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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 1998
Commission File number 0-24294
MEDIA ARTS GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0354419
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
521 Charcot Avenue
San Jose, California 95113
(Address of principal executive (Zip code)
offices)
Registrant's telephone number, including area code: (408) 324-2020
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to section 12(g) of the Act:
Common Stock, $0.01 Par Value
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No____
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (Section 229,405 of this chapter) is not contained
herein, and will not be contained, to the best of registrant's knowledge, in
definitive proxy or information statement incorporated by reference in Part
III of this Form 10-K or any amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant, based upon the closing price of the Common Stock on May 29,
1998, as reported on Nasdaq National Markets was approximately $122,231,000.
Shares of Common Stock held by each executive officer and director and by
each person who owns 5% or more of the outstanding Common Stock have been
excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive
determination for other purposes.
The number of shares of the registrant's $0.01 par value Common Stock
outstanding on May 31, 1998, was 12,975,554
Part III incorporates by reference from the definitive proxy statement
for the registrant's 1998 annual meeting of stockholders to be filed with the
Commission pursuant to Regulation 14A not later than 120 days after the end
of the fiscal year covered by this Form.
THIS FORM CONTAINS 43 PAGES. THE INDEX TO EXHIBITS IS ON PAGE 36.
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PART I
FORWARD LOOKING STATEMENTS IN THIS ANNUAL REPORT ON FORM 10-K, INCLUDING
THOSE SET FORTH IN ITEM 1 AND ITEM 7, ARE MADE PURSUANT TO THE SAFE HARBOR
PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.
STOCKHOLDERS ARE CAUTIONED THAT ALL FORWARD-LOOKING STATEMENTS PERTAINING TO
THE COMPANY INVOLVE RISKS AND UNCERTAINTIES, INCLUDING, WITHOUT LIMITATION,
THOSE CONTAINED IN ITEM 1 AND ITEM 7 OF THIS REPORT AND OTHER RISKS DETAILED
FROM TIME TO TIME IN THE COMPANY'S PERIODIC REPORTS AND OTHER INFORMATION
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION.
ITEM 1. BUSINESS
OVERVIEW
Media Arts Group, Inc. ("the Company") 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 Cards,
Inc., Avon Products, Inc. and QVC Inc.. 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 March
31, 1998 included 19 Thomas Kinkade Stores, 74 Signature Galleries and
approximately 2,500 other independent gift and collectible retailers as well
as through the strategic relationships. 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
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lines. By leveraging these new images and its existing library of over 170
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.
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 fiscal 1998, sales through Thomas Kinkade Stores and to
Signature Galleries accounted for approximately 48.8% 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
2,500 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 fiscal 1998, the Company added
over 345 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 1998, limited editions and open
editions represented 69.2% and 22.0% 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.
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
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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 Company's license agreement with
Thomas Kinkade dated December 3, 1997 (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 170 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 products to gain consumer acceptance as the Company
expands its distribution would have a material adverse effect on the Company.
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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 $1,495 per square foot in fiscal 1998. Sales through Thomas Kinkade
Stores were approximately $20.6 million in fiscal 1998. As of March 31, 1998,
the Company owned and operated 19 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 12 additional 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.
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 March 31, 1998, 74 Signature
Galleries had been opened or converted from existing independent dealers.
Sales to Signature Galleries were approximately $19.8 million in fiscal 1998.
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 approximately 100
additional Signature Galleries 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.
OTHER INDEPENDENT DEALERS. The Company's products currently are sold to
approximately 2,500 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.
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The Company also has been able to identify potential Signature Gallery owners
through its dealer program. As of March 31, 1998, there were approximately
275 Showcase Dealers, 350 Premier Dealers, 1,000 Authorized Dealers and 875
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.
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 March 31, 1998 the Company's sales force
consisted of a Vice President supported by four Regional Sales Directors, a
Director of Sales Operations and 32 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 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.
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THOMAS KINKADE COLLECTORS' SOCIETY. The Company sponsors and operates a
collector's club for consumers of Thomas Kinkade products. As of March 31,
1998, the Thomas Kinkade Collectors Society had over 20,700 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.
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.
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 recently upgraded its JD Edwards suite of software in order to be
Year 2000 compliant and plans to upgrade its AS/400 within the next six
months in order to increase operating capacity. In addition, the Company
recently completed 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 170 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
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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 Form 10-K, 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 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. Mr. Kinkade is also compensated as the
Company's Creative Director.
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
8
<PAGE>
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.
EMPLOYEES
As of March 31, 1998, the Company had 420 employees, including 121 in
manufacturing and distribution, 117 in sales and marketing, 127 in retail
sales and administration and 55 in corporate administration. The Company
believes that its labor relations are satisfactory and has never experienced
a work stoppage.
ITEM 2. 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 135,000 square feet.
As of March 31, 1998, the Company's retail operations were located in 19
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, the
Company expects to enter into leases for new retail sites and for
approximately 75,000 square feet of manufacturing and distribution facilities
through the end of fiscal 1999.
ITEM 3. 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS.
None.
9
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDERS
MATTERS
The Company's stock has been traded on the Nasdaq National Market since
the Company's initial public offering on August 10, 1994 under the Nasdaq
symbol ARTS. The following table sets forth, for the periods indicated, the
high and low closing sales prices for the Company's Common Stock as reported
by Nasdaq:
<TABLE>
<CAPTION>
Year Ended
March 31, High Low
---------- ---- ---
<S> <C> <C>
1997
----
First Quarter 3.25 2.625
Second Quarter 2.875 1.313
Third Quarter 2.875 1.438
Fourth Quarter 5.125 2.438
1998
----
First Quarter 5.125 3.75
Second Quarter 6.125 3.875
Third Quarter 17 6.5
Fourth Quarter 21.25 11.375
</TABLE>
As of May 31, 1998, there were approximately 212 holders of record of
the Company's Common Stock.
The Company has never paid cash dividends on its Common Stock. The
Company currently intends to retain earnings, if any, for use in its business
and does not anticipate paying any cash dividends in the foreseeable future.
10
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
Media Arts Group, Inc.
