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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, 2000
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 95131
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (408) 324-2020
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $0.01 Par Value
(Title of class)
Securities registered pursuant to section 12(g) of the Act: None
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 (ss. 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 31,
2000, as reported on the New York Stock Exchange was approximately $24,513,000.
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, 2000, was 13,140,546.
Part III incorporates by reference from the definitive proxy statement
for the registrant's 2000 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 46 PAGES. THE INDEX TO EXHIBITS IS ON PAGE 44.
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. is a leading designer, manufacturer, marketer
and branded retailer of art-based home decorative accessories, collectibles and
gift products based primarily upon the works of the artist Thomas Kinkade,
Painter of Light(R). Our primary products are canvas and paper lithographs that
feature Mr. Kinkade's unique use of light and his peaceful and inspiring themes.
We believe 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. We
strive to reach a broad consumer base by offering products at a variety of price
points, controlling distribution through our branded distribution channel of
independently owned and operated Thomas Kinkade Signature Galleries(TM) and
Showcase Galleries. We have also developed strategic marketing relationships
with companies such as Hallmark Cards, Inc., Avon Products, Inc. and QVC Inc.
Our products generally sell at retail price points ranging from $50 for small
gift prints to between $150 and $10,000 for paper and canvas lithographs. We
distribute Thomas Kinkade products through an extensive distribution network
which as of March 31, 2000 included 297 Signature Galleries, seven company-owned
retail Thomas Kinkade Stores and approximately 4,000 other independent gift and
collectible retailers as well as through our strategic relationships. We believe
that this broad distribution network has allowed us to develop Thomas Kinkade
into a leading art-based brand. In April of 1999, we decided to stop opening new
company-owned Thomas Kinkade Stores in order to focus on development of our
branded distribution through independent dealers. During fiscal 2000 we
transferred ownership of 26 company-owned Thomas Kinkade Stores to existing and
new Signature Gallery dealers. We expect the majority of our seven remaining
company-owned stores to be transferred to independent owners by the end of
fiscal 2001. We believe that this extensive distribution network, and our
abilities to develop such, will be a significant factor in the successful
development of new art-based brands based on the works of new artists who we
plan to publish. During fiscal 2000 we entered into a five year, renewable
publishing and licensing agreement with Howard Behrens, a well known
contemporary expressionist artist. In addition, subsequent to March 31, 2000, we
entered into a five year, renewable publishing and licensing agreement with
Simon Bull, a leading contemporary visual artist in the United Kingdom. We will
begin selling framed canvas and paper reproductions of Mr. Behrens' and Mr.
Bull's works during fiscal 2001. We intend to aggressively pursue publishing and
licensing agreements and other strategic relationships with other artists and
visual content owners in order to become the pre-eminent visual content
management company within the art, gift, collectibles and home decor industries.
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, ornaments and other home furnishings 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 by Packaged Facts, a consumer research organization. We believe
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 Packaged Facts 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 more decorative accessories, collectibles and other giftware from
specialty stores. The Packaged Facts report states that in 1997, specialty
stores accounted for 65% of retail sales for the overall giftware market,
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with department stores and mass merchants accounting for only 25% of such sales.
We believe 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
Our goal is to consolidate our position as the pre-eminent visual
content management company within the art, gift, collectibles and home decor
industries. The first step in achieving this goal has been to develop Thomas
Kinkade into a leading art-based brand with widespread consumer appeal. To
develop the brand, we have been executing the following strategies:
PROVIDE A WIDE ARRAY OF BRANDED ART-BASED HOME ACCESSORIES. We seek to
increase awareness of the Thomas Kinkade brand and lifestyle message by creating
products that appeal to a broad range of consumers. Our Thomas Kinkade images
are released first in our higher margin limited edition lithographs and are the
foundation of our product lines. By leveraging these new images and our existing
library of over 200 Thomas Kinkade images into a wide array of art-based home
accessories with accessible price points, we intend to reach a broad consumer
base and to build brand awareness.
