Web at
http:// www.sec.gov that contains reports and other information regarding
registrants that file electronically with the Commission, and certain of the
Company's filings are available at such web site.
48
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Report of Independent Accountants.......................................................................... F-2
Consolidated Balance Sheets at March 31, 1996 and 1997 and December 31, 1997............................... F-3
Consolidated Statements of Operations for the years ended March 31, 1995, 1996 and 1997 and for the nine
months ended December 31, 1996 (unaudited) and 1997...................................................... F-4
Consolidated Statements of Stockholders' Equity for the years ended March 31, 1995, 1996 and 1997 and for
the nine months ended December 31, 1997.................................................................. F-5
Consolidated Statements of Cash Flows for the years ended March 31, 1995, 1996 and 1997 and for the nine
months ended December 31, 1996 (unaudited) and 1997...................................................... F-6
Notes to Consolidated Financial Statements................................................................. F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Media Arts Group, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity and of cash flows
present fairly, in all material respects, the financial position of Media Arts
Group, Inc. and its subsidiaries at March 31, 1996 and 1997 and December 31,
1997, and the results of their operations and their cash flows for each of the
three years in the period ended March 31, 1997 and for the nine month period
ended December 31, 1997 in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
/s/ PRICE WATERHOUSE LLP
Price Waterhouse LLP
San Jose, California
January 13, 1998
F-2
<PAGE>
MEDIA ARTS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
MARCH 31,
-------------------------- DECEMBER 31,
1996 1997 1997
------------ ------------ -------------
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents............................................ $ 382,000 $ 374,000 $ 5,099,000
Accounts receivable, net of allowance for doubtful accounts and sales
returns of $1,154,000, $2,825,000 and $2,777,000................... 8,262,000 7,394,000 12,733,000
Receivable from related parties...................................... 99,000 114,000 77,000
Inventories (Note 5)................................................. 5,006,000 5,415,000 6,485,000
Net assets of discontinued operations (Note 3)....................... 17,398,000 890,000 --
Prepaid expenses and other current assets............................ 438,000 1,464,000 1,574,000
Deferred income taxes (Note 9)....................................... 1,059,000 1,581,000 2,341,000
Income taxes refundable.............................................. -- 2,002,000 34,000
------------ ------------ -------------
Total current assets............................................... 32,644,000 19,234,000 28,343,000
Property and equipment, net (Note 5)................................... 3,794,000 3,562,000 4,605,000
Other assets........................................................... 220,000 265,000 251,000
------------ ------------ -------------
$ 36,658,000 $ 23,061,000 $33,199,000
------------ ------------ -------------
------------ ------------ -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable..................................................... $ 2,801,000 $ 2,065,000 $ 3,352,000
Commissions payable.................................................. 185,000 403,000 942,000
Accrued royalties.................................................... 345,000 1,213,000 494,000
Accrued compensation costs........................................... 865,000 714,000 2,854,000
Accrued expenses..................................................... 2,198,000 2,250,000 2,808,000
Income taxes payable................................................. -- -- 3,871,000
Borrowings under line of credit (Note 6)............................. 4,375,000 2,655,000 24,000
Current portion of long-term debt (Note 6)........................... 586,000 2,062,000 500,000
------------ ------------ -------------
Total current liabilities.......................................... 11,355,000 11,362,000 14,845,000
Long-term debt, less current portion (Note 6).......................... 8,410,000 4,609,000 2,709,000
Convertible notes payable to related parties (Note 2).................. 1,200,000 1,200,000 1,200,000
------------ ------------ -------------
Total liabilities.................................................. 20,965,000 17,171,000 18,754,000
------------ ------------ -------------
Minority interest...................................................... 115,000 -- --
------------ ------------ -------------
Commitments and contingencies (Notes 6 and 7)
Stockholders' equity: (Note 8)
Preferred stock, $0.01 par value; 1,000,000 shares authorized; none
issued or outstanding.............................................. -- -- --
Common stock, $0.01 par value; 20,000,000 shares authorized;
9,867,032, 11,025,527 and 11,083,042 shares issued and
outstanding........................................................ 58,000 69,000 69,000
Additional paid-in capital........................................... 15,725,000 17,176,000 17,338,000
Cumulative translation adjustment.................................... 164,000 -- --
Accumulated deficit.................................................. (369,000) (11,355,000) (2,962,000)
------------ ------------ -------------
Total stockholders' equity......................................... 15,578,000 5,890,000 14,445,000
------------ ------------ -------------
$ 36,658,000 $ 23,061,000 $33,199,000
------------ ------------ -------------
------------ ------------ -------------
</TABLE>
The accompanying notes are an integral part of these financial statements
F-3
<PAGE>
MEDIA ARTS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED MARCH 31, DECEMBER 31,
----------------------------------- -----------------------
1995 1996 1997 1996 1997
---------- ---------- ----------- ----------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net sales...................... $33,485,000 $39,752,000 $47,018,000 $35,512,000 $57,209,000
Cost of sales.................. 10,330,000 13,343,000 16,760,000 12,982,000 18,812,000
---------- ---------- ----------- ----------- ----------
Gross profit................. 23,155,000 26,409,000 30,258,000 22,530,000 38,397,000
---------- ---------- ----------- ----------- ----------
Operating expenses
Selling and marketing........ 6,685,000 10,028,000 12,784,000 9,631,000 13,103,000
General and administrative... 10,073,000 10,834,000 10,683,000 7,581,000 11,430,000
---------- ---------- ----------- ----------- ----------
Total operating expenses... 16,758,000 20,862,000 23,467,000 17,212,000 24,533,000
---------- ---------- ----------- ----------- ----------
Operating income............... 6,397,000 5,547,000 6,791,000 5,318,000 13,864,000
Interest expense............... (870,000) (1,447,000) (2,348,000) (1,749,000) (1,438,000)
Gain on sale and leaseback..... -- -- -- -- 997,000
Foreign exchange losses........ -- (42,000) (31,000) (208,000) (93,000)
---------- ---------- ----------- ----------- ----------
Income before income taxes..... 5,527,000 4,058,000 4,412,000 3,361,000 13,330,000
Provision for income taxes..... 1,513,000 1,603,000 1,768,000 1,394,000 4,937,000
---------- ---------- ----------- ----------- ----------
Income from continuing
operations before
extraordinary loss........... 4,014,000 2,455,000 2,644,000 1,967,000 8,393,000
Loss from discontinued
operations, net of income
taxes........................ (53,000) (3,128,000) (1,385,000) (1,385,000) --
Loss on disposal of
discontinued operations, net
of income taxes.............. -- -- (12,245,000) (12,245,000) --
Extraordinary loss, net of
income taxes................. (172,000) -- -- -- --
---------- ---------- ----------- ----------- ----------
Net income (loss).............. $3,789,000 $ (673,000) $(10,986,000) $(11,663,000) $8,393,000
---------- ---------- ----------- ----------- ----------
---------- ---------- ----------- ----------- ----------
Earnings per common share:
Income from continuing
operations before
extraordinary loss........... $ 0.44 $ 0.25 $ 0.26 $ 0.20 $ 0.76
Discontinued operations........ -- (0.32) (1.36) (1.38) --
Extraordinary loss............. (0.02) -- -- -- --
---------- ---------- ----------- ----------- ----------
Net income (loss).............. 0.42 (0.07) (1.10) (1.18) 0.76
---------- ---------- ----------- ----------- ----------
---------- ---------- ----------- ----------- ----------
Earnings per common share
assuming dilution:
Income from continuing
operations before
extraordinary loss........... 0.42 0.25 0.26 0.20 0.73
Discontinued operations........ -- (0.32) (1.35) (1.37) --
Extraordinary loss............. (0.02) -- -- -- --
---------- ---------- ----------- ----------- ----------
Net income (loss).............. $ 0.40 $ (0.07) $ (1.09) $ (1.17) $ 0.73
---------- ---------- ----------- ----------- ----------
---------- ---------- ----------- ----------- ----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
MEDIA ARTS GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
RETAINED
COMMON STOCK ADDITIONAL CUMULATIVE EARNINGS
--------------------- PAID-IN TRANSLATION (ACCUMULATED
SHARES AMOUNT CAPITAL ADJUSTMENT DEFICIT) TOTAL
--------- ---------- ---------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Balance at March 31, 1994........... 7,794,647 $ 40,000 $1,058,000 $ -- $1,464,000 $ 2,562,000
Reclassification of retained
earnings on conversion of certain
subsidiaries from S Corporations
to C Corporations................. -- -- 2,685,000 -- (2,685,000) --
Issuance of Common Stock for cash... 1,437,500 14,000 8,046,000 -- -- 8,060,000
Issuance of Common Stock for
license........................... 223,600 2,000 1,675,000 -- -- 1,677,000
Issuance of Common Stock in exchange
for retirement of debt............ 249,626 2,000 1,668,000 -- -- 1,670,000
Issuance of Common Stock on exercise
of options........................ 13,502 -- 21,000 -- -- 21,000
Cumulative translation adjustment... -- -- -- 439,000 -- 439,000