Selected Financial Data (1)
<TABLE>
<CAPTION>
Year Three mths
ended ended Year ended March 31,
Dec. 31 March 31, ---------------------------------------------------
(In thousands, except per share data) 1993 1994 1995 1996 1997 1998
- ----------------------------------------------- --------- -------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA: (1)
Net sales $ 16,705 $ 6,258 $ 33,485 $ 39,752 $ 47,018 $ 82,650
Cost of sales 5,531 2,166 10,330 13,343 16,760 27,220
--------- -------- --------- --------- --------- ---------
Gross profit 11,174 4,092 23,155 26,409 30,258 55,430
--------- -------- --------- --------- --------- ---------
Operating expenses
Selling and marketing expenses 3,904 1,571 6,685 10,028 12,784 19,781
General and administrative expenses 3,234 1,473 10,073 10,834 10,683 15,457
Bonuses to S Corporation stockholders 1,256 - - - - -
--------- -------- --------- --------- --------- ---------
Total operating expenses 8,394 3,044 16,758 20,862 23,467 35,238
--------- -------- --------- --------- --------- ---------
Operating income 2,780 1,048 6,397 5,547 6,791 20,192
Interest expense (163) (389) (870) (1,447) (2,348) (1,612)
Gain on sale and leaseback - - - - - 997
Foreign exchange losses - - - (42) (31) (93)
--------- -------- --------- --------- --------- ---------
Income before income taxes 2,617 606 5,527 4,058 4,412 19,484
Provision for income taxes 109 75 1,513 1,603 1,768 7,209
--------- -------- --------- --------- --------- ---------
Income from continuing operations
before extraordinary loss 2,508 531 4,014 2,455 2,644 12,275
Discontinued operations - (30) (53) (3,128) (13,630) -
Extraordinary loss - - (172) - - (1,296)
--------- -------- --------- --------- --------- ---------
Net income (loss) $ 2,508 $ 501 $ 3,789 $ (673) $ (10,986) $ 10,979
--------- -------- --------- --------- --------- ---------
Income from continuing operations
before extraordinary loss per share:
Basic (2) (3) $ 0.32 $ 0.07 $ 0.44 $ 0.25 $ 0.26 $ 1.10
Diluted (2) (3) $ 0.31 $ 0.06 $ 0.42 $ 0.25 $ 0.26 $ 1.04
Net income (loss) per share:
Basic (2) (3) $ 0.32 $ 0.06 $ 0.42 $ (0.07) $ (1.10) $ 0.98
Diluted (2) (3) $ 0.31 $ 0.06 $ 0.40 $ (0.07) $ (1.09) $ 0.93
Shares used in per share calculations:
Basic (2) 7,795 8,026 9,130 9,756 9,991 11,190
--------- -------- --------- --------- --------- ---------
--------- -------- --------- --------- --------- ---------
Diluted (2) 8,183 8,464 9,479 9,906 10,108 11,850
--------- -------- --------- --------- --------- ---------
--------- -------- --------- --------- --------- ---------
SELECTED OPERATING DATA:
Net sales:
Wholesale - Signature $ - $ - $ - $ 340 $ 3,147 $ 19,748
Wholesale - Other $ 16,056 $ 5,469 $ 27,589 $ 25,683 $ 28,326 $ 42,335
Retail $ 649 $ 789 $ 5,896 $ 13,729 $ 15,545 $ 20,567
Percent of total net sales:
Wholesale - Signature - - - 0.9% 6.7% 23.9%
Wholesale - Other 96.1% 87.4% 82.4% 64.6% 60.2% 51.2%
Retail 3.9% 12.6% 17.6% 34.5% 33.1% 24.9%
Number of Thomas Kinkade Stores (4) 5 7 7 15 16 19
Retail sales per square foot (4) (5) - - $ 993 $ 986 $ 1,193 $ 1,495
Number of Signature Galleries (6) - - - - 17 74
</TABLE>
11
<PAGE>
<TABLE>
<CAPTION>
March 31,
Dec. 31
(In thousands) 1993 1994 1995 1996 1997 1998
- --------------------------------------------------- ------- ------ -------- ------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA: (1)
Cash and cash equivalents $ 801 $ 847 $ 1,552 $ 382 $ 374 $ 16,401
Working capital (7) 4,442 (2,229) 4,239 3,891 6,982 30,676
Total assets 12,871 18,764 31,271 36,658 23,061 51,339
Long-term debt less current portion (8) 5,216 3,326 3,166 9,610 5,809 1,200
Total stockholders' equity 3,998 2,562 18,033 15,578 5,890 35,119
</TABLE>
(1) Restated to reflect (i) discontinuance of John Hine Limited during the
year ended March 31, 1997, and (ii) acquisitions during the year ended
March 31, 1996 which have been accounted for as a pooling of interests.
See Item 7 and Notes 2 and 3 of "Notes to 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) For the year ended December 31, 1993 and the three months ended March 31,
1994 certain subsidiaries of the Company were S Corporations.
(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) Includes only Signature Galleries which have opened at retail.
(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.
Quarterly data for the Company for the years ended March 31, 1997 and 1998 is
presented under Item 7 "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Seasonality" on page 1 of this Form
10-K.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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. 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 fiscal 1998,
limited edition canvas and paper lithograph sales accounted for 69.2% of the
Company's net sales.
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 19 Thomas Kinkade Stores located in California, Hawaii, Minnesota,
Missouri and Illinois, and currently plans to open 12 additional Thomas
Kinkade 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 fiscal 1998, Thomas Kinkade
Stores accounted for 24.9% 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.
12
<PAGE>
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 March 31,
1998, there were 74 Signature Galleries. The Company currently plans to add
approximately 100 additional Signature Galleries, including through the
conversion of existing independent dealers, through the end of 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 fiscal 1998, sales to Signature Galleries accounted for 23.9% of
the Company's net sales, compared to 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.
The Company also markets its products through approximately 2,500
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.
13
<PAGE>
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>
Year Ended March 31,
-----------------------------------
1996 1997 1998
----- ----- -----
<S> <C> <C> <C>
Net sales............................................... 100.0% 100.0% 100.0%
Cost of sales........................................... 33.6 35.6 32.9
----- ----- -----
Gross margin........................................... 66.4 64.4 67.1
----- ----- -----
Selling and marketing expenses.......................... 25.2 27.2 23.9
General and administrative expenses..................... 27.3 22.7 18.8
----- ----- -----
Total operating expenses............................... 52.5 49.9 42.7
----- ----- -----
Operating income........................................ 13.9 14.5 24.4
Interest expense........................................ (3.6) (5.0) (1.9)
Gain on sale and leaseback.............................. - - 1.2
Foreign exchange losses................................. (0.1) (0.1) 0.1
----- ----- -----
Income from continuing operations before income
taxes................................................. 10.2 9.4 23.6
Provision for income taxes.............................. 4.0 3.8 8.7
----- ----- -----
Income from continuing operations before
extraordinary loss.................................... 6.2 5.6 14.9
Discontinued operations................................. (7.9) (29.0) -
Extraordinary loss...................................... - - (1.6)
----- ----- -----
Net income (loss)....................................... (1.7)% (23.4)% 13.3%
----- ----- -----
----- ----- -----
</TABLE>
NET SALES. Net sales from continuing operations were $39.8 million,
$47.0 million and $82.6 million for fiscal 1996, 1997 and 1998, respectively.
Net sales to wholesale customers increased 97.3% from fiscal 1997 to fiscal
1998. Net sales to wholesale accounts include sales to Signature Galleries,
sales to other independent galleries, sales to QVC and revenue generated from
licensing arrangements. Increased sales to Signature Galleries accounted for
$16.6 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 increased sales to existing accounts. Unit volume also increased
in fiscal 1998 due to a change to multiple size releases for each edition.
Retail sales through Thomas Kinkade Stores increased 32.3% from fiscal 1997
to fiscal 1998 due primarily to an increase in the number of units sold, a
shift in the retail product price mix towards higher priced editions and the
opening of 3 new retail stores during fiscal 1998.
Net sales to wholesale customers increased 20.9% from fiscal 1996 to
fiscal 1997. Sales to Signature Galleries accounted for $2.8 million of the
increase. The remainder of the increase was primarily due to an increase in
the number of wholesale accounts and increased sales to existing wholesale
accounts. Retail sales through Thomas Kinkade Stores increased 13.2% from
fiscal 1996 to fiscal 1997 due to an increase in the number of units sold and
to an increase in product prices during fiscal 1997.