PROVIDE HIGH QUALITY PRODUCTS. We believe that manufacturing high
quality products is essential to enhancing brand image. While we expect demand
for these products to increase, we remain committed to providing high quality
products. Accordingly, we plan to continue to improve quality control, increase
capacity and shorten production time by reengineering certain of our
manufacturing processes.
EXPAND CONTROLLED DISTRIBUTION THROUGH DEDICATED STORES AND GALLERIES.
We seek to enhance the Thomas Kinkade brand by developing a network of
independently owned, licensed Signature Galleries, which exclusively sell Thomas
Kinkade products. We grant Signature Gallery owners limited use of the Thomas
Kinkade name. This controlled distribution strategy enables us to have our
products presented in environments designed to showcase the Thomas Kinkade brand
and convey the Thomas Kinkade lifestyle message. Furthermore, most Signature
Gallery owners have completed a sales, marketing and management program at
Thomas Kinkade University, our training facility. Signature Galleries must
maintain minimum purchases of $100,000 annually. In fiscal 2000, sales to
company-owned stores and Signature Galleries accounted for approximately 60.3%
of net sales compared to 53.7% in fiscal 1999. We intend to continue to expand
the network of Thomas Kinkade Signature Galleries in the United States and
abroad, and we intend to continue to look for opportunities to transfer
company-owned stores to Signature Gallery owners.
EXPAND DEALER NETWORK AND PROMOTE EXISTING DEALERS. We seek to increase
sales and build brand awareness by continuing to expand our dealer network and
promoting existing dealers to higher incentive and commitment levels. We
currently distribute our products through approximately 4,000 independent
dealers organized into four dealer levels with minimum purchase requirements
ranging from a $500 minimum initial purchase requirement to a $30,000 minimum
annual purchase requirement. As dealers upgrade to higher levels, they receive
increasing benefits such as access to a wider range of our products.
FOCUS ON RETAIL. We remain committed to providing support to our
dealers in order to assist them in maximizing retail sales through their stores.
Our decision to stop opening new company-owned stores has allowed us to use our
resources more efficiently by focussing on dealer support services, particularly
for our Signature and Showcase dealers. During fiscal 2001 we expect to provide
additional training, marketing and promotional services to our branded dealers
in order to promote retail sales of our products.
DEVELOP STRATEGIC BUSINESS RELATIONSHIPS AND LICENSING AGREEMENTS TO
EXPAND PRODUCT LINES AND AUDIENCE REACH. We intend to continue to develop
strategic business relationships and licensing agreements 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. Our current strategic business relationships and
licensing agreements include, among others, Hallmark for stationery items,
ornaments and other gift products; Avon for gift products; QVC for paper
lithographs and other gift products; La-Z-Boy and Kincaid Furniture for
furniture; The Bradford Exchange for collectibles and other gift products; Amcal
for calendars and stationery items; and Warner Books for books.
DEVELOP AN INTERNET PRESENCE. In fiscal 2000 we introduced an
e-commerce web-site, thomaskinkade.com, to support
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and contribute to the growth of our retail distribution channel. We believe our
innovative web-site enables consumers to select and purchase Thomas Kinkade
branded products on-line, while encouraging actual store visits through customer
incentives that promote new continuing relationships with the stores. In
addition, during fiscal 2001 we desire to implement an extranet system that will
be exclusively designed for independent dealers to enhance communication by
providing on-line order entry and order status review, retail support services,
training, e-mail correspondence and an on-line exchange and auction for art
prints.
The next step in achieving our goal to become the pre-eminent visual
content management company within the art, gift, collectibles and home decor
industries is to develop publishing and licensing agreements and other strategic
relationships with other artists and visual content owners and to pursue
strategies similar to those utilized in developing the Thomas Kinkade brand. In
addition, we will explore opportunities to expand distribution worldwide. During
fiscal 2000 we entered into a five year, renewable publishing and licensing
agreement with Howard Behrens, a well known contemporary expressionist artist.