Distributions to S Corporation
stockholders...................... -- -- -- -- (358,000) (358,000)
Adjustment for acquisition of a
gallery from a related party (Note
2)................................ -- -- -- -- 173,000 173,000
Net income.......................... -- -- -- -- 3,789,000 3,789,000
--------- ---------- ---------- ----------- ------------ -----------
Balance at March 31, 1995........... 9,718,875 58,000 15,153,000 439,000 2,383,000 18,033,000
Adjustment for acquisition of a
gallery from a related party (Note
2)................................ -- -- -- -- (1,530,000) (1,530,000)
Issuance of warrants to
noteholders....................... -- -- 570,000 -- -- 570,000
Issuance of Common Stock on exercise
of options........................ 527 -- 2,000 -- -- 2,000
Issuance of Common Stock on exercise
of warrants....................... 147,630 -- -- -- -- --
Cumulative translation adjustment... -- -- -- (275,000) -- (275,000)
Distributions to S Corporation
stockholders...................... -- -- -- -- (549,000) (549,000)
Net loss............................ -- -- -- -- (673,000) (673,000)
--------- ---------- ---------- ----------- ------------ -----------
Balance at March 31, 1996........... 9,867,032 58,000 15,725,000 164,000 (369,000) 15,578,000
Issuance of warrants to
noteholders....................... -- -- 1,424,000 -- -- 1,424,000
Issuance of Common Stock to
noteholders for cash.............. 748,693 7,000 -- -- -- 7,000
Issuance of Common Stock on exercise
of warrants....................... 400,000 4,000 -- -- -- 4,000
Issuance of Common Stock on exercise
of options........................ 9,802 -- 27,000 -- -- 27,000
Cumulative translation adjustment... -- -- -- (164,000) -- (164,000)
Net loss............................ -- -- -- -- (10,986,000) (10,986,000)
--------- ---------- ---------- ----------- ------------ -----------
Balance at March 31, 1997........... 11,025,527 69,000 17,176,000 -- (11,355,000) 5,890,000
Issuance of Common Stock on exercise
of options........................ 57,515 -- 162,000 -- -- 162,000
Net income.......................... -- -- -- -- 8,393,000 8,393,000
--------- ---------- ---------- ----------- ------------ -----------
Balance at December 31, 1997........ 11,083,042 $ 69,000 $17,338,000 $ -- $(2,962,000) $14,445,000
--------- ---------- ---------- ----------- ------------ -----------
--------- ---------- ---------- ----------- ------------ -----------
</TABLE>
F-5
<PAGE>
MEDIA ARTS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED MARCH 31, DECEMBER 31,
----------------------------------- -----------------------
1995 1996 1997 1996 1997
---------- ---------- ----------- ----------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)............................... $3,789,000 $ (673,000) $(10,986,000) $(11,663,000) $8,393,000
Adjustments to reconcile net income to net cash
provided by (used in) continuing operating
activities:
Losses from discontinued operations........... 53,000 3,128,000 13,630,00 13,630,000 --
Gain on sale and leaseback.................... -- -- -- -- (997,000)
Depreciation.................................. 326,000 530,000 951,000 717,000 826,000
Amortization of intangibles................... 292,000 126,000 459,000 243,000 689,000
Deferred income taxes......................... (469,000) 82,000 (522,000) (411,000) (760,000)
Extraordinary write-off of debt discount...... 172,000 -- -- -- --
Provision for returns and allowances.......... 248,000 391,000 827,000 827,000 281,000
Provision for losses on accounts receivable... 171,000 (229,000) 844,000 651,000 (329,000)
Changes in assets and liabilities net of
effects from acquisition of companies:
Accounts receivable......................... (3,003,000) (2,744,000) (803,000) (714,000) (5,291,000)
Receivables from related parties............ (263,000) 143,000 -- (18,000) 37,000
Inventories................................. (2,083,000) (555,000) (215,000) (414,000) (1,070,000)
Prepaid expenses and other current assets... (692,000) 767,000 (1,048,000) (368,000) (110,000)
Income taxes refundable..................... -- -- (2,002,000) 1,699,000 1,968,000
Other assets................................ (30,000) (63,000) (127,000) (42,000) 3,000
Accounts payable............................ 554,000 (189,000) (487,000) 241,000 1,287,000
Payables to related parties................. (106,000) (1,069,000) -- -- --
Commissions payable......................... (112,000) (593,000) 216,000 88,000 539,000
Accrued compensation costs.................. -- -- (151,000) (255,000) 2,140,000
Income taxes payable........................ 828,000 (695,000) -- -- 3,871,000
Accrued royalties........................... -- 345,000 690,000 1,102,000 (719,000)
Accrued expenses............................ 821,000 910,000 (491,000) (416,000) (92,000)
---------- ---------- ----------- ----------- ----------
Net cash provided by (used in) continuing
operating activities...................... 496,000 (388,000) 785,000 4,897,000 10,666,000
Net cash provided by (used in) discontinued
operations...................................... (2,091,000) (6,473,000) 2,398,000 (2,164,000) 890,000
---------- ---------- ----------- ----------- ----------
Net cash provided by (used in ) operations........ (1,595,000) (6,861,000) 3,183,000 2,733,000 11,556,000
---------- ---------- ----------- ----------- ----------
Cash flows from investing activities:
Acquisition of property and equipment........... (927,000) (468,000) (719,000) (473,000) (1,869,000)
Proceeds from disposals of property and
equipment..................................... -- 104,000 -- -- 1,647,000
---------- ---------- ----------- ----------- ----------
Net cash used in investing activities............. (927,000) (364,000) (719,000) (473,000) (222,000)
---------- ---------- ----------- ----------- ----------
Cash flows from financing activities:
Proceeds from (repayment of) line of credit..... 23,000 1,817,000 (1,135,000) (2,169,000) (2,631,000)
Proceeds from (repayment of) notes payable...... (968,000) 5,427,000 (700,000) (323,000) (4,140,000)
Proceeds from (repayment of) notes payable to
related parties............................... (450,000) (58,000) -- -- --
Repayment of lease liabilities.................. (152,000) (602,000) (675,000) -- --
Proceeds from issuance of Common Stock, net..... 8,345,000 -- 38,000 -- 162,000
Payment of accrued license fees................. (1,323,000) -- -- -- --
Payments of distributions to S Corporation
stockholders.................................. (2,248,000) (529,000) -- -- --
---------- ---------- ----------- ----------- ----------
Net cash provided by (used in) financing
activities...................................... 3,227,000 6,055,000 (2,472,000) (2,492,000) (6,609,000)
---------- ---------- ----------- ----------- ----------
Net increase (decrease) in cash and cash
equivalents..................................... 705,000 (1,170,000) (8,000) (232,000) 4,725,000
Cash and cash equivalents at beginning of
period.......................................... 847,000 1,552,000 382,000 382,000 374,000
---------- ---------- ----------- ----------- ----------
Cash and cash equivalents at end of period........ $1,552,000 $ 382,000 $ 374,000 $ 150,000 $5,099,000
---------- ---------- ----------- ----------- ----------
---------- ---------- ----------- ----------- ----------
Supplemental cash flow disclosures:
Income taxes paid (refunded).................... $1,037,000 $1,597,000 $ 128,000 $ 128,000 $ (138,000)
Interest paid................................... 1,172,000 1,151,000 1,816,000 1,468,000 931,000
Noncash investing activities (Note 10)
</TABLE>
F-6
<PAGE>
MEDIA ARTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES:
THE COMPANY
The consolidated financial statements of Media Arts Group, Inc. (the
"Company") include the accounts of Media Arts Group, Inc. ("MAGI") (incorporated
in Delaware on April 28, 1993), its wholly owned subsidiary Thomas Kinkade
Stores, Inc. ("TK Stores") (incorporated in California on May 1, 1990) and its
majority owned subsidiary John Hine Limited (a United Kingdom corporation) from
the date of acquisition (Note 2). The Company disposed of John Hine Limited
during the year ended March 31, 1997 (Note 3). The Company designs,
manufactures, markets and retails branded art-based home accessories,
collectibles and gift products based upon the works of the artist Thomas
Kinkade.
Through March 31, 1994, the Company's business was principally operated
through Lightpost Publishing, Inc. (a wholly owned subsidiary which was merged
into MAGI in March 1997) and John Hine Limited and to a minor degree through TK
Stores. In order to organize the Company for future growth, on April 1, 1994,
all outstanding shares of Common Stock of Lightpost Publishing, Inc. and TK
Stores were exchanged for 6,970,250 shares of Common Stock of MAGI. The Company
accounted for this transaction in a manner similar to a pooling of interests due
to the companies being under common control. In May 1994, the Company effected a
1.054-for-1 stock split. All share and per share amounts have been adjusted to
retroactively reflect these transactions.
PRINCIPLES OF COMBINATION AND CONSOLIDATION
All intercompany transactions and accounts have been eliminated.
MANAGEMENT ESTIMATES
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
REVENUE RECOGNITION
Revenue from product sales is recognized upon shipment. Reserves for
estimated future returns, exchanges and credits for marketing and other sales
incentives are provided upon shipment.
CASH AND CASH EQUIVALENTS
Cash equivalents consist of highly liquid investments purchased with a
maturity from the date of purchase of three months or less.
CONCENTRATION OF CREDIT RISKS
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of trade accounts receivable.
The Company offers credit terms on the sale of its products to distributors and
retail dealers who operate primarily in the collectible art industry in the
United States. The Company performs ongoing credit evaluations of its customers'
financial condition and, generally, requires no collateral from its customers.
The Company maintains an allowance for uncollectible accounts receivable based
upon the expected collectibility of all accounts receivable.