GROSS MARGIN. Gross margin was 66.4%, 64.4% and 67.1% in fiscal 1996,
1997 and 1998, respectively. The increase in gross margin from fiscal 1997
to fiscal 1998 was 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. Gross margin declined from fiscal 1996 to
fiscal 1997 as a result of the introduction of lower priced products in
connection with the Company's strategy to leverage its library of Thomas
Kinkade images. Gross margin in fiscal 1997 was also adversely affected
14
<PAGE>
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 were
$10.0 million, $12.8 million and $19.8 million in fiscal 1996, 1997 and 1998,
respectively. Expressed as a percentage of net sales, selling and marketing
expenses were 25.2%, 27.2% and 23.9% in fiscal 1996, 1997 and 1998,
respectively. The 54.7% increase in absolute selling and marketing expenses
in fiscal 1998 as compared to fiscal 1997 was due primarily to higher
compensation costs associated with higher sales levels and higher advertising
and promotion costs. The decrease in selling and marketing costs as a
percentage of net sales in fiscal 1998 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.
The 27.5% increase in selling and marketing expenses in fiscal 1997 as
compared to fiscal 1996 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 were $10.8 million, $10.7 million and $15.5 million in fiscal 1996,
1997 and 1998, respectively. Expressed as a percentage of net sales, general
and administrative expenses were 27.3%, 22.7% and 18.7% in fiscal 1996, 1997
and 1998, respectively. The decrease in general and administrative expenses
as a percentage of net sales from fiscal 1997 to fiscal 1998 was due to the
leveraging of relatively fixed costs over a higher sales base. The 44.7%
increase in absolute general and administrative expenses from fiscal 1997 to
fiscal 1998 was due to payments under incentive compensation plans as a
result of higher profitability and to other costs related to expansion, such
as increased headcount and rent costs.
The decrease in general and administrative expenses from fiscal 1996 to
fiscal 1997 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 was $1.4 million, $2.3 million and
$1.6 million in fiscal 1996, 1997 and 1998, respectively. The decrease from
fiscal 1997 to fiscal 1998 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. The increase from fiscal 1996 to
fiscal 1997 was 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.
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
percentage of income before income taxes decreased from 39.5% in fiscal 1996
and 40.1% in fiscal 1997 to 37.0% in fiscal 1998.
DISCONTINUED OPERATIONS. In September 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. The Company
recorded a loss on disposal of the segment 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.
EXTRAORDINARY ITEM. In February 1998, the Company recorded a non-cash
write-off of deferred debt discount of $1.3 million (net of income tax
benefit of $761,000) as an extraordinary item on the repayment of secured
notes using proceeds from the Company's February 1998 public offering.
15
<PAGE>
SEASONALITY
The following table sets forth the Company's unaudited summary quarterly
data for each quarter of fiscal 1997 and 1998 (restated to reflect the
discontinuance of John Hine Limited).
<TABLE>
<CAPTION>
Year Ended March 31, 1997 Year Ended March 31, 1998
--------------------------------------- ---------------------------------------
(UNAUDITED, IN THOUSANDS EXCEPT PER June September December March June September December March
SHARE AMOUNTS) Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
- ------------------------------------------- ------- --------- -------- -------- -------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net sales $ 8,718 $ 11,323 $ 15,471 $ 11,506 $ 13,189 $ 17,224 $ 26,796 $ 25,441
Cost of sales 3,697 4,057 5,228 3,778 4,208 5,684 8,920 8,408
------- -------- -------- -------- -------- -------- -------- --------
Gross profit 5,021 7,266 10,243 7,728 8,981 11,540 17,876 17,033
------- -------- -------- -------- -------- -------- -------- --------
Operating expenses
Selling and marketing expenses 3,098 3,031 3,502 3,153 3,342 4,424 5,337 6,678
General and administrative expenses 2,274 2,474 2,833 3,102 2,794 3,120 5,516 4,027
------- -------- -------- -------- -------- -------- -------- --------
Total operating expenses 5,372 5,505 6,335 6,255 6,136 7,544 10,853 10,705
------- -------- -------- -------- -------- -------- -------- --------
Operating income (loss) (351) 1,761 3,908 1,473 2,845 3,996 7,023 6,328
Interest expense (516) (564) (669) (599) (688) (475) (275) (174)
Gain on sale and leaseback - - - - - 997 - -
Foreign exchange gains (losses) (62) - (146) 177 (61) 45 (77) -
------- -------- -------- -------- -------- -------- -------- --------
Income (loss) from continuing operations
before income taxes (929) 1,197 3,093 1,051 2,096 4,563 6,671 6,154
Provision for income taxes (365) 470 1,289 374 765 1,690 2,482 2,272
------- -------- -------- -------- -------- -------- -------- --------
Income (loss) from continuing
operations (564) 727 1,804 677 1,331 2,873 4,189 3,882
Discontinued operations (791) (12,839) - - - - - -
Extraordinary loss - - - - - - - (1,296)
------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) $(1,355) $(12,112) $ 1,804 $ 677 $ 1,331 $ 2,873 $ 4,189 $ 2,586
------- -------- -------- -------- -------- -------- -------- --------
------- -------- -------- -------- -------- -------- -------- --------
Income (loss) from continuing
operations per share (diluted) $ (0.06) $ 0.07 $ 0.18 $ 0.06 $ 0.12 $ 0.25 $ 0.35 $ 0.30
Net income (loss) per share (diluted) $ (0.14) $ (1.23) $ 0.18 $ 0.06 $ 0.12 $ 0.25 $ 0.35 $ 0.20
Shares used in computation of earnings
per share 9,867 9,992 9,932 10,639 11,294 11,298 12,004 12,805
------- -------- -------- -------- -------- -------- -------- --------
------- -------- -------- -------- -------- -------- -------- --------
</TABLE>
<TABLE>
<CAPTION>
June September December March June September December March
As a Percentage of Sales Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
- ------------------------------------------- ------- --------- -------- -------- -------- -------- --------- --------
<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 42.4 35.8 33.8 32.8 31.9 33.0 33.3 33.0
----- ----- ----- ----- ----- ----- ----- -----
Gross profit 57.6 64.2 66.2 67.2 68.1 67.0 66.7 67.0
----- ----- ----- ----- ----- ----- ----- -----
Operating expenses
Selling and marketing expenses 35.5 26.8 22.6 27.4 25.3 25.7 19.9 26.2
General and administrative expenses 26.1 21.8 18.3 27.0 21.2 18.1 20.6 15.9
----- ----- ----- ----- ----- ----- ----- -----
Total operating expenses 61.6 48.6 40.9 54.4 46.5 43.8 40.5 42.1
----- ----- ----- ----- ----- ----- ----- -----
Operating income (loss) (4.0) 15.6 25.3 12.8 21.6 23.2 26.2 24.9
Interest expense (5.9) (5.0) (4.3) (5.2) (5.2) (2.8) (1.0) (0.7)
Gain on sale and leaseback - - - - - 5.8 - -
Foreign exchange gains (losses) (0.7) - (0.9) 1.5 (0.5) 0.3 (0.3) -
----- ----- ----- ----- ----- ----- ----- -----
Income (loss) from continuing operations
before income taxes (10.6) 10.6 20.1 9.1 15.9 26.5 24.9 24.2
Provision for income taxes (4.2) 4.2 8.3 3.3 5.8 9.8 9.3 8.9
----- ----- ----- ----- ----- ----- ----- -----
Income (loss) from continuing
operations (6.4) 6.4 11.8 5.8 10.1 16.7 15.6 15.3
Discontinued operations (9.1) (113.4) - - - - - -
Extraordinary loss - - - - - - - (5.1)
----- ----- ----- ----- ----- ----- ----- -----
Net income (loss) (15.5)% (107.0)% 11.8% 5.8% 10.1% 16.7% 15.6% 10.2%
----- ----- ----- ----- ----- ----- ----- -----
----- ----- ----- ----- ----- ----- ----- -----
</TABLE>
Net sales during the quarter ended June 30, 1996 were lower as the
Company accelerated the production of some higher-priced products during the
preceding quarter. As a result, cost of sales, selling and marketing
expenses and general and administrative expenses all increased significantly
as a percentage of net sales as compared to other quarters.
