<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission File Number: 0-24294
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 Ave, San Jose, California 95131
(Address of principal executive offices and zip code)
Registrant's telephone number: (408) 324-2020
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
--- ---
The number of shares outstanding of the Registrant's Common Stock, $0.01
par value, was 12,939,794 at September 30, 1999.
This report consists of 20 pages of which this page is number 1.
1
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MEDIA ARTS GROUP, INC.
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
Page
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<S> <C>
Part I: Financial Information
Item 1: Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of
September 30, 1999 and March 31, 1999 3
Condensed Consolidated Statements of Income for the Three
and Six Month Periods Ended September 30, 1999 and 1998 4
Condensed Consolidated Statements of Cash Flows for
the Six Month Periods Ended September 30, 1999 and 1998 5
Notes to Unaudited Condensed Consolidated Financial Statements 6
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 3: Quantitative and Qualitative Disclosures
About Market Risk 16
Part II: Other Information
Item 1: Legal Proceedings 18
Item 2: Changes in Securities 18
Item 3: Defaults upon Senior Securities 18
Item 4: Submission of Matters to a Vote of Security Holders 18
Item 5: Other Information 18
Item 6: Exhibits and Reports on Form 8-K 18
Signatures 19
</TABLE>
2
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MEDIA ARTS GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, UNAUDITED)
<TABLE>
<CAPTION>
September 30, March 31,
1999 1999
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 569 $ 6,361
Accounts receivable, net 25,690 22,354
Inventories 19,159 16,683
Prepaid expenses and other current assets 6,222 5,346
Deferred income taxes 5,319 5,288
--------- ---------
Total current assets 56,959 56,032
Property and equipment, net 14,392 10,971
Notes receivable 2,652 --
Cash value of life insurance 1,598 920
Other assets 248 223
--------- ---------
Total assets $ 75,849 $ 68,146
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 6,122 $ 4,883
Commissions payable 1,270 981
Accrued royalties 1,329 1,339
Accrued compensation costs 2,290 2,274
Accrued expenses 2,330 1,942
Income taxes payable 4,817 2,828
--------- ---------
Total current liabilities 18,158 14,247
Deferred compensation cost 1,745 908
Convertible notes 1,200 1,200
--------- ---------
Total liabilities 21,103 16,355
--------- ---------
Stockholders' equity:
Common Stock 88 88
Additional paid-in capital 37,560 37,367
Retained earnings 21,224 17,976
Treasury stock (4,126) (3,640)
--------- ---------
Total stockholders' equity 54,746 51,791
--------- ---------
Total liabilities and stockholders' equity $ 75,849 $ 68,146
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
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MEDIA ARTS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS, UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, September 30,
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net sales $ 34,624 $ 29,595 $ 60,369 $ 55,934
Cost of sales 13,073 9,208 22,900 18,274
--------- --------- --------- ---------
Gross profit 21,551 20,387 37,469 37,660
--------- --------- --------- ---------
Operating expenses
Selling and marketing 8,874 8,159 17,803 14,748
General and administrative 7,957 5,547 14,319 10,120
--------- --------- --------- ---------
Total operating expenses 16,831 13,706 32,122 24,868
--------- --------- --------- ---------
Operating income 4,720 6,681 5,347 12,792
Interest income (expense) (3) 235 7 366
--------- --------- --------- ---------
Income before income taxes 4,717 6,916 5,354 13,158
Provision for income taxes 1,864 2,643 2,113 5,014
--------- --------- --------- ---------
Net income $ 2,853 $ 4,273 $ 3,241 $ 8,144
========= ========= ========= =========
Net income per share:
Basic $ 0.22 $ 0.33 $ 0.25 $ 0.63
Diluted $ 0.22 $ 0.31 $ 0.25 $ 0.58
Shares used in net income per
share computation:
Basic 12,926 12,904 12,929 12,936
Diluted 13,067 13,838 13,141 13,987
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
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MEDIA ARTS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS, UNAUDITED)
<TABLE>
<CAPTION>
Six Months Ended September 30,
1999 1998
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 3,241 $ 8,144
Adjustments to reconcile to net cash
provided by continuing operating activities:
Depreciation 1,913 949
Amortization of intangibles 7 14
Deferred income taxes (31) (161)
Provision for returns and allowances (213) 357
Provision for losses on accounts receivable 173 (58)
Changes in assets and liabilities:
Accounts receivable (3,296) (3,364)
Receivables from related parties (14) (27)