F-7
<PAGE>
MEDIA ARTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
INVENTORIES
Inventories are recorded at the lower of cost or market; cost is determined
on a first-in, first-out basis.
PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost. Depreciation is computed on a
straight-line basis over the following estimated useful lives:
<TABLE>
<S> <C>
Machinery and equipment................................ 5 years
Furniture and fixtures................................. 7 years
7 years or life of
Leasehold improvements................................. lease
Computer equipment..................................... 5 years
Automobiles............................................ 4 or 5 years
</TABLE>
LONG-LIVED ASSETS
On April 1, 1996, the Company adopted Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets to be
Disposed Of." This statement established accounting standards for the impairment
of long-lived assets, certain identifiable intangibles and goodwill. The
adoption of this statement had no effect on the Company's financial position or
results of operations.
INCOME TAXES
The Company accounts for income taxes using the asset and liability approach
which recognizes deferred tax assets and liabilities for the expected future tax
consequences of temporary differences between the book and tax basis of assets
and liabilities. A valuation allowance is established for any deferred assets
for which realization is uncertain.
STOCK-BASED COMPENSATION
The Company accounts for stock-based employee compensation arrangements in
accordance with provisions of APB No. 25, "Accounting for Stock Issued to
Employees," and complies with the disclosure provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation." Under APB No. 25, compensation cost
is recognized based on the difference, if any, on the date of grant between the
fair value of the Company's stock and the amount an employee must pay to acquire
the stock.
FOREIGN CURRENCY TRANSLATION
The functional currency of John Hine Limited was the local currency.
Accordingly, all assets and liabilities for this operation were translated at
the current exchange rate at the end of each operating period and revenue and
expenses were translated at average exchange rates in effect during the period.
The gains and losses from foreign currency translation of this subsidiary's
financial statements were recorded directly into a separate component of
stockholders' equity.
F-8
<PAGE>
MEDIA ARTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
EARNINGS PER SHARE
The Company adopted Statement of Financial Accounting No. 128, "Earnings Per
Share" ("SFAS 128") during the third quarter of fiscal 1998. SFAS 128 requires
presentation of both Basic EPS and Diluted EPS on the face of the income
statement. Basic EPS, which replaces primary EPS, is computed by dividing net
income available to common stockholders (numerator) by the weighted average
number of common shares outstanding (denominator) during the period. Unlike the
computation of primary EPS, Basic EPS excludes the dilutive effect of stock
options. Diluted EPS replaces fully diluted EPS and gives effect to all dilutive
potential common shares outstanding during a period. In computing Diluted EPS,
the average stock price for the period is used in determining the number of
shares assumed to be purchased from exercise of stock options rather than the
higher of the average or ending stock price as used in the computation of fully
diluted EPS.
Following is a reconciliation of the numerators and denominators of the
Basic and Diluted EPS computations for the periods presented below:
<TABLE>
<CAPTION>
NINE MONTHS ENDED DECEMBER
YEAR ENDED MARCH 31, 31,
----------------------------------------- ---------------------------
1995 1996 1997 1996 1997
------------ ------------ ------------- ------------ -------------
<S> <C> <C> <C> <C> <C>
Numerator:
Income from continuing operations before
extraordinary items.................... $ 4,014,000 $ 2,455,000 $ 2,644,000 $ 1,967,000 $ 8,393,000
------------ ------------ ------------- ------------ -------------
------------ ------------ ------------- ------------ -------------
Denominator for basic earnings per common
share.................................. 9,130,000 9,756,000 9,991,000 9,867,000 11,049,000
Effect of dilutive securities:
Stock options and warrants............... 349,000 150,000 117,000 63,000 483,000
------------ ------------ ------------- ------------ -------------
Denominator for diluted earnings per
common share........................... 9,479,000 9,906,000 10,108,000 9,930,000 11,532,000
------------ ------------ ------------- ------------ -------------
------------ ------------ ------------- ------------ -------------
Income from continuing operations before
extraordinary items per common share:
Basic.................................... $ 0.44 $ 0.25 $ 0.26 $ 0.20 $ 0.76
------------ ------------ ------------- ------------ -------------
------------ ------------ ------------- ------------ -------------
Diluted.................................. $ 0.42 $ 0.25 $ 0.26 $ 0.20 $ 0.73
------------ ------------ ------------- ------------ -------------
------------ ------------ ------------- ------------ -------------
</TABLE>
UNAUDITED INTERIM RESULTS FOR DECEMBER 31, 1996
The accompanying consolidated statements of operations and of cash flows for
the nine month period ended December 31, 1996 are unaudited. In the opinion of
management, the interim data has been prepared on the same basis as the audited
financial statements and include all adjustments, consisting only of normal
recurring adjustments, necessary for the fair statement of the results for the
interim periods.
PRESENTATION
Certain prior year amounts have been reclassified to conform to 1997
presentation.
F-9
<PAGE>
MEDIA ARTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," and SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information." The Company will be required to adopt
both statements for the year ending March 31, 1999. Under SFAS No. 130,
companies are required to report in the financial statements, in addition to net
income, comprehensive income including, as applicable, foreign currency items,
minimum pension liability adjustments and unrealized gains and losses on certain
investments in debt and equity securities. SFAS No. 131 requires that companies
report separately, in the financial statements, certain financial and
descriptive information about operating segments, if applicable. The Company is
currently assessing its disclosure requirements under SFAS No. 130 and SFAS No.
131.
NOTE 2--ACQUISITIONS:
In December 1993, the Company acquired 51% of the outstanding stock of John
Hine Limited in exchange for consideration aggregating $7,426,000. In August
1994, the Company acquired an additional 46% of the outstanding stock of John
Hine Limited in exchange for consideration of $6,370,000. The acquisition was
accounted for under the purchase method of accounting and, accordingly, the
purchase price was allocated to the assets acquired based on their estimated
fair values at the date of acquisition. Total consideration for these
acquisitions consisted of:
<TABLE>
<S> <C>
Notes and convertible notes.................................... $4,129,000
Cash........................................................... 7,468,000
Common stock (223,600 shares).................................. 1,677,000
Expenses of the transaction.................................... 522,000
----------
Total purchase price........................................... $13,796,000
----------
----------
</TABLE>
The assets acquired consisted of:
<TABLE>
<S> <C>
Current assets................................................. $8,999,000
Property and equipment......................................... 2,775,000
Goodwill....................................................... 5,980,000
Other assets................................................... 4,566,000
Minority interest.............................................. 2,245,000
----------
$24,565,000
----------
----------
</TABLE>
The liabilities assumed consisted of:
<TABLE>
<S> <C>
Current liabilities............................................ $5,950,000
Long-term debt, less current portion........................... 1,555,000
Other liabilities.............................................. 770,000
Minority interest.............................................. 2,494,000
----------
10,769,000
----------
Net assets acquired............................................ $13,796,000
----------
----------
</TABLE>
F-10
<PAGE>
MEDIA ARTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--ACQUISITIONS: (CONTINUED)
On September 27, 1996, the Company decided to dispose of John Hine Limited,
and accordingly the results of John Hine Limited have been accounted for as a
discontinued operation (Note 3).
Effective June 1, 1995, the Company acquired a gallery located in San Jose,
California (the "Valley Fair Gallery"), owned and operated by the spouse of a
founder. Consideration for this acquisition consisted of cash of $31,000, an 8%
promissory note in the amount of $299,000 which was repaid in July 1996 and an
8% convertible note in the amount of $1,200,000 due in October 2002. The
convertible note is convertible into Common Stock of the Company at a conversion
price of $7.25 per share (as adjusted in accordance with the terms of the
convertible note).
The Company has accounted for this transaction in a manner similar to a
pooling of interests due to the Company and the Valley Fair Gallery being under
common control. Accordingly, the results of the Valley Fair Gallery are included
in the consolidated statement of operations commencing from April 1, 1995. The
results of the Valley Fair Gallery prior to April 1, 1995 were not significant
and have been recorded as an adjustment to the Company's consolidated retained
earnings as of March 31, 1995. The consideration paid for the acquisition in
excess of net assets acquired recorded on an historical basis of $1,530,000 has
been recorded as a reduction of retained earnings.
Effective March 31, 1996, the Company acquired six galleries (the "Monterey
Galleries") located in Monterey and Carmel, California. Consideration for this
acquisition consisted of 444,483 shares of Common Stock of MAGI. The Company has
accounted for this transaction as a pooling of interests. Accordingly, the
Company's financial statements have been restated to include the results of the
Monterey Galleries for all periods presented.