The Company discontinued the operations of John Hine Limited during the
quarter ended September 30, 1996,
16
<PAGE>
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 repaid certain secured notes during the quarter ended March
31, 1998 prior to their scheduled maturity, resulting in the recognition of
an after-tax extraordinary loss of $1.3 million for the write-off of
unamortized deferred debt discount.
The Company's business has experienced, and is expected to continue to
experience, significant seasonality. The Company's net revenues are generally
higher in the September and December quarters and lower in the March and June
quarters. In addition, 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. Accordingly, the results of operations
in any one 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 $30.7 million at
March 31, 1998 compared to $7.9 million at March 31, 1997.
Net cash provided by operations for fiscal 1998 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, accrued compensation costs and accounts
payable and receipt of an income tax refund partly offset by increases in
account receivable and inventory. 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 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 $364,000, $719,000 and $1.6
million in fiscal 1996, 1997 and 1998, respectively. The Company's investing
activities have primarily related to capital expenditures for property and
equipment. In fiscal 1998, 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 1999 will be approximately $8.0 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 provided by financing activities was $6.1 million in fiscal
1998 and related primarily to $18.3 million from the issuance of common stock
partly offset by repayment of $2.7 million of borrowings under lines of
credit and $9.5 million under notes payable. Net cash used in financing
activities was $2.5 million in fiscal 1997 and related primarily to repayment
of borrowings under lines of credit and notes payable. Net cash provided by
financing activities was $6.1 million in fiscal 1996 and related primarily to
$1.8 million borrowed under lines of credit and $8.0 million borrowed under
notes payable partly offset by repayment of $2.6 million borrowed under
secured notes payable.
The Company has a $10.0 million secured line of credit 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 March 31, 1998. The Company's indebtedness
under bank lines of credit was $2.7 million as of March 31, 1997 which
17
<PAGE>
was fully repaid as of March 31, 1998. Cash on hand as of March 31, 1998
aggregated $16.4 million.
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 cash on hand 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.
In fiscal 1998 the Company upgraded its JD Edwards suite of software in
order to be Year 2000 compliant. The Company does not expect to incur any
additional significant costs in connection with Year 2000 compliance issues.
The Company has made in this report, and from time to time may otherwise
make, statements which constitute forward looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. These
statements include statements regarding the intent, belief or current
expectations of the Company, its directors and its officers primarily with
respect to the Company's operations and financial performance. Investors are
cautioned that any such forward looking statements are not guarantees of
future performance and involve risks and uncertainties, and that actual
results may differ materially from those in the forward looking statements as
a result of various factors. Some of the factors may include (i) the
Company's dependence on Thomas Kinkade and its lack of product revenue
diversification, (ii) risks associated with the Company's expansion of its
distribution channels, (iii) the Company's ability to effectively manage
expansion, (iv) changes in consumer preferences or spending, (v) fluctuations
in operating results, (vi) successful introduction and acceptance of new
product lines, (viii) competition from other marketers of home decorative
accessories, collectibles and gift products.
ITEM 8. FINANCIAL STATEMENT AND SUPPLEMENTARY DATA
The Financial Statements and supplemental data of the Company required
by this item are set forth at the pages indicated at Item 14(a).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information regarding directors and executive officers required by
this Item is incorporated by reference from the definitive proxy statement
for the Company's 1998 annual meeting of stockholders to be filed with the
Commission pursuant to Regulation 14A not later than 120 days after the end
of the fiscal year covered by this Form (the "Proxy Statement").
Information required by this item with respect to compliance with
Section 16(a) of the Securities Exchange Act of 1934 is incorporated by
reference from the Proxy Statement under the caption "EXECUTIVE COMPENSATION
AND OTHER MATTERS".
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference from
the Proxy Statement under the caption "EXECUTIVE COMPENSATION AND OTHER
MATTERS."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference from
the Proxy Statement under the caption "INFORMATION ABOUT MEDIA ARTS GROUP,
INC.--Stock Ownership of Certain Beneficial Owners and Management."
18
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference from
the Proxy Statement under the caption "CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS."
19
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Form:
Page
1. Financial Statements:
Report of Independent Accountants....................... 21
Consolidated Balance Sheets at March 31, 1997 and 1998.. 22
Consolidated Statements of Operations for the years
ended March 31, 1996, 1997 and 1998................... 23
Consolidated Statements of Stockholders' Equity for the
years ended March 31, 1996, 1997 and 1998............. 24
Consolidated Statements of Cash Flows for the years
ended March 31, 1996, 1997 and 1998................... 25
Notes to Consolidated Financial Statements.............. 26
2. Financial Statement Schedules:
For the years ended March 31, 1996, 1997 and 1998
SCHEDULE
--------
VIII. Valuation and Qualifying Accounts and Reserves... 35
All other schedules are omitted because they are not applicable or
the required information is shown in the consolidated financial
statements or notes thereto.
3. Exhibits: See Index to Exhibits on page 36. The Exhibits
listed in the accompanying Index to Exhibits are filed or
incorporated by reference as part of this report.
(b) Reports on Form 8-K:
None
20
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Media Arts Group, Inc.
In our opinion, the consolidated financial statements
listed in the Index appearing under Item 14(a) 1. and 2.