Inventories (3,220) (5,670)
Prepaid expenses and other current assets 430 (738)
Accounts payable 1,246 179
Commissions payable 289 433
Accrued compensation costs 16 (555)
Income taxes payable and refundable, net 1,989 252
Accrued expenses (672) 393
Accrued royalties (10) 371
Deferred compensation liability 837 --
--------- ---------
Net cash provided by operations 2,685 519
--------- ---------
Cash flows from investing activities:
Acquisitions of property and equipment (6,315) (4,205)
Disposals of galleries 2,791 --
Increase in cash surrender value of life insurance (678) --
Acquisition of gallery, net of cash acquired -- (321)
Purchases of short-term investments -- (3,898)
--------- ---------
Net cash used in investing activities (4,202) (8,424)
--------- ---------
Cash flows from financing activities:
Receipt of notes receivable (3,982) --
Proceeds from issuance of common stock 193 445
Purchases of treasury stock (486) (2,664)
--------- ---------
Net cash used in financing activities (4,275) (2,219)
--------- ---------
Net decrease in cash and cash equivalents (5,792) (10,124)
Cash and cash equivalents at beginning of period 6,361 16,401
--------- ---------
Cash and cash equivalents at end of period $ 569 $ 6,277
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
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MEDIA ARTS GROUP, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - Basis of Presentation
The consolidated financial statements of Media Arts Group, Inc. (the
"Company") include the accounts of its wholly owned subsidiaries,
Lightpost Publishing, Inc. and Thomas Kinkade Stores, Inc., and Exclaim
Technologies, Inc., a majority owned subsidiary. The Company primarily
designs, manufactures, markets and retails branded art-based home
accessories, collectibles and gift products based on the works of the
artist Thomas Kinkade. 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. Exclaim is an Internet based
applications service provider, developing products for the
business-to-business market as well as business-to-consumer e-commerce
for Thomas Kinkade based products.
The condensed interim consolidated financial statements of Media Arts
Group, Inc. have been prepared by the Company without audit. Certain
information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to rules and
regulations of the Securities and Exchange Commission. The information
included in this report should be read in conjunction with the Company's
audited consolidated financial statements and notes thereto included in
the Company's Annual Report on Form 10-K.
In the opinion of management, the accompanying unaudited interim
condensed consolidated financial statements reflect all material
adjustments (consisting solely of normal recurring adjustments) necessary
for a fair presentation of the financial position, operating results and
cash flows for the periods presented. The results of the interim period
ended September 30, 1999 are not necessarily indicative of the results
that may be expected for the entire fiscal year which ends March 31, 2000.
NOTE 2 - Net income per share
The following summarizes the effects of the assumed issuance of dilutive
securities on weighted average shares for basic net income per share (in
thousands).
6
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<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, September 30,
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Weighted average number of
shares - basic 12,926 12,904 12,929 12,936
Incremental shares from assumed
issuance of stock options 141 934 212 1,051
--------- --------- --------- ---------
Weighted average number of
shares - diluted 13,067 13,838 13,141 13,987
========= ========= ========= =========
</TABLE>
NOTE 3 - Inventories
Inventories consisted of (in thousands):
<TABLE>
<CAPTION>
September 30, March 31,
1999 1999
--------- ---------
<S> <C> <C>
Raw materials $ 2,641 $ 2,579
Work-in-process 2,640 1,235
Finished goods 13,878 12,869
--------- ---------
$ 19,159 $ 16,683
========= =========
</TABLE>
NOTE 4 - Related Party Transactions
Effective September 15, 1999, Media Arts sold the Company-owned Thomas
Kinkade Stores located in Monterey and Carmel, California to an entity in
which a relative of a founder and member of the board of directors
is an investor. Consideration for this sale consisted of cash of $75,000
and an 8.5% promissory note in the amount of $678,000 due in August 2006
with semi-annual principal and interest payments. An additional
promissory note will be received during the subsequent quarter for the
inventory purchased at wholesale with terms consistent with the terms for
the sales of other Company-owned stores to non-related parties. The
Company commissioned an independent valuation of the Company-owned stores
in Monterey and Carmel, California and the terms of the sale were based
upon the independent valuation.