Adjustments have been made to eliminate the impact of sales by the Company
to the Valley Fair Gallery and the Monterey Galleries, as well as the related
profit in inventory. Combined and separate results of the Company and the
Monterey Galleries for the periods preceding the acquisition are as follows:
<TABLE>
<CAPTION>
MONTEREY
COMPANY GALLERIES ADJUSTMENTS COMBINED
------------- ------------ ------------ -------------
<S> <C> <C> <C> <C>
YEAR ENDED MARCH 31, 1995
Net sales............................................ $ 31,872,000 $ 3,398,000 $ (1,785,000) $ 33,485,000
Income from continuing operations before
extraordinary items................................ 3,894,000 377,000 (257,000) 4,014,000
Net income........................................... 3,669,000 377,000 (257,000) 3,789,000
Distributions to S Corporation stockholders.......... -- 358,000 -- 358,000
YEAR ENDED MARCH 31, 1996
Net sales............................................ 37,095,000 4,594,000 (1,937,000) 39,752,000
Income from continuing operations before
extraordinary items................................ 2,165,000 345,000 (55,000) 2,455,000
Net income (loss).................................... (963,000) 345,000 (55,000) (673,000)
Distributions to S Corporation stockholders.......... $ -- $ 549,000 $ -- $ 549,000
</TABLE>
NOTE 3--DISCONTINUED OPERATIONS
On January 10, 1994, the Company adopted a plan to dispose of the assets and
operations of TK Stores which consisted of seven art galleries. The anticipated
disposal was accounted for as a discontinued operation
F-11
<PAGE>
MEDIA ARTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--DISCONTINUED OPERATIONS (CONTINUED)
and accordingly the assets held for disposal and operating results of TK Stores
were segregated and reported as discontinued operations. As the Company expected
to realize a net gain from the sale of the galleries, all losses incurred by TK
Stores subsequent to January 10, 1994 were deferred until the anticipated sale
of the galleries.
On December 16, 1994, the Company decided to retain the assets and
operations of TK Stores as the Company had not received any purchase offers that
met criteria established in the formal plan of disposal and accordingly the
Company ceased accounting for TK Stores as a discontinued operation. Deferred
losses of TK Stores at March 31, 1994, of $211,000 have been recognized in the
year ended March 31, 1995.
On September 27, 1996, the Company decided to dispose of the assets and
operations of John Hine Limited, a United Kingdom company which was acquired in
December 1993 and which manufactured and distributed collectible miniature
cottages and similar products. On November 11, 1996, a Receiver was appointed by
Natwest, John Hine Limited's lender in the United Kingdom. The Receiver ceased
operations of John Hine Limited on December 31, 1996, and a Liquidator was
appointed on February 7, 1997 to dispose of the remaining assets of John Hine
Limited. The disposal has been accounted for as a discontinued operation and
accordingly the assets held for disposal and operating results of John Hine
Limited have been segregated and reported as discontinued operations in the
accompanying consolidated balance sheets and statements of operations. Prior
year financial statements have been restated to reflect the discontinuance of
the John Hine Limited operations. The net assets of the discontinued operations
at March 31, 1997 consist primarily of accounts receivable and inventory related
to United States operations, and at March 31, 1996 also include goodwill,
licenses and customer lists aggregating $8,389,000 together with the assets and
liabilities of the United Kingdom operation.
Operating results of discontinued operations are summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
--------------------------------------------
1995 1996 1997
------------- ------------- --------------
<S> <C> <C> <C>
Net sales of discontinued operations................................ $ 20,900,000 $ 14,249,000 $ 6,788,000
------------- ------------- --------------
------------- ------------- --------------
Loss from discontinued operations before income taxes............... $ (142,000) $ (5,008,000) $ (2,253,000)
Benefit from income tax reduction................................... 89,000 1,880,000 868,000
------------- ------------- --------------
Loss from discontinued operations................................... $ (53,000) $ (3,128,000) $ (1,385,000)
------------- ------------- --------------
------------- ------------- --------------
Loss on disposal of discontinued operations before income taxes..... $ -- $ -- $ (14,664,000)
Benefit from income tax reduction................................... -- -- 2,419,000
------------- ------------- --------------
Loss on disposal of discontinued operations......................... $ -- $ -- $ (12,245,000)
------------- ------------- --------------
------------- ------------- --------------
</TABLE>
The income tax benefit attributable to discontinued operations differs from
the federal statutory rate due principally to state income taxes for all years
presented, and to net operating loss carryforwards not currently recognized for
the year ended March 31, 1997.
NOTE 4--RELATED PARTY TRANSACTIONS:
Certain original art works used for reproductions by the Company have been
supplied by a founder of the Company and remain the property of the founder.
Royalties paid to the founder for sales of reproductions of the founder's art
works by the Company aggregated $320,000, $808,000 and $1,159,000, for the years
ended
F-12
<PAGE>
MEDIA ARTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--RELATED PARTY TRANSACTIONS: (CONTINUED)
March 31, 1995, 1996 and 1997, and aggregated $823,000 (unaudited) and
$1,998,000 for the nine months ended December 31, 1996 and 1997, respectively.
In March 1996, the Company acquired six galleries in Monterey and Carmel,
California. The owner of those galleries became a vice president of the Company
and retained ownership of a gallery in Catalina.
Expenses of the acquisition of John Hine Limited include $326,000 which the
Company agreed to pay to certain minority stockholders of the Company for
services rendered in connection with that acquisition (Note 2).
NOTE 5--DETAILS OF BALANCE SHEET COMPONENTS
<TABLE>
<CAPTION>
MARCH 31,
-------------------------- DECEMBER 31,
1996 1997 1997
------------ ------------ -------------
<S> <C> <C> <C>
Inventories:
Raw materials.............................................. $ 863,000 $ 843,000 $ 1,075,000
Work in process............................................ 44,000 12,000 8,000
Finished goods............................................. 4,099,000 4,560,000 5,402,000
------------ ------------ -------------
$ 5,006,000 $ 5,415,000 $ 6,485,000
------------ ------------ -------------
------------ ------------ -------------
<CAPTION>
MARCH 31,
-------------------------- DECEMBER 31,
1996 1997 1997
------------ ------------ -------------
<S> <C> <C> <C>
Property and equipment:
Machinery and equipment.................................... $ 186,000 $ 266,000 $ 629,000
Furniture and fixtures..................................... 1,101,000 1,124,000 1,288,000
Leasehold improvements..................................... 1,402,000 1,666,000 2,363,000
Computer hardware and software............................. 2,384,000 2,722,000 3,264,000
Automobiles................................................ 79,000 93,000 196,000
------------ ------------ -------------
5,152,000 5,871,000 7,740,000
Less accumulated depreciation.............................. 1,358,000 2,309,000 3,135,000
------------ ------------ -------------
$ 3,794,000 $ 3,562,000 $ 4,605,000
------------ ------------ -------------
------------ ------------ -------------
</TABLE>
Automobiles, machinery and equipment and computer hardware and software
acquired under capital leases aggregated $1,845,000 at March 31, 1996 and 1997
and December 31, 1997. Accumulated amortization at March 31, 1996 and 1997 and
December 31, 1997 aggregated $224,000, $579,000 and $857,000 respectively.
F-13
<PAGE>
MEDIA ARTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--DEBT:
Long-term debt:
<TABLE>
<CAPTION>
MARCH 31,
-------------------------- DECEMBER 31,
1996 1997 1997
------------ ------------ -------------
<S> <C> <C> <C>
Secured notes, net of unamortized debt discount at March 31,
1996 and 1997 and December 31, 1997 of $1,609,000,
$2,843,000 and $2,191,000, respectively.................... $ 6,391,000 $ 4,557,000 $ 3,209,000
Convertible notes............................................ 1,482,000 1,555,000 --
Capital leases............................................... 1,123,000 559,000 --
------------ ------------ -------------
8,996,000 6,671,000 3,209,000
Less current portion......................................... 586,000 2,062,000 500,000
------------ ------------ -------------
$ 8,410,000 $ 4,609,000 $ 2,709,000
------------ ------------ -------------
------------ ------------ -------------
</TABLE>
On February 21, 1997, the Company entered into a two year financing
agreement with a bank for the provision of an $8,000,000 line of credit (the
"Senior Debt"). The financing agreement also provided a facility for the
provision of up to $2,000,000 in support of trade letters of credit. The total
amount available under the line, based on the Company's eligible accounts
receivable and inventory, was $6,180,000 at March 31, 1997 and $10,000,000 at
December 31, 1997. Borrowings under the line bear interest at the bank's prime
rate plus 1 percent (9.25% at December 31, 1997). Interest payments are due
monthly and the principal is due in February, 1999. Outstanding borrowings under
the line of credit aggregated $2,655,000 and $24,000 at March 31, 1997 and
December 31, 1997, respectively. Borrowings under previous lines of credit
aggregated $4,375,000 at March 31, 1996.
In conjunction with the acquisition of John Hine Limited, the Company
borrowed $2,225,000 in December 1993 from investors (the "Investors") in
exchange for unsecured notes (the "Investor Notes") with an interest rate of 18%
per annum. In consideration for accepting the Investor Notes the Company sold to
the Investors, for total consideration of $4,000, warrants to purchase 164,239
shares of the Company's Common Stock at $0.68 per share. A portion of the
proceeds of the Investor Notes attributable to the warrants was accounted for as
additional paid-in capital and debt discount in the amount of $658,000. Debt
discount was amortized over the anticipated term of the related notes (13
months) using the interest method. Amortization of the debt discount aggregated
$154,000 for the year ended March 31, 1995.
In conjunction with the Company's initial public offering in August 1994,
the Company exchanged $1,670,000 of the Investor Notes for 249,626 shares of
Common Stock and warrants to purchase approximately 299,000 shares of Common
Stock at $7.50 per share, and exchanged the balance of the Investor Notes for
cash of $555,000. The Company also agreed to waive the exercise price of 147,630
shares under the warrants previously issued to the Investors. The extinguishment
of the Investor Notes prior to their scheduled maturity date resulted in the
recognition of an extraordinary loss of $172,000 (net of income tax benefit of
$96,000) attributable to the write-off of unamortized debt discount and prepaid
interest.