present fairly, in all material respects, the financial
position of Media Arts Group, Inc. and its subsidiaries at
March 31, 1997 and 1998, and the results of their operations
and their cash flows for each of the three years in the period
ended March 31, 1998 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
April 27, 1998
21
<PAGE>
MEDIA ARTS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31,
-------------------------------
1997 1998
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents....................................... $ 374,000 $ 16,401,000
Accounts receivable, net of allowance for doubtful accounts and
sales returns of $2,825,000, and $2,434,000.................... 7,394,000 15,841,000
Receivable from related parties................................. 114,000 78,000
Inventories (Note 5)............................................ 5,415,000 9,094,000
Net assets of discontinued operations........................... 890,000 -
Prepaid expenses and other current assets....................... 1,464,000 2,371,000
Deferred income taxes (Note 9).................................. 1,581,000 1,878,000
Income taxes refundable......................................... 2,002,000 33,000
------------ ------------
Total current assets.......................................... 19,234,000 45,696,000
Property and equipment, net (Note 5)............................. 3,562,000 5,397,000
Other assets..................................................... 265,000 246,000
------------ ------------
$ 23,061,000 $ 51,339,000
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................ $ 2,065,000 $ 4,804,000
Commissions payable............................................. 403,000 1,003,000
Accrued royalties............................................... 1,213,000 653,000
Accrued compensation costs...................................... 714,000 3,881,000
Accrued expenses................................................ 2,250,000 2,469,000
Income taxes payable............................................ - 2,210,000
Borrowings under line of credit (Note 6)........................ 2,655,000 -
Current portion of long-term debt (Note 6)...................... 2,062,000 -
------------ ------------
Total current liabilities..................................... 11,362,000 15,020,000
Long-term debt, less current portion (Note 6).................... 4,609,000 -
Convertible notes payable to related parties (Note 2)............ 1,200,000 1,200,000
------------ ------------
Total liabilities............................................. 17,171,000 16,220,000
------------ ------------
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;
11,025,527 and 12,667,477 shares issued and outstanding........ 69,000 85,000
Additional paid-in capital...................................... 17,176,000 35,410,000
Accumulated deficit............................................. (11,355,000) (376,000)
------------ ------------
Total stockholders' equity.................................... 5,890,000 35,119,000
------------ ------------
$ 23,061,000 $ 51,339,000
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of these financial statements
22
<PAGE>
MEDIA ARTS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended March 31,
-----------------------------------------------
1996 1997 1998
------------- ------------- -----------
<S> <C> <C> <C>
Net sales...................................................... $ 39,752,000 $ 47,018,000 82,650,000
Cost of sales.................................................. 13,343,000 16,760,000 27,220,000
------------- ------------- -----------
Gross profit.................................................. 26,409,000 30,258,000 55,430,000
------------- ------------- -----------
Operating expenses
Selling and marketing......................................... 10,028,000 12,784,000 19,781,000
General and administrative.................................... 10,834,000 10,683,000 15,457,000
------------- ------------- -----------
Total operating expenses..................................... 20,862,000 23,467,000 35,238,000
------------- ------------- -----------
Operating income............................................... 5,547,000 6,791,000 20,192,000
Interest expense............................................... (1,447,000) (2,348,000) (1,612,000)
Gain on sale and leaseback..................................... - - 997,000
Foreign exchange losses........................................ (42,000) (31,000) (93,000)
------------- ------------- -----------
Income from continuing operations before income taxes.......... 4,058,000 4,412,000 19,484,000
Provision for income taxes..................................... 1,603,000 1,768,000 7,209,000
------------- ------------- -----------
Income from continuing operations before extraordinary loss... 2,455,000 2,644,000 12,275,000
Loss from discontinued operations, net of income taxes........ (3,128,000) (1,385,000) -
Loss on disposal of discontinued operations, net of
income taxes................................................ - (12,245,000) -
Extraordinary loss, net of income taxes....................... - - (1,296,000)
------------- ------------- -----------
Net income (loss)............................................. $ (673,000) $(10,986,000) $ 10,979,000
------------- ------------- -----------
------------- ------------- -----------
Basic earnings (loss) per common share:
Income from continuing operations before extraordinary loss.. $ 0.25 $ 0.26 $ 1.10
Discontinued operations...................................... (0.32) (1.36) -
Extraordinary loss........................................... - - (0.12)
------------- ------------- -----------
Net income (loss)............................................ $ (0.07) $ (1.10) $ 0.98
------------- ------------- -----------
------------- ------------- -----------
Diluted earnings (loss) per common share:
Income from continuing operations before extraordinary loss.. $ 0.25 $ 0.26 $ 1.04
Discontinued operations...................................... (0.32) (1.35) -
Extraordinary loss........................................... - - (0.11)
------------- ------------- -----------
Net income (loss)............................................ $ (0.07) $ (1.09) $ 0.93
------------- ------------- -----------
------------- ------------- -----------
</TABLE>
The accompanying notes are an integral part of these financial statements
23
<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, 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 options.................................... 9,802 - 27,000 - - 27,000
Issuance of Common Stock on exercise
of warrants................................... 400,000 4,000 - - - 4,000
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.................................... 138,665 1,000 381,000 - - 382,000
Issuance of Common Stock on exercise
of warrants................................... 3,285 - 21,000 - - 21,000
Issuance of Common Stock for cash.............. 1,500,000 15,000 17,645,000 - - 17,660,000
Tax benefit of stock option transactions....... - - 187,000 - - 187,000
Net income..................................... - - - - 10,979,000 10,979,000
---------- -------- ------------ ---------- ------------ ------------
Balance at March 31, 1998...................... 12,667,477 $ 85,000 $ 35,410,000 $ - $ (376,000) $ 35,119,000
---------- -------- ------------ ---------- ------------ ------------
---------- -------- ------------ ---------- ------------ ------------
</TABLE>
The accompanying notes are an integral part of these financial statements
24
<PAGE>
MEDIA ARTS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended March 31,
---------------------------------------------
1996 1997 1998
----------- ------------ -------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)....................................................... $ (673,000) $(10,986,000) $ 10,979,000
Adjustments to reconcile net income (loss) to net cash provided by (used
in) continuing operating activities:
Losses from discontinued operations..................................... 3,128,000 13,630,000 -
Gain on sale and leaseback.............................................. - - (997,000)
Depreciation............................................................ 530,000 951,000 1,385,000
Amortization of deferred debt discount.................................. 126,000 459,000 812,000
Deferred income taxes................................................... 82,000 (522,000) (297,000)
Extraordinary write-off of debt discount................................ - - 1,296,000
Provision for returns and allowances.................................... 391,000 827,000 (23,000)
Provision for losses on accounts receivable ............................ (229,000) 844,000 (368,000)
Changes in assets and liabilities net of effects from acquisition
of companies:
Accounts receivable ................................................... (2,744,000) (803,000) (8,056,000)
Receivables from related parties....................................... 143,000 - 36,000
Inventories............................................................ (555,000) (215,000) (3,679,000)
Prepaid expenses and other current assets.............................. 767,000 (1,048,000) (907,000)
Income taxes refundable................................................ - (2,002,000) 1,969,000
Other assets........................................................... (63,000) (127,000) 19,000
Accounts payable ...................................................... (189,000) (487,000) 2,739,000
Payables to related parties............................................ (1,069,000) - -
Commissions payable.................................................... (593,000) 216,000 600,000
Accrued compensation costs............................................. - (151,000) 3,167,000
Income taxes payable................................................... (695,000) - 2,971,000
Accrued royalties...................................................... 345,000 690,000 (560,000)
Accrued expenses....................................................... 910,000 (491,000) (431,000)
----------- ------------ -------------
Net cash provided by (used in) continuing operating activities........... (388,000) 785,000 10,655,000
Net cash provided by (used in) discontinued operations................... (6,473,000) 2,398,000 890,000
----------- ------------ -------------
Net cash provided by (used in) operations................................ (6,861,000) 3,183,000 11,545,000
----------- ------------ -------------
Cash flows from investing activities:
Acquisition of property and equipment................................... (468,000) (719,000) (3,220,000)
Proceeds from sale and leaseback........................................ - - 1,647,000
Proceeds from disposals of property and equipment....................... 104,000 - -
----------- ------------ -------------
Net cash used in investing activities.................................... (364,000) (719,000) (1,573,000)
----------- ------------ -------------
Cash flows from financing activities:
Proceeds from (repayment of) line of credit............................. 1,817,000 (1,135,000) (2,655,000)
Proceeds from (repayment of) notes payable.............................. 5,427,000 (700,000) (9,540,000)
Repayment of notes payable to related parties........................... (58,000) - -
Repayment of lease liabilities.......................................... (602,000) (675,000) -
Proceeds from issuance of Common Stock, net............................ - 38,000 18,250,000
Payments of distributions to S Corporation stockholders................ (529,000) - -
----------- ------------ -------------
Net cash provided by (used in) financing activities...................... 6,055,000 (2,472,000) 6,055,000
----------- ------------ -------------
Net increase (decrease) in cash and cash equivalents..................... (1,170,000) (8,000) 16,027,000
Cash and cash equivalents at beginning of year........................... 1,552,000 382,000 374,000
----------- ------------ -------------
Cash and cash equivalents at end of year................................. $ 382,000 $ 374,000 $ 16,401,000
----------- ------------ -------------
----------- ------------ -------------
Supplemental cash flow disclosures:
Income taxes paid....................................................... $ 1,597,000 $ 128,000 $ 2,395,000
Interest paid........................................................... 1,151,000 1,816,000 800,000
Noncash investing activities (Note 10)
</TABLE>
The accompanying notes are an integral part of these financial statements
25
<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 on the works of the artist
Thomas Kinkade.