7
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NOTE 5 - Operating Segments and Geographic Information
Media Arts has three operating segments: wholesale, retail and Internet.
The wholesale segment includes sales to the Company's branded
distribution channel (which includes Company-owned Thomas Kinkade Stores,
and independently owned Thomas Kinkade Signature Galleries and Showcase
dealers), other independent dealers and strategic partners such as QVC,
Avon and Hallmark. Media Arts' retail segment consists of sales by
Company-owned Thomas Kinkade Stores. The Internet segment consists of
the development of vertical business-to-business trade communities that
will link buyers and sellers together to create supply chain
efficiencies. The first industry applications are intended to be the
fine art, gift and collectibles, furniture and home decor industries.
The Company believes that these business-to-business Internet products
may be scalable and may leverage Exclaim into other highly fragmented
industries. The Company intends to continue funding Exclaim through the
remainder of the fiscal year, although the Company may seek outside
capital investments in the future and discontinue its funding, which may
result in reducing its ownership interest to a level that would no longer
require consolidation in its financial statements. The operating
segments have management teams that report directly to the Chief
Operating Decision Maker ("CODM"), as defined by Statement of Financial
Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information." The CODM evaluates performance and
allocates resources to each operating segment based on its net sales and
operating profits or business opportunities for diversification.
Information on the Company's reportable segments is as follows (in
thousands):
8
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<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, September 30,
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues:
External wholesale $ 29,284 $ 22,666 $ 48,673 $ 44,099
Intersegment wholesale 2,658 4,909 6,188 8,323
Retail 5,296 6,929 11,597 11,835
Internet 44 -- 99 --
Eliminations (2,658) (4,909) (6,188) (8,323)
--------- --------- --------- ---------
Total company $ 34,624 $ 29,595 $ 60,369 $ 55,934
========= ========= ========= =========
Operating income (loss):
Wholesale $ 7,142 $ 8,212 $ 9,611 $ 14,930
Retail (1,148) (486) (2,132) (582)
Internet (922) -- (1,328) --
Eliminations (352) (1,045) (804) (1,556)
--------- --------- --------- ---------
Total company $ 4,720 $ 6,681 $ 5,347 $ 12,792
========= ========= ========= =========
Assets:
Wholesale $ 66,109 $ 49,432
Retail 7,931 12,769
Internet 3,688 --
Eliminations (1,879) (3,885)
--------- ---------
Total company $ 75,849 $ 58,316
========= =========
Depreciation:
Wholesale $ 635 $ 426 $ 1,206 $ 794
Retail 314 81 680 155
Internet 27 -- 27 --
--------- --------- --------- ---------
Total company $ 976 $ 507 $ 1,913 $ 949
========= ========= ========= =========
Capital expenditures:
Wholesale $ 1,366 $ 1,781 $ 2,893 $ 2,756
Retail 3 1,089 72 1,449
Internet 1,581 -- 3,350 --
--------- --------- --------- ---------
Total company $ 2,950 $ 2,870 $ 6,315 $ 4,205
========= ========= ========= =========
</TABLE>
Media Arts currently does not sell to geographic regions outside the
United States, Canada and the UK. Currently sales to Canada and the UK
are immaterial. During the three and six month periods ended September
30, 1999 and 1998 no customer accounted for greater than 10% of net sales.
9
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ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information set forth below should be read in conjunction with the
unaudited condensed consolidated financial statements and notes thereto
included in Part I - Item 1 of this Quarterly Report and the Company's
Annual Report on Form 10-K for the year ended March 31, 1999 which
contains the audited financial statements and notes thereto for the years
ended March 31, 1997, 1998 and 1999 and Management's Discussion and
Analysis of Financial Condition and Results of Operations for those
respective periods.