On July 25, 1995 the Company issued a $3,000,000 12.5% convertible
redeemable note (the "Convertible Note"), a $4,000,000 12.375% promissory note
and a $1,000,000 12.375% promissory note (together the "Notes") and a warrant to
purchase 400,000 shares of the Company's Common Stock at an exercise price of
$5.9375 (the "Warrant") to an investor in exchange for cash of $8,000,000 (the
"Subordinated Debt"). The Convertible Note
F-14
<PAGE>
MEDIA ARTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--DEBT: (CONTINUED)
was convertible into Common Stock of the Company at a conversion price of $6.25
per share (as adjusted in accordance with the terms of the Convertible Note).
On March 12, 1996, the Company changed the interest rate on the Subordinated
Debt to 13.5% effective October 1, 1995 and changed the per share exercise price
of the Warrant to $2.00 in exchange for modification of certain financial
covenants. The Company also amended the conversion price of the Convertible Note
such that $960,000 was convertible at $2.00 per share and $810,000 was
convertible at $3.00 per share with the balance of $1,230,000 having no right of
conversion.
Effective February 21, 1997, in conjunction with entering into the Senior
Debt Agreement, the Company renegotiated the terms and covenants of the
Subordinated Debt and restructured the Notes to a single note aggregating $7.4
million (the "New Note"), after a payment of $592,000 pursuant to the
renegotiation. As part of the renegotiation, the Warrant exercise price was
amended to $0.01 per share which was fully exercised through a cashless
exercise, resulting in the issuance of 398,693 shares of Common Stock. The
conversion rights under the Notes were also amended to provide that
approximately $8,000 of principal amount would be convertible into Common Stock
at an exercise price of $0.01 per share. These conversion rights were also fully
exercised in conjunction with the renegotiation resulting in the issuance of
750,000 shares of Common Stock.
The Senior Debt and the Subordinated Debt are secured by substantially all
of the assets of the Company.
The New Note is repayable at 102% of the principal in the event of a Change
in Management or Control of the Company (as defined under the terms of the
Notes), including any event or transaction whereby (i) Thomas Kinkade (Art
Director) and Ken Raasch (Chairman) cease to collectively beneficially own more
than 35 percent of the voting power of the Company; (ii) any person or group
acquires beneficial ownership of voting power of the Company greater than the
collective beneficial ownership of Thomas Kinkade and Ken Raasch; or (iii) Ken
Raasch ceases to remain in the office of Chairman.
Debt issuance costs related to the issuance of the Notes and the New Note
aggregated approximately $3,420,000 (including $2,005,000 attributable to the
Warrants and Common Stock issued in conjunction with the Notes and New Note) and
are being amortized over the term of the New Note using the interest method.
Interest on the New Note is due monthly, and principal payments are due from
December 1998 through September 2002.
On June 30, 1997, the Company repaid $1.3 million of the New Note, and on
July 7, 1997 repaid a further $700,000 of the New Note. The payments were made
using the proceeds of a federal income tax refund. The remaining principal
balance of $5.4 million is due as follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDING MARCH 31,
- -------------------------------------------------------------------------------
<S> <C>
1998........................................................................... $ --
1999........................................................................... 500,000
2000........................................................................... 1,050,000
2001........................................................................... 2,200,000
2002........................................................................... 1,650,000
-------------
5,400,000
Unamortized debt discount at December 31, 1997................................. (2,191,000)
-------------
$ 3,209,000
-------------
-------------
</TABLE>
F-15
<PAGE>
MEDIA ARTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--DEBT: (CONTINUED)
The Senior Debt and the Subordinated Debt prohibit the payment of cash
dividends and require the maintenance of various financial covenants. Without
the prior consent of the lenders, the Company is also prohibited from incurring
debt and lease commitments in excess of specified amounts or entering into
acquisitions, sales of business, merger or joint venture agreements in excess of
certain amounts.
NOTE 7--COMMITMENTS:
The Company has certain noncancellable operating leases for facilities and
equipment. Future minimum lease commitments under noncancellable leases as of
December 31, 1997 are as follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDING MARCH 31, OPERATING
- ------------------------------------------------------------------------------- -------------
<S> <C>
1998........................................................................... $ 674,000
1999........................................................................... 2,590,000
2000........................................................................... 2,318,000
2001........................................................................... 1,629,000
2002........................................................................... 1,012,000
2003........................................................................... 726,000
Thereafter..................................................................... 1,219,000
-------------
$ 10,168,000
-------------
-------------
</TABLE>
Rent expense under operating leases was $2,014,000, $1,714,000 and
$2,006,000 for the years ended March 31, 1995, 1996 and 1997, respectively and
was $1,783,000 (unaudited) and $2,308,000 for the nine months ended December 31,
1996 and 1997, respectively. TK Stores maintains leases for certain art
galleries which stipulate that additional rent will be payable if the revenues
of those galleries exceed a certain amount.
Certain officers and stockholders have entered into employment agreements
with the Company ranging from three to five years. Compensation payable under
the agreements excluding performance bonuses, aggregates $323,000 for the three
months ending March 31, 1998, and aggregates $1,129,000, $540,000, $210,000,
$180,000 and $90,000 for the years ending March 31, 1999, 2000, 2001, 2002 and
2003, respectively. Each of the agreements provides for the officer to receive
all salary and bonus payments that would have been payable to him under the
agreement for a period of three to five years after a change in control of the
Company which provides "Good Reason" for the officer to terminate his
employment. "Good Reason" is defined in the agreements to include the assignment
to the officer of duties inconsistent with his senior executive status, a
reduction in his base salary, a relocation of the officer or the Company's
principal office and the termination of any compensation or other employee
benefit plans in which he was eligible to participate.
NOTE 8--COMMON STOCK:
On August 10, 1994 and September 9, 1994, the Company issued an aggregate of
1,437,500 shares of Common Stock at a price of $7.25 per share in an
underwritten public offering and received proceeds of $8,060,000 (net of
underwriting and offering costs of $2,362,000). The principal purpose of the
offering was to obtain additional working capital, to repay certain
indebtedness, to purchase an additional 46% interest in John Hine Limited and to
pay an S corporation distribution to the Company's existing shareholders. In
conjunction with the offering, the Company issued 223,600 shares of Common Stock
to an artist in consideration for entering into a license agreement with John
Hine Limited (Note 2), and issued warrants to purchase 125,000 shares of
F-16
<PAGE>
MEDIA ARTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8--COMMON STOCK: (CONTINUED)
Common Stock at $9.06 per share to the offering Underwriters. During the year
ended March 31, 1995 the Company issued warrants to purchase 27,353 shares of
Common Stock at $7.00 per share to certain investors.
In conjunction with the acquisition of John Hine Limited the Company sold to
certain noteholders (the "Investors"), at a price of $0.03 per warrant, warrants
to purchase 164,239 shares of the Company's Common Stock at $0.68 per share
(Note 6). The warrants are transferable and are exercisable through December 31,
1998, except that if the closing price of the Company's Common Stock equals or
exceeds $10.50 for a period of 20 consecutive trading days, the Company has the
right to accelerate the exercise date of the warrants to 60 days from the
exercise of that right.
In conjunction with the initial public offering in August 1994, the Company
extinguished debt aggregating $1,670,000 by issuing to the Investors 249,626
shares of Common Stock and warrants to purchase approximately 299,000 shares of
Common Stock at $7.50 per share. The Company also agreed to pay the $0.68
exercise price of 147,630 shares of the warrants previously issued to the
Investors. In fiscal 1996, 147,630 shares of the Company's Common Stock were
issued upon exercise of those warrants. The remaining warrants are exercisable
through August 10, 2004.
Effective March 31, 1996, the Company acquired six galleries in Monterey and
Carmel, California, in exchange for 444,483 shares of the Company's Common
Stock.
On February 21, 1997, the Company issued 1,148,693 shares of Common Stock to
the holders of the Subordinated Debt (Note 6). In conjunction with the
negotiation of a new License Agreement with Thomas Kinkade in December 1997, the
Company issued to Thomas Kinkade an option to purchase 600,000 shares of the
Company's Common Stock at an exercise price of $12.375 per share.
In February 1994, the Company adopted the Employee Stock Option Plan (the
"Employee Plan") and the Stock Option Plan for Outside Directors (the "Directors
Plan") under which 1,124,863 shares and 50,000 shares, respectively, of Common
Stock are reserved for issuance to employees and outside directors.
Options granted under the Employee Plan may be either incentive stock
options or non-qualified stock options. The exercise price of options granted
under the Employee Plan may not be less than the fair market value of the shares
of the Company's Common Stock on the date of grant. However, in the case of
options granted to an optionee who owns stock representing more than 10% of the
voting power of all classes of the Company's stock, the exercise price must not
be less than 110% of the fair market value on the date of grant and the maximum
term of such options may not exceed five years.
Incentive stock options generally expire on the earlier of three months
after termination of employment, or ten years after date of grant. Non-qualified
stock options generally expire on the earlier of six months after termination of
employment, or ten years after date of grant.
Under the terms of the Directors Plan the Company's two outside directors at
the date of adoption of the Directors Plan were each granted options to purchase
7,909 shares. Outside directors subsequently appointed are entitled to receive
an option to purchase 5,000 shares of Common Stock. Outside directors are
entitled to receive an option to purchase 1,500 shares of Common Stock after
each year of service as an outside director. All such options vest immediately
and generally expire three months after termination of office, or 10 years after
date of grant.