In addition, subsequent to March 31, 2000, we entered into a five year,
renewable publishing and licensing agreement with Simon Bull, a leading
contemporary visual artist in the United Kingdom. We will begin selling framed
canvas and paper reproductions of Mr. Behrens' and Mr. Bull's works during
fiscal 2001 through many of our independent dealers. Howard Behrens' and Simon
Bull's works will not be distributed through Thomas Kinkade Signature Galleries,
since those galleries are designed to exclusively promote the works of Thomas
Kinkade. As we gain consumer acceptance of the Howard Behrens and Simon Bull
brands, we may develop an exclusive retail format to promote their works.
PRODUCTS
Our current 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
our product categories, product strategy and creative process.
PRODUCT CATEGORIES. Our 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 indefinitely. In
fiscal 2000, limited editions and open editions represented 66.0% and 29.4% of
our 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 original oil paintings. Our 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. We market our
limited edition canvas lithographs in ten sub-editions and our paper lithographs
in eight sub-editions with various edition sizes and attributes to provide
levels of collectibility at multiple price points. When determining edition
sizes, we seek to balance anticipated market demand and the desire to maintain
collectibility. In order to enable dealers to meet the ever increasing demand
for Thomas Kinkade limited edition products, we introduced multi-size releases
in fiscal 1998 and multi-phased releases in fiscal 1999. Multi-size releases
allow collectors the opportunity to select an image from several available image
sizes to best accommodate their size and price needs. Multi-phased releases were
canceled during fiscal 2000 due to the negative market response to the
significant increase in total edition sizes.
Our open edition products include gift prints, gift products and
home accessories based on popular Thomas Kinkade images. Gift prints are
smaller versions of previously released images, reproduced in a number of
formats with varying sizes and attributes. Our 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 and stationery items.
PRODUCT STRATEGY. Our product strategy focuses on creating high
perceived value by limiting edition sizes and creating collectibility, as well
as 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. We seek to
create high perceived value by producing
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lithographs in numbered limited editions accompanied by
certificates of authenticity. Historically, secondary market
prices for our sold-out editions have exceeded original offering
prices. Although we do not promote the potential economic
advantages of purchasing our limited edition artwork, we believe
that the existence of this secondary market is an important
consideration for some of our customers.
- CREATE COLLECTIBILITY THROUGH PRODUCT SERIES. We seek to promote
collectibility and successive purchases by consumers by
introducing many of our 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." We have found that releasing new images in
series has allowed us to generate pre-release orders from
retailers anticipating collector demand.
- LEVERAGE THOMAS KINKADE IMAGES INTO A BROAD ARRAY OF PRODUCTS. We
leverage our library of Thomas Kinkade images, particularly our
most successful limited edition releases, into a wide array of
home accessories and gift products. Through this strategy, we seek
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, we offer 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, $250 to $500 for an
unframed paper lithograph, $500 to $2,100 for a canvas lithograph,
$1,800 to $6,000 for a canvas lithograph hand signed by Thomas
Kinkade and $3,000 to $10,000 for a canvas lithograph hand signed
and highlighted by Thomas Kinkade. Our gift and home accessory
products generally sell for under $50.
CREATIVE PROCESS. Our products have been 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 our license agreement with Thomas
Kinkade dated December 3, 1997, Mr. Kinkade will provide 150 paintings to us
during the 15 year period commencing December 3, 1997, with at least 10
paintings to be delivered during each of the first five years. We also have
perpetual and exclusive rights to produce and sell additional products based
on a previously existing library of over 170 Thomas Kinkade images. In
particular, we have 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 Mr. Kinkade in promoting the sale of our
products and development of any brand name associated with Mr. Kinkade. See
"License with Thomas Kinkade." We have an active product development
department that works with Mr. Kinkade, dealers of our products, our in-house
sales force and strategic business partners to create new products. We seek
to gauge demand for proposed new products by pre-marketing prior to product
introductions. We are 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 we expand our distribution would have a material adverse effect
on our business and results of operations. In order to mitigate the potential
decline in customer demand for products based upon the artwork of Thomas
Kinkade, and as part of our goal to become the pre-eminent visual content
management company within the art, gift, collectibles and home decor
industries, we are aggressively pursuing publishing and licensing agreements
and other strategic relationships with other artists and visual content
owners, as demonstrated by the recent signings of Howard Behrens and Simon
Bull.