Forward looking statements in this Quarterly Report on Form 10-Q as well
as the Company's Annual Report on Form 10-K for the year ended March 31,
1999, 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, other risks
detailed from time to time in the Company's periodic reports and other
information filed with the Securities and Exchange Commission.
RESULTS OF OPERATIONS
Net Sales
Net sales for the quarter ended September 30, 1999 were $34.6 million, a
17.0% increase compared to the $29.6 million reported for the quarter
ended September 30, 1998. The increase in net sales was primarily
attributable to increased demand resulting from the discontinuance of the
phased release program and the related reduction in edition sizes, the
increase in the number of Signature Galleries and the quality of releases
introduced during the quarter. Net sales for the six months ended
September 30, 1999 were $60.4 million, up 7.9% from $55.9 million during
the six months ended September 30, 1998 primarily attributable to the
increase in the number of Signature Galleries offset by a sales decrease
during the first three months of fiscal 2000.
Gross Profit
Gross profit increased by $1.2 million, or 5.7%, to $21.6 million for
the quarter ended September 30, 1999 compared to $20.4 million for the
quarter ended September 30, 1998. Gross profit was $37.5 million for the
six months ended September 30, 1999 compared to $37.7 million in the
prior year. Consolidated gross margin was 62.2% and 62.1% for the three
and six month periods ended September 30, 1999 compared to 68.9% and
67.3% for the same periods in the prior year. The increase in gross
profit in absolute terms was due primarily to increased sales levels.
The softening in gross margin was primarily a result of excess
manufacturing capacity and the loss of the retail margin from thirteen
Thomas Kinkade Stores sold to Signature Gallery dealers during the six
months ended September 30, 1999.
10
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Selling and Marketing Expenses
Selling and marketing expenses were $8.9 million and $17.8 million for
the three and six month periods ended September 30, 1999 compared to $8.2
million and $14.7 million for the same periods in the prior year. As a
percentage of net sales, selling and marketing expenses were 25.6% and
29.5% for the three and six month periods ended September 30 ,1999
compared to 27.6% and 26.4% for the same periods in the prior year.
Selling and marketing expenses increased in absolute terms primarily due
to increased advertising and promotional costs. As a percentage of
sales, selling and marketing expenses decreased for the quarter due to
increased sales compared to the prior year. For the six month period
ended September 30, 1999 selling and marketing expenses increased as a
percentage of sales due to lower than anticipated sales in the first
three months of the period.
General and Administrative Expenses
General and administrative expenses were $8.0 million and $14.3 million
for the three and six month periods ended September 30, 1999 compared to
$5.5 million and $10.1 million for the same periods in the prior year.
Expressed as a percentage of net sales, general and administrative
expenses were 23.0% and 23.7% for the three and six month periods ended
September 30, 1999 compared to 18.7% and 18.1% for the same periods in
the prior year. The increase in general and administrative expenses was
primarily due to a non-recurring charge of $1.3 million for severance
payments relating to cost reductions and certain settlement payments
under key management contracts, as well as general and administrative
expenses of $809,000 and $1.3 million for the three and six month periods
ended September 30, 1999 for Internet business expenses initiated this
year.
Wholesale Segment
Net sales to wholesale accounts include sales to our branded distribution
channel, including independently owned Signature Galleries and Showcase
dealers, our Company-owned Thomas Kinkade Stores, other independent
dealers and strategic partners, as well as revenue generated from
licensing arrangements. Net sales to wholesale customers before
intersegment eliminations increased 15.8% to $31.9 million in the
September 1999 quarter compared to $27.6 million in the September 1998
quarter. The increase in net sales for this segment was primarily due to
increased demand resulting from the discontinuance of the phased release
program and the related reduction in edition sizes, the increase in the
number of Signature Galleries and the quality of releases introduced
during the quarter. Net sales to wholesale customers before intersegment
eliminations for the six months ended September 30, 1999 were $54.9
million, up 4.7% from $52.4 million during the same period in the prior
year. Sales to Signature Galleries increased 112.7% to $16.4 million in
the September 1999 quarter from $7.7 million in September 1998 quarter
due to an increase in the number of Signature Galleries to 228 as of
September 30, 1999 from 116 as of one year ago.