F-17
<PAGE>
MEDIA ARTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8--COMMON STOCK: (CONTINUED)
The following table summarizes option activities:
<TABLE>
<CAPTION>
WEIGHTED
OPTIONS AVERAGE
AVAILABLE OPTIONS EXERCISE
FOR GRANT OUTSTANDING PRICE
----------- ----------- -----------
<S> <C> <C> <C>
Balance at March 31, 1994................................................... 609,045 240,955 $ 2.71
Granted..................................................................... (434,950) 434,950 7.05
Exercised................................................................... -- (13,502) 2.50
----------- -----------
Balance at March 31, 1995................................................... 174,095 662,403 5.56
Reserved.................................................................... 250,000 --
Granted..................................................................... (37,000) 37,000 5.82
Exercised................................................................... -- (527) 2.37
Expired..................................................................... 15,005 (15,005) 4.15
----------- -----------
Balance at March 31, 1996................................................... 402,100 683,871 5.55
Granted..................................................................... (152,000) 152,000 3.07
Exercised................................................................... -- (9,802) 2.74
Expired..................................................................... 118,878 (118,904) 3.29
----------- -----------
Balance at March 31, 1997................................................... 368,978 707,165 3.15
Reserved.................................................................... 990,000 -- --
Granted..................................................................... (1,120,000) 1,120,000 8.90
Exercised................................................................... -- (57,515) 2.83
Expired..................................................................... 79,803 (92,984) 3.61
----------- -----------
Balance at December 31, 1997................................................ 318,781 1,676,666 6.90
----------- -----------
----------- -----------
</TABLE>
On August 21, 1996, the Company canceled 395,450 options with exercise
prices between $5.50 and $7.25 (a weighted average exercise price of $7.02) and
reissued those options with an exercise price of $3.00. As of December 31, 1997,
options to purchase 1,163,584 shares of Common Stock were fully vested. The
weighted average grant-date fair value of options granted during the years ended
March 31, 1996 and 1997 and the nine months ended December 31, 1997 was $3.56,
$1.93 and $5.55, respectively.
The following table summarizes information regarding stock options which are
outstanding and exercisable:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------------- ---------------------------------
NUMBER WEIGHTED NUMBER
OUTSTANDING AT WEIGHTED AVERAGE AVERAGE EXERCISABLE AT
RANGE OF EXERCISE DECEMBER 31, REMAINING CONTRACTUAL EXERCISE DECEMBER 31, WEIGHTED AVERAGE
PRICES 1997 LIFE (YEARS) PRICE 1997 EXERCISE PRICE
- ----------------- --------------- --------------------- ------------- --------------- ----------------
<S> <C> <C> <C> <C> <C>
$ 1.31 - $ 2.75 271,401 6.3 $ 2.32 231,901 $ 2.35
2.76 - 4.00 348,356 7.6 3.25 232,774 3.08
4.01 - 6.00 385,000 9.6 4.79 70,000 4.81
6.01 - 8.63 71,909 7.7 7.44 28,909 6.88
8.64 - 12.375 600,000 9.9 12.375 600,000 12.375
--------------- ---------------
1,676,666 1,163,584
--------------- ---------------
--------------- ---------------
</TABLE>
F-18
<PAGE>
MEDIA ARTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8--COMMON STOCK: (CONTINUED)
The Company applies the provisions of APB No. 25 and related Interpretations
in accounting for compensation expense under the Company's option plans. Had
compensation expense under these plans been determined pursuant to SFAS No. 123,
the Company's net income and net income per share would have been as follows:
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
---------------------------- NINE MONTHS ENDED
1996 1997 DECEMBER 31, 1997
------------ -------------- -----------------
<S> <C> <C> <C>
Income from continuing operations before extraordinary loss
As reported................................................... $ 2,455,000 $ 2,644,000 $ 8,393,000
Pro forma..................................................... 2,422,000 2,387,000 8,013,000
Net income (loss)
As reported................................................... (673,000) (10,986,000) 8,393,000
Pro forma..................................................... (706,000) (11,243,000) 8,013,000
Income from continuing operations before extraordinary loss per
share (diluted)
As reported................................................... 0.25 0.26 0.73
Pro forma..................................................... 0.22 0.22 0.72
Net income (loss) per share (diluted)
As reported................................................... (0.07) (1.09) 0.73
Pro forma..................................................... (0.07) (1.03) 0.72
</TABLE>
The fair value of the shares granted under the Company's option plans was
estimated using the Black-Scholes model with the following weighted-average
assumptions: zero dividend yield; an expected life of 4.5 years; expected
volatility of 75%; and a risk-free interest rate of 6.0% and 6.4% for the years
ended March 31, 1996 and 1997, respectively, and 6.0% for the nine months ended
December 31, 1997.
NOTE 9--INCOME TAXES:
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
NINE MONTHS ENDED DECEMBER
YEAR ENDED MARCH 31, 31,
---------------------------------------- --------------------------
1995 1996 1997 1997
------------ ------------ ------------ 1996 ------------
------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Current:
Federal................................... $ 499,000 $ 1,195,000 $ 1,975,000 $ 1,557,000 $ 4,740,000
State..................................... 1,483,000 326,000 315,000 248,000 957,000
------------ ------------ ------------ ------------ ------------
1,982,000 1,521,000 2,290,000 1,805,000 5,697,000
------------ ------------ ------------ ------------ ------------
Deferred:
Federal................................... (147,000) 82,000 (467,000) (368,000) (689,000)
State..................................... (322,000) -- (55,000) (43,000) (71,000)
------------ ------------ ------------ ------------ ------------
(469,000) 82,000 (522,000) (411,000) (760,000)
------------ ------------ ------------ ------------ ------------
$ 1,513,000 $ 1,603,000 $ 1,768,000 $ 1,394,000 $ 4,937,000
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
</TABLE>
F-19
<PAGE>
MEDIA ARTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9--INCOME TAXES: (CONTINUED)
A reconciliation of income taxes computed at the federal statutory income
tax rate to income taxes reported in the statement of operations is as follows:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED MARCH 31, DECEMBER 31,
------------------------------------- ----------------------------
1995 1996 1997 1997
--- --- --- 1996 ---
---------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Federal statutory income tax rate................... 34% 34% 34% 34% 34%
S Corporation income not subject to federal income
taxes............................................. (1) (2) -- -- --
State income taxes.................................. 6 5 3 3 5
Recognition of deferred tax benefit on conversion of
certain subsidiaries from S Corporations to C
Corporations...................................... (11) -- -- -- --
Other............................................... (1) 2 3 4 (2)
--
--- --- --- ---
27% 39% 40% 41% 37%
--
--
--- --- --- ---
--- --- --- ---
</TABLE>
Deferred income tax assets consisted of:
<TABLE>
<CAPTION>
MARCH 31,
-------------------------- DECEMBER 31,
1996 1997 1997
------------ ------------ -------------
<S> <C> <C> <C>
Allowances for sales returns and doubtful accounts........... $ 607,000 $ 1,051,000 $ 909,000
Inventory reserves........................................... 261,000 235,000 138,000
Accrued compensation costs................................... -- -- 865,000
State income taxes........................................... 27,000 48,000 283,000
Other........................................................ 164,000 247,000 146,000
------------ ------------ -------------
Net deferred income tax assets........................... $ 1,059,000 $ 1,581,000 $ 2,341,000
------------ ------------ -------------
------------ ------------ -------------
</TABLE>
Net deferred tax assets aggregating $638,000 and an income tax benefit in an
equal amount were recorded in the financial statements of the Company on April
1, 1994, when Lightpost and TK Stores ceased to be treated as S corporations.
Gross deferred income tax assets at March 31, 1996 and 1997 also relate to John
Hine Limited and its U.S. subsidiary, John Hine Studios, Inc. Goodwill arising
from the acquisition of John Hine Limited was reduced by $749,000 during the
year ended March 31, 1995 to reflect the recognition of a reduction in the
valuation allowance for deferred tax assets acquired as part of the acquisition
of John Hine Limited for which a full valuation allowance was provided at the
time of acquisition.
NOTE 10--NON CASH INVESTING AND FINANCING ACTIVITIES:
On February 21, 1997, the Company refinanced its Senior Debt and
renegotiated the terms of its Subordinated Debt. In conjunction with the
refinancing and renegotiation of that debt the Company issued 1,148,693 shares
of Common Stock to the holder of the Subordinated Debt (Note 6).
The Company acquired the Valley Fair Gallery effective June 1, 1996 in
exchange for cash of $31,000 and notes aggregating $1,494,000. The Company
acquired the Monterey Galleries effective March 31, 1996 in exchange for 444,483
shares of the Company's Common Stock.
F-20
<PAGE>
MEDIA ARTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--NON CASH INVESTING AND FINANCING ACTIVITIES: (CONTINUED)
Asset acquisitions under capital leases aggregated $388,000 and $1,212,000
for the years ended March 31, 1996 and 1995, respectively, and were not
significant for any other period presented.