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 to the customer.
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 AND FOREIGN CURRENCY 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.
INVENTORIES
Inventories are recorded at the lower of cost or market; cost is
determined on a first-in, first-out basis.
26
<PAGE>
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
Leasehold improvements........... 7 years or life of 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".
EARNINGS PER SHARE
The Company adopted Statement of Financial Accounting No. 128, "Earnings
Per Share" ("SFAS 128") during 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>
Year Ended March 31,
-----------------------------------------------
1996 1997 1998
----------- ----------- ------------
<S> <C> <C> <C>
Numerator:
Income from continuing operations before extraordinary items....... $ 2,455,000 $ 2,644,000 $ 12,275,000
----------- ----------- ------------
----------- ----------- ------------
Denominator for basic earnings per common share.................... 9,756,000 9,991,000 11,190,000
Effect of dilutive securities:
Stock options and warrants......................................... 150,000 117,000 660,000
----------- ----------- ------------
Denominator for diluted earnings per common share.................. 9,906,000 10,108,000 11,850,000
----------- ----------- ------------
----------- ----------- ------------
Income from continuing operations before extraordinary items
per common share:
Basic.............................................................. $ 0.25 $ 0.26 $ 1.10
----------- ----------- ------------
----------- ----------- ------------
Diluted............................................................ $ 0.25 $ 0.26 $ 1.04
----------- ----------- ------------
----------- ----------- ------------
</TABLE>
27
<PAGE>
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.
PRESENTATION
Certain prior year amounts have been reclassified to conform to fiscal
1998 presentation.
NOTE 2 - ACQUISITIONS:
Effective June 1, 1995, the Company acquired a gallery located in San
Jose, California, owned and operated by the spouse of a founder (the "Valley
Fair Gallery"). 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).
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, 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 September 27, 1996, the Company decided to dispose of the assets and
operations of John Hine Limited, a United Kingdom manufacturer and
distributor of collectible miniature cottages and similar products. The
disposal was 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. The financial
statements have been restated to reflect the discontinuance of the John Hine
Limited operations. Operating results of discontinued operations are
summarized as follows (in thousands):
28
<PAGE>
<TABLE>
<CAPTION>
Year ended March 31,
-----------------------------
1996 1997
------------ ------------
<S> <C> <C>
Net sales of discontinued operations...................... $ 14,249,000 $ 6,778,000
------------ ------------
------------ ------------
Loss from discontinued operations before income taxes..... $ (5,008,000) $ (2,253,000)
Benefit from income tax reduction......................... 1,880,000 868,000
------------ ------------
Loss from discontinued operations......................... $ (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 by the Company under various licensing
agreements aggregated $808,000, $1,159,000, and $3,919,000 for the years
ended March 31, 1996, 1997 and 1998, respectively.
NOTE 5 - DETAILS OF BALANCE SHEET COMPONENTS
<TABLE>
<CAPTION>
March 31,
-------------------------
1997 1998
---------- ----------
<S> <C> <C>
Inventories:
Raw materials................................... $ 843,000 $ 993,000
Work in process................................. 12,000 8,000
Finished goods.................................. 4,560,000 8,093,000
---------- ----------
$5,415,000 $9,094,000
---------- ----------
---------- ----------
Property and equipment:
Machinery and equipment......................... $ 266,000 $ 860,000
Furniture and fixtures.......................... 1,124,000 1,529,000
Leasehold improvements.......................... 1,666,000 2,586,000
Computer hardware and software ................. 2,722,000 3,719,000
Automobiles..................................... 93,000 221,000
---------- ----------
5,871,000 8,915,000
Less accumulated depreciation................... 2,309,000 3,518,000
---------- ----------
$3,562,000 $5,397,000
---------- ----------
---------- ----------
</TABLE>
Automobiles, machinery and equipment and computer hardware and software
acquired under capital leases aggregated $1,845,000 at March 31, 1996, 1997
and 1998. Accumulated amortization at March 31, 1996, 1997 and 1998
aggregated $224,000, $579,000 and $948,000, respectively.
29
<PAGE>
NOTE 6 - DEBT:
Long-term debt:
<TABLE>
<CAPTION>
March 31,
1997
------------
<S> <C>
Secured notes, net of unamortized debt discount at
March 31, 1997 of $2,843,000...................... $ 4,557,000
Convertible notes................................. 1,555,000
Capital leases.................................... 559,000
------------
6,671,000
Less current portion.............................. 2,062,000
------------
$ 4,609,000
------------
------------
</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 $10,000,000 at March 31, 1998.
Borrowings under the line bear interest at the bank's prime rate plus 1
percent (9.25% at March 31, 1998) and are secured by substantially all of the
Company's assets. Interest payments are due monthly and the principal is due
in February, 1999. There were no outstanding borrowings under the line of
credit at March 31, 1998. Borrowings under previous lines of credit
aggregated $2,655,000 at March 31, 1997. The Senior Debt prohibits the
payment of cash dividends and requires 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.
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 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 % 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.
On February 21, 1997, in conjunction with entering into the Senior Debt
agreement, the Company changed the terms and covenants of the Subordinated
Debt and exchanged the Notes and the Warrant for a $7,400,000 13.5%
promissory note (the "New Note"), $592,500 of cash and 1,148,693 shares of
Common Stock.
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 were amortized over the term of the Notes using the interest method.
The Company repaid the Subordinated Debt in February 1998. The
extinguishment of the New Note prior to its scheduled maturity date resulted
in the recognition of an extraordinary loss of $1,296,000 (net of income tax
benefit of $761,000) attributable to the write-off of unamortized debt
discount.
30
<PAGE>
NOTE 7 - COMMITMENTS:
The Company has certain noncancellable operating leases for facilities and
equipment. Future minimum lease commitments under noncancellable leases as
of March 31, 1998 are as follows:
<TABLE>
<CAPTION>
Year
----
<S> <C>
1999............................ $ 2,718,000
2000............................ 2,445,000
2001............................ 1,734,000
2002............................ 1,116,000
2003............................ 849,000
Thereafter...................... 1,438,000
-------------
Total minimum lease payments.... $ 10,300,000
-------------
-------------
</TABLE>
Rent expense under operating leases was $1,714,000, $2,006,000 and
$2,933,000 for the years ended March 31, 1996, 1997 and 1998, 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 $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:
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, subject
to stockholder approval.
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.
In May 1998, the Company adopted the Media Arts Group, Inc. Employee Stock
Purchase Plan (the "Purchase Plan") and reserved a total of 125,000 shares of
the Company's Common Stock for issuance thereunder, subject to stockholder
approval. The Purchase Plan permits eligible employees to acquire shares of
the Company's Common Stock through payroll deductions.