11
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Operating income for the wholesale segment before intersegment
eliminations decreased 13.0% to $7.1 million in the September 1999
quarter compared to $8.2 million in the September 1998 quarter.
Operating margin for the wholesale segment before intersegment
eliminations decreased to 22.4% in the September 1999 quarter from 29.8%
in the September 1998 quarter. The decrease was primarily due to a
decrease in gross margin resulting from excess manufacturing capacity and
a non-recurring charge of $1.3 million for severance payments relating to
cost reductions and certain settlement payments under key management
contracts. Operating income before intersegment eliminations decreased
35.6% to $9.6 million during the six months ended September 30, 1999
compared to $14.9 million in the same period in the prior year.
Operating margin for the wholesale segment before intersegment
eliminations for the six months ended September 30, 1999 decreased to
17.5% from 28.5% for the same period in the prior year. The decrease was
due primarily to the $1.3 million non-recurring charge, as well as
increased advertising and promotional costs and increased infrastructure
costs in anticipation of higher sales volumes during the first three
months of fiscal 2000.
Retail Segment
Net sales for the retail segment consist of sales by Company-owned
Thomas Kinkade Stores and decreased 23.6% to $5.3 million in the
September 1999 quarter compared to $6.9 million in the September 1998
quarter. The decrease in net sales was primarily due to the transfer of
Thomas Kinkade Stores to Signature Gallery dealers during the September
1999 quarter and declining same store sales with the announcement and
conversions of Company-owned stores offset by the opening of new
Company-owned stores during fiscal 1999. There were 20 Company-owned
galleries as of September 30, 1999 compared to 26 as of September 30,
1998. Eleven galleries were transferred to Signature Gallery dealers
during the September 1999 quarter, bringing the total number of Thomas
Kinkade Stores transferred to thirteen. We expect to transfer the
majority of our Company-owned galleries to Signature Gallery owners by
the end of fiscal 2000. Net sales for the retail segment during the six
months ended September 30, 1999 decreased 2.0% to $11.6 million from
$11.8 million for the same period in the prior year.
Operating losses for the retail segment increased 136.2% to $1.1 million
in the September 1999 quarter compared to $486,000 in the September 1998
quarter. Operating losses for the six months ended September 30, 1999
increased 266.3% to $2.1 million from $582,000 for the same period in the
prior year. The increase in operating losses is primarily due to
increased per store advertising and promotional activities. Our retail
segment purchases products from our wholesale segment at the same price
as external wholesale customers.
Internet Segment
Net sales for the Internet segment for the three and six month periods
ended September 30, 1999 were $44,000 and $99,000. There were no
Internet segment operations during the three and six month periods ended
12
<PAGE>
September 30, 1998. Net sales for the Internet segment consist of
subscription fees paid by retailers for access to a web-based gift store
and gallery management system, named Storefront. Storefront is designed
to assist gallery owners with inventory management, customer contact
management and automated purchasing and point of sale processing. As of
September 30, 1999, net sales of Storefront have been made solely to
Signature Galleries. We believe that there will be opportunities to sell
Storefront to other galleries and gift stores outside of the existing
Thomas Kinkade branded distribution network. In addition, we believe
that Storefront may be marketed to other markets outside of fine art,
gift and collectibles.
Operating losses for the Internet segment were $922,000 and $1.3 million
for the three and six month periods ended September 30, 1999. There were
no Internet segment operations during the three and six month periods
ended September 30, 1998. Operating expenses of the Internet segment
consist primarily of salaries and consulting expenses related to the
development of Exclaim's existing and future products.
Interest Income (Expense)
Interest expense was $3,000 for the three months ended September 30, 1999
compared to interest income of $235,000 for the same period in the prior
year. Interest income was $7,000 and $366,000 for the six months ended
September 30, 1999 and 1998. The decrease in interest income was due to
decreased cash balances.