Consideration for the acquisition of 51% of John Hine Limited in December
1993 included notes aggregating $496,000 and accrued liabilities aggregating
$1,480,000 (Note 2). Consideration for the acquisition of 46% of John Hine
Limited in August 1994 included convertible notes aggregating $2,310,000 and
202,667 shares of Common Stock issued in conjunction with the Company's initial
public offering (Note 2). The Company issued an additional 20,933 shares of
Common Stock in conjunction with the offering to repay $157,000 of the accrued
liabilities incurred for the acquisition of the 51% interest in John Hine
Limited.
In conjunction with the Company's initial public offering in August 1994,
the Company exchanged $1,670,000 of notes for 249,626 shares of Common Stock and
warrants to purchase approximately 299,000 shares of Common Stock at $7.50. The
extinguishment of the notes prior to their scheduled maturity date resulted in
the recognition of an extraordinary loss of $172,000 (net of income tax benefit
of $96,000) attributable to the write-off of unamortized debt discount and
prepaid interest.
Goodwill arising from the acquisition of John Hine Limited was reduced by
$749,000 during the year ended March 31, 1995 to reflect the recognition of a
reduction in the valuation allowance for deferred tax assets acquired as part of
the acquisition of John Hine Limited for which a full valuation allowance was
provided at the time of acquisition.
NOTE 11--GAIN ON SALE AND LEASEBACK:
In July 1997, the Company exercised an option to purchase its San Jose
leasehold facility. The Company subsequently sold the facility and entered into
a four year lease agreement with the purchaser. The gain on the sale and
leaseback of the facility, after transaction costs of $110,000 and deferral of
$650,000 to offset future rent increases as compared to the previous lease,
aggregated $997,000.
F-21
<PAGE>
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- -------------------------------------------------
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NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN
THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY, ANY
SELLING STOCKHOLDER OR ANY UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE
AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY TO ANY PERSON IN ANY
JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION WOULD BE UNLAWFUL OR TO ANY
PERSON TO WHOM IT IS UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR
ANY OFFER OR SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY
IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY OR
THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT
TO THE DATE HEREOF.
--------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Prospectus Summary............................... 3
Risk Factors..................................... 5
Use of Proceeds.................................. 11
Price Range of Common Stock...................... 11
Dividend Policy.................................. 11
Capitalization................................... 12
Selected Consolidated Financial Data............. 13
Management's Discussion and Analysis of Financial
Condition and Results of Operations............. 15
Business......................................... 23
Management....................................... 32
Principal and Selling Stockholders............... 39
Certain Transactions............................. 41
Shares Eligible for Future Sale.................. 43
Description of Capital Stock..................... 44
Underwriting..................................... 46
Legal Matters.................................... 47
Experts.......................................... 47
Available Information............................ 48
Index to Consolidated Financial Statements....... F-1
</TABLE>
2,409,500 SHARES
[LOGO]
COMMON STOCK
--------------
PROSPECTUS
--------------
HAMBRECHT & QUIST
NATIONSBANC MONTGOMERY
SECURITIES LLC
, 1998
- -------------------------------------------------
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- -------------------------------------------------
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<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The expenses to be paid by the Company in connection with the distribution
of the securities being registered are as set forth in the following table:
<TABLE>
<S> <C>
Securities and Exchange Commission Fee.......................... $ 12,520
NASD Filing Fee................................................. 4,744
Nasdaq National Market Listing Fee.............................. 17,500
*Legal Fees and Expenses........................................ 150,000
*Accounting Fees and Expenses................................... 175,000
*Printing Expenses.............................................. 100,000
*Blue Sky Fees and Expenses..................................... 5,000
*Registrar and Transfer Agent Fees and Expenses................. 5,000
*Underwriting Discounts and Commissions (1)..................... 600,000
*Miscellaneous.................................................. 30,236
---------
*Total.......................................................... $1,100,000
---------
---------
</TABLE>
- ------------------------
* Estimated.
(1) The Company has agreed to reimburse Levine Leichtman for up to $600,000 for
underwriting discounts and commissions relating to Levine Leichtman's sale
of 700,000 shares of Common Stock in the offering notwithstanding the actual
amount thereof, provided that if the number of shares of Common Stock sold
by Levine Leichtman in the offering is less than 700,000, the payment shall
be proportionately reduced.
The Company will bear certain expenses in connection with the registration
and offering of shares by the Selling Stockholders, other than the underwriting
discounts and commissions (except as provided above) and the fees and expenses
of any separate counsel, advisors or accountants retained by the Selling
Stockholders (other than the separate counsel retained by Levine Leichtman).
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS
As permitted by Section 145 of the Delaware General Corporation Law (the
"DGCL"), the Company's Amended and Restated Certificate of Incorporation
includes a provision that eliminates the personal liability of its directors for
monetary damages for breach of fiduciary duty as a director, except for
liability (i) for any breach of the director's duty of loyalty to the Company or
its stockholders; (ii) for acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of the law; (iii) pursuant to
Section 174 of the DGCL; or (iv) for any transaction from which the director
derived an improper personal benefit.
In addition, the Bylaws of the Company provide that (i) the Company shall
indemnify any person who was or is a party or is threatened to be made a party
to any action, suit or proceeding by reason of the fact that he or she is or was
a director or officer of the Company, or is or was serving in certain capacities
of other enterprises (including, for example, subsidiaries of the Company) at
the Company's request, including those circumstances in which indemnification
would otherwise be discretionary; (ii) expenses incurred by a director or
officer arising from a threatened or pending action, suit or proceeding shall be
paid by the Company in advance of final disposition of the action upon receipt
of an undertaking by or on behalf of such director or officer to repay such
amount if ultimately he is not entitled to indemnification; and (iii) the rights
conferred in the Bylaws are not exclusive and the Company is authorized to enter
into indemnification agreements with its directors, officers and employees. The
Bylaws permit the Company to maintain director and officer liability insurance
for its directors and officers whether or not the Company would have the power
or the obligation to indemnify them against such liability under the
indemnification provisions of the Bylaws.
The Company has obtained a policy of directors' and officers' liability
insurance for its directors and officers to insure directors and officers
against the costs of defense, settlement or payment of a judgment under certain
circumstances. The Company has entered into employment agreements with certain
of its executive officers and indemnity agreements with certain of its directors
that provide indemnity as allowed by Section 145 of the DGCL and the Bylaws.
II-1
<PAGE>
ITEM 16. EXHIBITS
<TABLE>
<S> <C>
1.1* Form of Underwriting Agreement.
4.1(1) Amended and Restated Certificate of Incorporation.
4.2* Bylaws.
4.3(1) Form of Specimen Common Stock Certificate.
5.1* Opinion of Latham & Watkins.
10.1* Employees Stock Option Plan.
10.2(1) Stock Option Plan for Outside Directors.
10.3(1) Employment Agreement entered into between the Company and Kenneth E. Raasch,
dated as of January 1, 1994.
10.4* Amendment to Employment Agreement between the Company and Kenneth E. Raasch,
entered into as of October 29, 1997.
10.5* Amended Employment Agreement between the Company and John Lackner, made and
entered into as of October 10, 1997.
10.6(6) Employment Agreement entered into between the Company and James F. Landrum,
Jr., dated as of May 1, 1997.
10.7(6) Employment Agreement entered into between the Company and Craig Fleming, dated
as of May 8, 1997.
10.8(5) Employment Agreement entered into between the Company and Richard F. Barnett,
dated as of March 31, 1996.
10.9(1) Employment Agreement entered into between the Company and Daniel P. Byrne,
dated as of January 1, 1994.
10.10(1) Employment Agreement entered into between the Company and Raymond A. Peterson,
dated as of January 1, 1994.
10.11(1) Employment Agreement entered into between the Company and Thomas Kinkade, dated
as of January 1, 1994.
10.12* License Agreement entered into by the Company and Thomas Kinkade, effective as
of December 3, 1997.
10.13(1) Contribution Agreement between the Company and Kenneth E. Raasch, Thomas
Kinkade, Dennis McCarthy and Robert Wallace, dated as of April 1, 1994.
10.14(1) Sublease Agreement between Pillsbury, Madison & Sutro and the Lightpost Group,
dated as of June 15, 1993.
10.15(1) Lease Agreement between South Bay/Crip 3 and the Company, dated February 17,
1994 and First Amendment to Lease dated as of April 15, 1994.
10.16(2) Securities Purchase Agreement dated July 7, 1995 by and among Levine Leichtman,
as Purchaser, and the Company, Lightpost Publishing, Inc., Thomas Kinkade
Stores, Inc., MAGI Entertainment Products, Inc. and John Hine Studios, Inc.,
as Issuers.
10.17(3) First Amendment to the Securities Purchase Agreement dated March 12, 1996, by
and among Levine Leichtman, as Purchaser and the Company, Lightpost
Publishing, Inc., Thomas Kinkade Stores, Inc., MAGI Entertainment Products,
Inc. and John Hine Studios, Inc., as Issuers.
10.18(4) Financing Agreement dated as of February 21, 1997 by and among CIT
Group/Business Credit, Inc., the Company, Thomas Kinkade Stores, Inc. and
California Coast Galleries, Inc.
10.19(4) Credit Agreement dated as of February 21, 1997 by and among Levine Leichtman,
the Company, MAGI Entertainment Products, Inc., California Coast Galleries,
Inc. and MAGI Sales, Inc.
10.20(6) Lease Agreement between Limar Realty Corp. #36 and the Company, dated as of May
22, 1997.