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
31
<PAGE>
ten years after date of grant.
Under the terms of the Directors Plan when outside directors are appointed
they are entitled to receive an option to purchase 5,000 shares of Common
Stock when appointed and 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.
The following table summarizes option activities:
<TABLE>
<CAPTION>
Options Outstanding
---------------------
Weighted
Options Average
Available Options Exercise
for Grant Outstanding Price
---------- ----------- -------
<S> <C> <C> <C>
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 ......................... (1,127,000) 1,127,000 8.94
Exercised ....................... - (138,665) 2.84
Expired.......................... 83,303 (96,484) 3.86
---------- ----------
Balance at March 31, 1998........ 315,281 1,599,016 $ 7.15
---------- ----------
---------- ----------
</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 March 31,
1998, options to purchase 1,086,134 shares, respectively, of Common Stock
were fully vested.
The following table summarizes information regarding stock options
outstanding and exercisable at March 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------------------------- ----------------------
Weighted
Number Average Number Weighted
Range of Outstanding Remaining Weighted Exercisable Average
Exercise at March 31, Contractual Average at March 31, Exercise
Prices 1998 Life (years) Exercise Price 1998 Price
------------- ----------- ----------- -------------- ----------- --------
<S> <C> <C> <C> <C>
$ 1.31 - $ 3.70 439,107 6.3 $ 2.67 358,025 $ 2.61
3.71 - 5.55 481,000 9.3 4.59 99,200 4.51
5.56 - 9.25 71,909 7.5 7.44 28,909 6.88
11.10 - 12.95 600,000 9.7 12.38 600,000 12.38
12.96 - 18.50 7,000 9.9 17.07 - -
--------- ---------
1,599,016 8.6 $ 7.15 1,086,134 $ 8.29
--------- ---------
--------- ---------
</TABLE>
32
<PAGE>
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,
----------------------------------------------
1996 1997 1998
------------ ------------ -------------
<S> <C> <C> <C>
Income from continuing operations before extraordinary loss
As reported............................................... $ 2,455,000 $ 2,644,000 $ 12,275,000
Pro forma................................................. 2,422,000 2,387,000 12,084,000
Net income (loss)
As reported............................................... (673,000) (10,986,000) 10,979,000
Pro forma................................................. (706,000) (11,243,000) 10,788,000
Income from continuing operations before extraordinary loss
per share
Basic:
As reported............................................... 0.25 0.26 1.10
Pro forma................................................. 0.25 0.24 1.08
Diluted:
As reported .............................................. 0.25 0.26 1.04
Pro forma................................................. 0.22 0.22 1.04
Net income (loss) per share
Basic:
As reported .............................................. (0.07) (1.10) 0.98
Pro forma................................................. (0.07) (1.13) 0.96
Diluted:
As reported............................................... (0.07) (1.09) 0.93
Pro forma................................................. (0.07) (1.03) 0.93
</TABLE>
The fair value of the shares granted under the Company's option plans was
estimated using the Black-Scholes model with the following assumptions: zero
dividend yield; an expected life of 4.5 years; expected volatility of 75%;
and a risk-free interest rate of 6.0%, 6.4% and 6.0% for the years ended
March 31, 1996, 1997 and 1998 respectively. The pro forma amounts reflect
compensation expense related to stock options granted during the years ended
March 31, 1996, 1997 and 1998 only. In future years, the annual compensation
expense computed in accordance with SFAS No. 123 will increase relative to
the fair value of stock options granted in those years.
NOTE 9 - INCOME TAXES:
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
Year ended March 31,
------------------------------------------
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
Current:
Federal......... $ 1,195,000 $ 1,975,000 $ 6,150,000
State........... 326,000 315,000 1,356,000
------------ ------------ ------------
1,521,000 2,290,000 7,506,000
------------ ------------ ------------
Deferred:
Federal......... 82,000 (467,000) (37,000)
State........... - (55,000) (260,000)
------------ ------------ ------------
82,000 (522,000) (297,000)
------------ ------------ ------------
$ 1,603,000 $ 1,768,000 $ 7,209,000
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
33
<PAGE>
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>
Year ended March 31,
-------------------------------
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Federal statutory income tax rate....... 34% 34% 34%
S corporation income not subject to
federal income taxes.................. (2) - -
State income taxes...................... 5 3 5
Other................................... 2 3 (2)
---- ---- ----
39% 40% 37%
---- ---- ----
---- ---- ----
</TABLE>
Deferred income tax assets consisted of:
<TABLE>
<CAPTION>
March 31,
-------------------------
1997 1998
------------ ----------
<S> <C> <C>
Allowances for sales returns and doubtful accounts..... $ 1,051,000 $ 949,000
Inventory reserves..................................... 235,000 261,000
State income taxes..................................... 48,000 229,000
Deferred gain on sale and leaseback.................... - 223,000
Other.................................................. 247,000 216,000
------------ ----------
Net deferred income tax assets......................... $ 1,581,000 $1,878,000
------------ ----------
------------ ----------
</TABLE>
Gross deferred income tax assets at March 31, 1997 also relate to John
Hine Limited and its U.S. subsidiary, John Hine Studios, Inc..
NOTE 10 - NON CASH INVESTING AND FINANCING ACTIVITIES:
On February 21, 1997, the Company refinanced its Senior Debt and
renegotiated the terms of its Senior Subordinated Debt. In conjunction with
the refinancing and renegotiation of that debt the Company issued 1,148,693
shares of Common Stock to the Senior Subordinated Lender in exchange for
$11,000 of cash (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.
During fiscal 1998 the Company repaid notes aggregating $7.4 million prior
to their scheduled maturity date which resulted in the recognition of an
extraordinary loss of $1,296,000 (net of income tax benefit of $761,000)
attributable to the write-off of unamortized debt discount and prepaid
interest.
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.
34
<PAGE>
SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
MEDIA ARTS GROUP, INC. AND SUBSIDIARIES
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO BALANCE
BEGINNING OF COSTS AND AT END
DESCRIPTION PERIOD EXPENSES DEDUCTIONS OF PERIOD
- ------------------------------------------ ------------ ---------- ---------- ---------
<S> <C> <C> <C> <C>
YEAR ENDED MARCH 31, 1996:
Reserve for Returns and Allowances....... $ 421 $4,931 $(4,540) $ 812
Allowance for Doubtful Accounts.......... 571 803 (1,032) 342
YEAR ENDED MARCH 31, 1997:
Reserve for Returns and Allowances....... 812 2,316 (1,489) 1,639
Allowance for Doubtful Accounts.......... 342 1,212 (368) 1,186
YEAR ENDED MARCH 31, 1998:
Reserve for Returns and Allowances....... 1,639 3,706 (3,729) 1,616
Allowance for Doubtful Accounts.......... $1,186 $ 369 $ (737) $ 818
</TABLE>
35
<PAGE>
INDEX TO EXHIBITS FILED TOGETHER WITH THIS ANNUAL REPORT
(a) The following exhibits are filed herewith:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
- ------- -------------
<C> <S>
4.1(1) Amended and Restated Certificate of Incorporation.
4.2(7) Bylaws.
4.3(1) Form of Specimen Common Stock Certificate.
10.1(7) 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(7) Amendment to Employment Agreement between the Company and Kenneth E.
Raasch, entered into as of
October 29, 1997.