Provision for Income Tax
The provision for income taxes was $1.9 million and $2.1 million for the
three and six months ended September 1999, respectively, compared to $2.6
million and $5.0 million for the same periods in the prior year. The
effective income tax rate for the three and six months ended September
30, 1999 was 39.5%, compared to 38.2% and 38.1% for the same periods in
the prior year.
Seasonality; Fluctuations in Quarterly Results
Our business has experienced, and is expected to continue to experience,
significant seasonal fluctuations in net sales and income. Our net sales
historically have been highest in the December quarter and lower in the
subsequent March and June quarters. Despite overall increases in annual
net sales in fiscal 1999, net sales in the December 1998 quarter were
$39.0 million and sales in the subsequent March 1999 and June 1999
quarters were $31.4 million and $25.7 million. We believe that the
seasonal effect is due to customer buying patterns, particularly with
respect to holiday purchases, and is typical of the home decorative
accessories, collectibles and gift product industries. We expect these
seasonal trends to continue in the foreseeable future.
Our quarterly operating results have fluctuated significantly in the past
and may continue to fluctuate as a result of numerous factors including:
13
<PAGE>
- - Demand for the art of Thomas Kinkade and our Thomas Kinkade products
(including new product categories and series),
- - Our ability to achieve our expansion plans,
- - The timing, mix and number of new product releases,
- - The successful implementation of the Signature Gallery program and
expansion of distribution generally,
- - The sales of Storefront to new customers outside of our existing dealer
network and the successful launch and customer acceptance of Exclaim's
products generally,
- - Our ability to implement strategic business alliances,
- - Our ability to hire and train new manufacturing, sales and
administrative personnel,
- - Continued implementation of manufacturing efficiencies,
- - Timing of product deliveries, and
- - The incurrence of other operating costs.
In addition, since a significant portion of our net sales are generated
from orders received in the quarter, net sales in any quarter are
substantially dependent on orders booked in that quarter. Our results
may also fluctuate based on extraordinary events. Accordingly, the
results of operations in any quarter will not necessarily be indicative
of the results that may be achieved for a full fiscal year or any future
quarter. Fluctuations in operating results may also result in volatility
in the price of our common stock.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of funds in the first six months of fiscal
2000 has been from its operations. The Company's working capital as of
September 30, 1999 was $38.8 million, compared to $41.8 million as of
March 31, 1999.
Net cash provided by operations for the first six months of fiscal 2000
was $2.7 million consisting primarily of income from operations adjusted
by increases in accounts receivable and inventory. Accounts receivable
increased due to increased sales levels as well as higher sales during
the last month of the quarter. Inventory increased due to increased
distribution and receipt of additional paper lithographs in full edition
quantities as partial edition purchasing had not fully taken effect
during the quarter. Net cash provided by operations for the first six
months of fiscal 1999 was $519,000 consisting primarily of income from
continuing operations adjusted by increases in inventory and accounts
receivable.
Net cash used in investing activities was $4.2 million for the first six
months of fiscal 2000 and primarily related to investment in Internet
related technologies and capital expenditures for property and equipment
offset by the transfer of thirteen Company-owned stores to Signature
Gallery dealers. Net cash used in investing activities was $8.4 million
in the first six months of fiscal 1999. The Company anticipates that
total capital expenditures in fiscal 2000 will be approximately $10
million, and will relate primarily to Internet business development and
continued manufacturing and infrastructure investments.
14
<PAGE>
Net cash used in financing activities was $4.3 million in the first six
months of fiscal 2000 compared to $2.2 million in the first six months of
fiscal 1999. Cash used in financing activities during the first six
months of fiscal 2000 was primarily for financing the sales of thirteen
Company-owned galleries and promissory notes received related to the
implementation of changes in our credit policies. The notes received due
to changes in our credit policies totaled $1.7 million, bear interest of
9.5% and generally have one to two year terms with monthly principal and
interest payments. Net cash used in financing activities during the
first six months of fiscal 1999 was related primarily to the purchase of
shares of the Company's Common Stock under the Company's continuing stock
repurchase program.