DISTRIBUTION
We currently distribute our products through independent Thomas Kinkade
Signature Galleries, company-owned Thomas Kinkade Stores, a network of other
independent dealers consisting of gift and collectible retailers and strategic
relationships with Hallmark, Avon and QVC among others. We seek to strengthen
the Thomas Kinkade brand and increase sales by expanding our network of Thomas
Kinkade Signature Galleries, promoting independent dealers to higher incentive
and commitment levels and expanding distribution through strategic business
relationships.
THOMAS KINKADE SIGNATURE GALLERIES AND THOMAS KINKADE STORES.
Independently owned, licensed Thomas Kinkade Signature Galleries and
company-owned Thomas Kinkade Stores provide warm and inviting environments that
convey Thomas
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Kinkade's lifestyle message and display Thomas Kinkade lithographs and other
products as they might appear in a customer's home. In 1996, we initiated the
Signature Gallery program in order to develop a network of stores owned and
operated by individual entrepreneurs that exclusively sell Thomas Kinkade
products. We believe that the Signature Gallery program enables us to benefit
from the regional knowledge of local Signature Gallery owners, strengthen the
Thomas Kinkade brand and broaden our distribution network, all without
significant investment by us. As of March 31, 2000, 297 Signature Galleries were
in operation. Sales to Signature Galleries were approximately $66.3 million in
fiscal 2000. We intend to expand the Signature Gallery program aggressively and
have identified target areas within our United States sales districts, as well
as internationally, for potential placement of Signature Galleries. We identify
new Signature Gallery owners through referrals generated by our in-house sales
force, direct inquiries and referrals from existing dealers and Signature
Gallery owners. We currently plan to add approximately 100 additional Signature
Galleries in fiscal 2001.
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 of our products annually, maintain a 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. We grant 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 exclusive
limited edition inventory. In addition, Signature Galleries have the opportunity
to participate in exclusive promotional events. There can be no assurance that
we will be able to identify suitable owners for the planned Signature Galleries
expansion or that such owners will become effective distributors for our
products, but through the qualification and selection process, we attempt to
choose dealers with the highest probability of long term success.
OTHER INDEPENDENT DEALERS. Our products currently are sold to over
4,000 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. We have 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 our 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 $30,000 annually in
limited edition canvas and paper products. By promoting lower level dealers to
higher incentive and commitment levels, we believe we can strengthen our dealer
network, increase sales and build brand awareness by leveraging productive
dealers. We also have been able to identify potential Signature Gallery owners
through our dealer programs. As of March 31, 2000, there were approximately 420
Showcase Dealers, 340 Premier Dealers, 1,200 Certified Dealers and 2,400 Open
Edition Accounts.
The substantial majority of our product distribution, as well as
interaction with the end consumer, is conducted by independent dealers,
including Signature Gallery owners, whose stores may bear the Thomas Kinkade
name. We have entered into formal licensing agreements with Signature Gallery
owners granting them limited rights to use the Thomas Kinkade name. Failure to
achieve the planned expansion of distribution through Thomas Kinkade Signature
Galleries and other independent dealers or to do so on a profitable basis could
have a material adverse effect on our business and results of operations. In
addition, the failure of these dealers to properly represent our products could
damage our reputation or the reputation of Thomas Kinkade and adversely affect
our ability to build the Thomas Kinkade brand.
STRATEGIC BUSINESS RELATIONSHIPS
We have 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 La-Z-Boy, Inc. and its subsidiary Kincaid Furniture, as well as
through the bestselling book written by Thomas Kinkade and published by Warner
Books entitled LIGHTPOSTS FOR LIVING. We also sell Thomas Kinkade brand products
through direct marketing on QVC and through direct mail catalogs, such as Avon.
Our paper lithographs, open edition gift prints and other home accessory and
gift products were featured on domestic QVC shows totaling 21 hours and
generating sales of $14.1 million at retail in fiscal 2000. In addition, during
fiscal 2000 our products were featured for the first time on QVC-U.K. totaling
three hours and generating sales of $200,000 at retail. We intend to continue to
develop strategic
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business relationships with leading consumer marketing companies in the United
States and abroad.