</TABLE>
II-2
<PAGE>
<TABLE>
<S> <C>
10.21* Investment Monitoring Agreement by and among Levine Leichtman, the Company,
Thomas Kinkade Stores, Inc., MAGI Entertainment Products, Inc. and MAGI Sales,
Inc., dated as of September 10, 1996.
10.22* First Amendment to Investment Monitoring Agreement by and among Levine
Leichtman, the Company, Thomas Kinkade Stores, Inc., MAGI Entertainment
Products, Inc., MAGI Sales, Inc. and California Coast Galleries, dated as of
February 21, 1997.
10.23* Consulting Agreement between the Company and Mike Kiley, dated as of April 1,
1997.
10.24* Amendment to Consulting Agreement between the Company and Mike Kiley, dated as
of August 1, 1997.
10.25* Purchase and Sale Agreement by and between the Company and Limar Realty Corp.
#36, dated as of June 3, 1997.
10.26* Form of Director Indemnity Agreement.
11.1* Statement regarding Computation of Per Share Earnings.
23.1 Consent of Price Waterhouse LLP.
23.2 Consent of Latham & Watkins (included in Exhibit 5.1).
24.1* Powers of Attorney.
</TABLE>
- ------------------------
(1) Incorporated by reference from the Company's Registration Statement on Form
S-1 (File No. 33-79744).
(2) Incorporated by reference from the Company's Form 8-K dated July 26, 1995
(File No. 0-24294).
(3) Incorporated by reference from the Company's Form 8-K dated March 12, 1996
(File No. 0-24294).
(4) Incorporated by reference from the Company's Form 8-K dated February 21,
1997 (File No. 0-24294).
(5) Incorporated by reference from the Company's Form 10-K for the fiscal year
ended March 31, 1997 (File No. 0-24294).
(6) Incorporated by reference from the Company's Form 10-Q for the quarterly
period ended September 30, 1997 (File No. 0-24294).
* Previously filed.
ITEM 17. UNDERTAKINGS
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
of 1933 and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act of 1933 and will be governed by the final adjudication of such issue.
The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act of
1933, the information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act shall be deemed to be part of this registration
statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act of
1933, each post-effective amendment that contains a form of prospectus shall be
deemed to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to be
the initial bona fide offering thereof.
II-3
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT
HAS DULY CAUSED THIS AMENDMENT TO REGISTRATION STATEMENT TO BE SIGNED ON ITS
BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF SAN JOSE,
STATE OF CALIFORNIA, ON FEBRUARY 11, 1998.
MEDIA ARTS GROUP, INC.
By:/s/ RAYMOND A. PETERSON
------------------------------------
Name: Raymond A. Peterson
Title: Chief Financial Officer
POWER OF ATTORNEY
Pursuant to the requirements of the Securities Act of 1933, this Amendment
to Registration Statement has been signed by each of the following persons in
the capacities and on the dates indicated:
NAME TITLE DATE
- -------------------- ------------------------------ -------------------
* President and Chief Executive
- -------------------- Officer (Principal Executive February 11, 1998
CRAIG FLEMING Officer)
/s/ RAYMOND A.
PETERSON Chief Financial Officer
- -------------------- (Principal Financial February 11, 1998
RAYMOND A. PETERSON Officer)
Corporate Controller and
* Principal Accounting Officer
- -------------------- (Principal Accounting February 11, 1998
GREG NASH Officer)
*
- -------------------- Chairman February 11, 1998
KENNETH E. RAASCH
*
- -------------------- Director February 11, 1998
THOMAS KINKADE
*
- -------------------- Director February 11, 1998
MICHAEL L. KILEY
*
- -------------------- Director February 11, 1998
NORMAN T. MAHONEY
*
- -------------------- Director February 11, 1998
NORMAN A. NASON
*By: /s/ RAYMOND A. PETERSON
-------------------------
Raymond A. Peterson
ATTORNEY-IN-FACT
II-4
<PAGE>
EXHIBIT INDEX
<TABLE>
<S> <C>
1.1* Form of Underwriting Agreement.
4.1(1) Amended and Restated Certificate of Incorporation.
4.2* Bylaws.
4.3(1) Form of Specimen Common Stock Certificate.
5.1* Opinion of Latham & Watkins.
10.1* Employees Stock Option Plan.
10.2(1) Stock Option Plan for Outside Directors.
10.3(1) Employment Agreement entered into between the Company and Kenneth E. Raasch, dated
as of January 1, 1994.
10.4* Amendment to Employment Agreement between the Company and Kenneth E. Raasch,
entered into as of October 29, 1997.
10.5* Amended Employment Agreement between the Company and John Lackner, made and entered
into as of October 10, 1997.
10.6(6) Employment Agreement entered into between the Company and James F. Landrum, Jr.,
dated as of May 1, 1997.
10.7(6) Employment Agreement entered into between the Company and Craig Fleming, dated as
of May 8, 1997.
10.8(5) Employment Agreement entered into between the Company and Richard F. Barnett, dated
as of March 31, 1996.
10.9(1) Employment Agreement entered into between the Company and Daniel P. Byrne, dated as
of January 1, 1994.
10.10(1) Employment Agreement entered into between the Company and Raymond A. Peterson,
dated as of January 1, 1994.
10.11(1) Employment Agreement entered into between the Company and Thomas Kinkade, dated as
of January 1, 1994.
10.12* License Agreement entered into by the Company and Thomas Kinkade, effective as of
December 3, 1997.
10.13(1) Contribution Agreement between the Company and Kenneth E. Raasch, Thomas Kinkade,
Dennis McCarthy and Robert Wallace, dated as of April 1, 1994.
10.14(1) Sublease Agreement between Pillsbury, Madison & Sutro and the Lightpost Group,
dated as of June 15, 1993.
10.15(1) Lease Agreement between South Bay/Crip 3 and the Company, dated February 17, 1994
and First Amendment to Lease dated as of April 15, 1994.
10.16(2) Securities Purchase Agreement dated July 7, 1995 by and among Levine Leichtman, as
Purchaser, and the Company, Lightpost Publishing, Inc., Thomas Kinkade Stores,
Inc., MAGI Entertainment Products, Inc. and John Hine Studios, Inc., as Issuers.
10.17(3) First Amendment to the Securities Purchase Agreement dated March 12, 1996, by and
among Levine Leichtman, as Purchaser and the Company, Lightpost Publishing, Inc.,
Thomas Kinkade Stores, Inc., MAGI Entertainment Products, Inc. and John Hine
Studios, Inc., as Issuers.
10.18(4) Financing Agreement dated as of February 21, 1997 by and among CIT Group/Business
Credit, Inc., the Company, Thomas Kinkade Stores, Inc. and California Coast
Galleries, Inc.
10.19(4) Credit Agreement dated as of February 21, 1997 by and among Levine Leichtman, the
Company, MAGI Entertainment Products, Inc., California Coast Galleries, Inc. and
MAGI Sales, Inc.
10.20(6) Lease Agreement between Limar Realty Corp. #36 and the Company, dated as of May 22,
1997.
</TABLE>
<PAGE>
<TABLE>
<S> <C>
10.21* Investment Monitoring Agreement by and among Levine Leichtman, the Company, Thomas
Kinkade Stores, Inc., MAGI Entertainment Products, Inc. and MAGI Sales, Inc.,
dated as of September 10, 1996.
10.22* First Amendment to Investment Monitoring Agreement by and among Levine Leichtman,
the Company, Thomas Kinkade Stores, Inc., MAGI Sales, Inc. and California Coast
Galleries, dated as of February 21, 1997.
10.23* Consulting Agreement between the Company and Mike Kiley, dated as of April 1, 1997.
10.24* Amendment to Consulting Agreement between the Company and Mike Kiley, dated as of
August 1, 1997.
10.25* Purchase and Sale Agreement by and between the Company and Limar Realty Corp. #36,
dated as of June 3, 1997.
10.26* Form of Director Indemnity Agreement.
11.1* Statement regarding Computation of Per Share Earnings.
23.1 Consent of Price Waterhouse LLP.
23.2 Consent of Latham & Watkins (included in Exhibit 5.1).
24.1* Powers of Attorney.
</TABLE>
- ------------------------
(1) Incorporated by reference from the Company's Registration Statement on Form
S-1 (File No. 33-79744).
(2) Incorporated by reference from the Company's Form 8-K dated July 26, 1996
(File No. 0-24294).
(3) Incorporated by reference from the Company's Form 8-K dated March 12, 1996
(File No. 0-24294).
(4) Incorporated by reference from the Company's Form 8-K dated February 21,
1997 (File No. 0-24294).
(5) Incorporated by reference from the Company's Form 10-K for the fiscal year
ended March 31, 1997 (File No. 0-24294).
(6) Incorporated by reference from the Company's Form 10-Q for the quarterly
period ended September 30, 1997 (File No. 0-24294).
* Previously filed.
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use in the Prospectus constituting part of this
Registration Statement on Form S-1 of our report dated January 13, 1998,
relating to the financial statements of Media Arts Group, Inc., which appears in
such Prospectus. We also consent to the references to us under the headings
"Experts" and "Selected Financial Data" in such Prospectus. However, it should
be noted that Price Waterhouse LLP has not prepared or certified such "Selected
Financial Data."
/s/ PRICE WATERHOUSE LLP
San Jose, California
February 10, 1998