10.5(7) 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(7) 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.
10.21(7) 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(7) 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(7) Consulting Agreement between the Company and Mike Kiley, dated as of
April 1, 1997.
10.24(7) Amendment to Consulting Agreement between the Company and Mike Kiley,
dated as of August 1, 1997.
10.25(7) Purchase and Sale Agreement by and between the Company and Limar
Realty Corp. #36, dated as of June 3, 1997.
10.26(7) Form of Director Indemnity Agreement.
10.27(7) Second Amendment to Employment Agreement between the Company and John
R. Lackner, dated as of February 11, 1998.
10.28 Second Amendment to Consulting Agreement between the Company and Mike
Kiley, dated as of April 1, 1998.
21.1 Subsidiaries of the Registrant.
23.1 Consent of Price Waterhouse LLP.
24.1 Power of Attorney.
36
<PAGE>
27.1 Financial Data Schedule (EDGAR version only)
</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).
(7) Incorporated by reference from the Company's Registration Statement on Form
S-1 (File No. 333-42815)
(b) The following financial statement schedules are filed herewith:
Schedule VIII -- Valuation and Qualifying Accounts and Reserves
37
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
Media Arts Group, Inc.
- -------------------------------------------
(Registrant)
/s/ Greg H. L. Nash
- -------------------------------------------
GREG H. L. NASH
VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER)
Dated: June 22, 1998
38
<PAGE>
EXHIBIT 10.28
SECOND AMENDMENT TO CONSULTING AGREEMENT BETWEEN THE COMPANY AND MIKE KILEY
AGREEMENT made this 1st day of April, 1998 between Media Arts Group, Inc.
(hereinafter "the company" and Mike Kiley (hereinafter, "the consultant").
WITNESSETH
(1) As compensation of the consultant's services hereunder, the company agrees
to pay the consultant an additional amount (hereinafter, "incentive
compensation") equal to Paragraph (2) below based on EPS growth of
consolidated net earnings of the company and its subsidiaries.
(2) The earnings per share growth of the company shall be determined from a
base EPS of .98 established 4/1/98. The net earnings per share
calculation for the Agreement will be the same calculation used for the
company's management incentive bonus plan. Consultant will receive
incentive compensation in two parts. The 1st incentive payout will be
based on EPS growth as of 10/1/98. The 2nd incentive payout will be based
on EPS growth as of fiscal year end, 3/31/99, minus the 1st incentive
payout
<TABLE>
<CAPTION>
Threshold Target Superior
--------- ------ --------
EPS Incentive EPS Incentive EPS Incentive
--- --------- --- --------- --- ---------
<S> <C> <C> <C> <C> <C>
0.98 - 1.02 11,000 1.36 - 1.39 98,000 1.61 - 1.67 188,000
1.03 - 1.07 22,000 1.40 - 1.42 108,000 1.68 - 1.73 208,000
1.08 - 1.12 33,000 1.43 - 1.45 118,000 1.74 - 1.79 228,000
1.13 - 1.17 44,000 1.46 - 1.48 128,000 1.80 - 1.85 248,000
1.21 - 1.25 55,000 1.49 - 1.51 138,000 1.86 - 1.91 268,000
1.25 - 1.29 66,000 1.52 - 1.54 148,000 1.92 - 1.97 288,000
1.29 - 1.33 77,000 1.55 - 1.57 158,000 1.98 - 2.03 308,000
1.33 - 1.35 88,000 1.58 - 1.60 168,000 2.03 - 2.17 328,000
</TABLE>
(3) The determination of consolidated net earnings per share made shall be
final and binding on company and consultant, and no adjustments in
incentive compensation shall subsequently be made because of adjustments
in federal income taxes or other items. The consolidated growth of net
earnings per share for purposes of this incentive compensation shall be
computed and paid out not later than 30 days after 10/1/98 and 3/31/99,
company's fiscal year end.
IN WITNESS WHEREOF the company and the consultant have executed this
agreement as of the day and year first written above.
MEDIA ARTS GROUP, INC. MIKE KILEY
by /s/ Raymond A. Peterson /s/ Mike Kiley
----------------------- --------------
CEO Consultant
<PAGE>
EXHIBIT 21.01
MEDIA ARTS GROUP, INC.
LIST OF SUBSIDIARIES
<TABLE>
<CAPTION>
Jurisdiction of Ownership
Name of subsidiary Incorporation percentage
- --------------------------------- ------------- ----------
<S> <C> <C>
Thomas Kinkade Stores, Inc. USA (California) 100%
MAGI Entertainment Products, Inc. USA (California) 100%
MAGI Sales, Inc. USA (California) 100%
</TABLE>
<PAGE>
EXHIBIT 23.01
MEDIA ARTS GROUP, INC.
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Forms S-8 (No.333-51667, No.333-154 and No.33-87090) of Media Arts
Group, Inc. of our report dated April 27, 1998, which appears on page 21 of
this Form 10-K.
/s/ PRICE WATERHOUSE LLP
Price Waterhouse LLP
San Jose, California
June 22, 1998
<PAGE>
EXHIBIT 24.01
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Greg H. L. Nash as his attorney-in-fact, with
the power of substitution, for him in any and all capacities, to sign any
amendments to this Report on Form 10-K, and or file same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act if 1934, this
report has been signed on June 22, 1998 by the following persons on behalf of
the registrant and in the capacities indicated.
<TABLE>
<CAPTION>
Signature Title
- --------------------------------- --------------------------------------
<S> <C>
/s/ Raymond A. Peterson PRESIDENT AND CHIEF EXECUTIVE OFFICER
- --------------------------------- (PRINCIPAL EXECUTIVE OFFICER)
(Raymond A. Peterson)
/s/ Greg H. L. Nash VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
- --------------------------------- (PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER)
(Greg H. L. Nash)
/s/ Kenneth E. Raasch CHAIRMAN
- ---------------------------------
(Kenneth E. Raasch)
/s/ Thomas Kinkade DIRECTOR
- ---------------------------------
(Thomas Kinkade)
/s/ Norman A. Nason DIRECTOR
- ---------------------------------
(Norman A. Nason)
/s/Michael L. Kiley DIRECTOR
- ---------------------------------
(Michael L. Kiley)
/s/ Norman T. Mahoney DIRECTOR
- ---------------------------------
(Norman T. Mahoney)
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-END> MAR-31-1998
<CASH> 16,401
<SECURITIES> 0
<RECEIVABLES> 18,275
<ALLOWANCES> 2,434
<INVENTORY> 9,094
<CURRENT-ASSETS> 45,096
<PP&E> 8,915
<DEPRECIATION> 3,518
<TOTAL-ASSETS> 51,339
<CURRENT-LIABILITIES> 15,020
<BONDS> 0
0
0
<COMMON> 85
<OTHER-SE> 35,034
<TOTAL-LIABILITY-AND-EQUITY> 51,339
<SALES> 82,650
<TOTAL-REVENUES> 82,650
<CGS> 27,220
<TOTAL-COSTS> 35,238
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 369
<INTEREST-EXPENSE> 1,612
<INCOME-PRETAX> 19,484
<INCOME-TAX> 7,209
<INCOME-CONTINUING> 12,275
<DISCONTINUED> 0
<EXTRAORDINARY> (1,296)
<CHANGES> 0
<NET-INCOME> 10,979
<EPS-PRIMARY> 0.98
<EPS-DILUTED> 0.93
</TABLE>