We have a $10 million secured bank line-of-credit facility. We are
currently negotiating a new line-of-credit which will range between $20
million and $30 million based on financial performance and is expected to
be completed in the 1999 calendar year. Borrowing capacity under the
existing credit facility is based upon eligible accounts receivable and
inventory. There were no outstanding borrowings under this credit
facility as of September 30, 1999.
We intend to continue funding Exclaim through the remainder of the fiscal
year, although we may seek outside capital investments in the future and
discontinue our funding, which may result in reducing our ownership
interest to a level that would no longer require consolidation in our
financial statements.
Our working capital requirements in the foreseeable future will change
depending on the rate of our expansion, our operating results and any
other adjustments in our operating plan as needed in response to
competition, acquisition opportunities or unexpected events. We believe
that existing borrowing capacity under our lines of credit, together with
revenues from operations, will be sufficient to meet our working capital
requirements through fiscal 2000. However, there can be no assurance
that we will not seek additional capital in the future as a result of
expansion or otherwise.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products may be
coded to accept only two-digit entries in the date code field and as the
Year 2000 approaches, these code fields will need to accept four digit
entries to distinguish years beginning with "19" from those beginning
with "20." As a result, in less than three months, computer systems
and/or software products used by many companies will need to be upgraded
to comply with such Year 2000 requirements.
Our Year 2000 Project (the "Project") was substantially complete by the
end of fiscal 1999. The scope and content of the Project included:
15
<PAGE>
- - Assessing the ability of computer programs and embedded computer chips
to distinguish between the year 1900 and the year 2000,
- - Conducting a review of our information technology ("IT") and non-IT
systems to identify those areas that could be affected by Year 2000
issues,
- - Developing a comprehensive, risk-based plan to address IT and non-IT
systems and products, as well as dependencies on our business
partners,
- - Completing an inventory and risk-assessment of our computer systems and
related technology, and
- - Developing and carrying out the testing and remediation process.
As part of the remediation process, in fiscal 1999 we upgraded our main
IT system and related JD Edwards software, IBM AS400 and PC-based network
to be Year 2000 compliant. The total cost for ensuring Year 2000
compliance was not material to our financial position. The total cost of
the Year 2000 Project was approximately $1 million, including upgrades
for the JD Edwards software, the IBM AS400 and the PC-based network. At
present, we believe that with the current modifications to existing
software and conversions to new software, the Year 2000 problem will not
pose significant operational issues for our operations. However, we
cannot accurately predict a "worst case scenario" with regard to our Year
2000 issues.
We understand we may encounter difficulties interfacing or
interconnecting with third party systems, whether or not those systems
claim to be "compliant," and therefore have completed an inventory and
risk assessment of our outside vendors and have identified those key
vendors that represent a significant risk. We are continuing to
communicate with those vendors to determine their Year 2000 readiness.
Part of our preparation included preparing contingency plans in the event
of non-compliance by those vendors. Overall, we believe Year 2000 risks
with key vendors and suppliers are low because many are small
manufacturers with relatively simple business systems, however, we cannot
guarantee that the systems of those vendors and suppliers, or other
companies on which we rely, will be Year 2000 compliant. Failure by
another company to convert their systems to be Year 2000 compliant could
require us to incur unanticipated expenses to remedy problems, which
could have a material adverse effect on our business, operating results
and financial condition.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk for changes in interest rates relates
primarily to our investment portfolio and borrowings. We do not use
derivative financial instruments in our investment portfolio and our
investment portfolio only includes highly liquid instruments purchased
with an original maturity of 90 days or less and are considered to be
cash equivalents. We did not have short-term investments as of September
30, 1999. We are subject to fluctuating interest rates that may impact,
adversely or otherwise, our results from operations or cash flows for our
16
<PAGE>
variable rate cash and cash equivalents and borrowings. We do not expect
any material loss with respect to our investment portfolio. The table
below presents principal (or notational) amounts and related weighted
average interest rates for our investment portfolio and debt obligations
(in thousands):
September 30,
1999
---------
Assets:
Cash and cash equivalents $ 569
Average interest rate 2.71%
Liabilities:
Bank line-of-credit $ --
Interest rate (prime rate plus 0.5%) 8.50%
Convertible note payable to related party $ 1,200
Fixed interest rate 8.00%
17
<PAGE>
PART II - Other Information
ITEM 1. LEGAL PROCEEDINGS - Not Applicable
ITEM 2. CHANGES IN SECURITIES - Not Applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES - None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Annual Meeting of Media Arts Group, Inc. was convened on
August 18 1999.
(b) The following directors were elected to hold office until the next
annual meeting:
Votes
Nominee Votes Withheld
Kenneth E. Raasch 12,121,974 507,075
Thomas Kinkade 12,306,572 322,477
Michael L. Kiley 12,141,454 487,595
Norman A. Nason 12,131,654 497,395
W. Michael West 12,186,654 442,395
Raymond A. Peterson 12,282,175 346,874
(c) The following matters were voted upon at the meeting:
The approval of an amendment to the Company's 1998 Stock Incentive
Plan which increases the number of shares reserved for issuance
under the 1998 Stock Incentive Plan to 1,150,000 shares.
Votes for - 8,074,030, against - 1,166,622, abstain - 31,670
Broker nonvote - 3,728,887
The selection and ratification of PricewaterhouseCoopers LLP as the
Company's independent public accountants for the fiscal year ending
March 31, 2000.
Votes for - 12,540,205, against - 65,244, abstain - 23,600
Broker nonvote - 372,160
ITEM 5. OTHER INFORMATION - Not Applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit 10.37 - Amendment to Consulting Agreement between the
Company and Mike Kiley, dated as of April 1, 1999
(b) Exhibit 27 - Financial Data Schedule (EDGAR version only)
(c) Reports on Form 8-K - none
18
<PAGE>
MEDIA ARTS GROUP, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MEDIA ARTS GROUP, INC.
(Registrant)
By /s/ Craig Fleming
--------------------------------------
Craig Fleming
President & Chief Executive Officer
By /s/ Michael J. Catelani
--------------------------------------
Michael J. Catelani
Vice President of Finance
(Principal Financial Officer)
Date: November 15, 1999
19
<PAGE>
EXHIBIT INDEX
Exhibit Number
10.37 Amendment to Consulting Agreement between the Company and Mike
Kiley, dated as of April 1, 1999
27 Financial Data Schedule
20
<PAGE>
Exhibit 10.37
AMENDMENT TO CONSULTING AGREEMENT
This Amendment to the Consulting Agreement (the "Amendment") is made
effective as of April 1, 1999 between Media Arts Group, Inc., (the
"Company") and Michael L. Kiley ("Consultant").
WHEREAS, the Company and Consultant previously entered into a
consulting agreement as of April 1, 1997 (the "Agreement"); and
WHEREAS, the Company and Consultant amended the Agreement as of April 1,
1998; and
WHEREAS, the Company and Consultant wish to further amend the Agreement;
NOW, THEREFORE, THE PARTIES AGREE AS FOLLOWS:
I. AMENDMENTS
1. Term and Termination:
Paragraph 5(a) of the Agreement shall be amended in its entirety as
follows:
This Agreement shall commence on April 1, 1999 and shall terminate on
March 31, 2000 or upon termination as provided below.
Exhibit B:
A portion of Exhibit B of the Agreement shall be amended as follows:
Compensation of Consultant:
Options: Grant of 20,000 options at $9.75.
Bonus: Consultant shall be included in the Executive Management Bonus
program, as approved by the Board of Directors.
II. COUNTERPARTS. This Amendment may be signed by the parties in
different counterparts and the signature pages combined shall create a
document binding on all parties.
III. CONFLICT. In the event that any of the terms and conditions of
this Amendment conflict with any of the terms and conditions of the
Agreement, the terms and conditions of this Amendment shall govern. All
other terms of the Agreement shall remain in full force and effect.
IN WITNESS WHEREOF, the parties hereto have executed this Amendment
this 1st day of April, 1999.
MEDIA ARTS GROUP, INC: CONSULTANT:
By: /s/ Raymond A. Peterson /s/ Michael L. Kiley
----------------------- -------------------------
Raymond A. Peterson Michael L. Kiley
Chief Executive Officer & President
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