SALES AND MARKETING
Our 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, 2000 our sales force consisted of
a Vice President supported by four Regional Sales Directors, a Director of Sales
Operations, 25 District Sales Managers and three key account 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,
independent dealers and other potential dealers. Certain of our 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. We conduct training programs for in-house sales personnel,
retail consultants and other 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
company-owned store managers attend training sessions at Thomas Kinkade
University and participate in quarterly regional and national sales meetings.
MARKETING PROGRAMS. We design and sell promotional materials including
postcards, catalogs and videotapes to Signature Galleries and independent
dealers for sale or direct marketing to consumers. In addition, we produce print
advertising available to Signature Galleries on a co-operative basis. Signature
Galleries and other high level independent dealers may pay to participate in
regional events (including appearances by Thomas Kinkade) organized by us from
time to time. In addition, we benefit from advertising funded by our strategic
business partners, such as exclusive shows on QVC.
THOMAS KINKADE COLLECTORS' SOCIETY. We sponsor and operate a collectors
club for consumers of Thomas Kinkade products. As of March 31, 2000, the Thomas
Kinkade Collectors Society had approximately 27,000 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
We manufacture canvas lithographs and assemble, warehouse and ship
lithograph products from our production facility in San Jose, California. Most
of our three-dimensional products and gift items, as well as paper lithographs,
are manufactured by third parties under manufacturing or licensing arrangements.
Our proprietary manufacturing process for a canvas lithograph begins
with an original 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 the artist, who works with an independent printer and our artistic
team to develop a paper lithograph that best represents the original painting.
The paper lithographs are then printed and sent to our warehouse facilities,
where they are sent through a double authentication signing process, inspected,
transferred to canvas and hand-highlighted. The manufacturing process takes
approximately four days to complete. We then frame and ship 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
us in the lithograph production process. The failure of any of these third party
vendors to produce products that meet our specifications could result in lower
sales or otherwise adversely affect consumer perceptions of our brand and
products. There can be no assurance that we will not encounter shortages in the
future, and any prolonged shortage in frames or other materials could have a
material adverse effect.
We are committed to assuring that our products meet our quality
standards and continually evaluate our manufacturing processes to maintain
quality control. Systematic quality control procedures are in place at various
points in the manufacturing
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process, including spot inspections and regular inspection check stations. In
order to improve quality control, shorten production time and increase capacity,
we may automate certain portions of the production process, invest in packaging,
conveyance and MIS equipment, vertically integrate certain of our manufacturing
processes and develop further improvements in the lithograph manufacturing
process.
SYSTEMS
We use 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 our business. We have completed our
Year 2000 upgrade project. See Item 7. "Year 2000 Compliance."
BACKLOG
Because we generally ship products within a short period after receipt
of an order, we do 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
We entered into the a license agreement with Thomas Kinkade, effective
as of December 3, 1997 (the "New License Agreement"), the material terms of
which are discussed below. Under the New License Agreement Thomas Kinkade
granted us perpetual and exclusive rights to each image he produces under the
New License Agreement, as well as to the library of over 170 existing Thomas
Kinkade images, subject to certain exceptions. In particular, we have the
exclusive right to produce, sell, distribute and promote reproductions of Mr.
Kinkade's artwork in any form and the right to use his name and likeness in
promoting the sale of our products and development of any brand name associated
with Mr. Kinkade. The New License Agreement requires Mr. Kinkade to deliver 150
paintings during the 15 year period commencing December 3, 1997, with at least
10 paintings to be delivered during each of the first five years. Mr. Kinkade
has the right to approve our 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 our prior
consent, provided that he first offers the opportunity to us. Mr. Kinkade is
otherwise subject to a non-compete agreement 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 net sales of Thomas Kinkade branded artwork
and products through May 8, 2000, and 5.0% of the net sales of Thomas Kinkade
branded artwork and products thereafter, provided that if the net sales of
Thomas Kinkade branded artwork and products 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 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 55.0% 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. We must pay Mr. Kinkade $25,000 for each new painting and pay for his
studio rent and office support. We receive all of the licensing income from the
licensing of products that incorporate Thomas Kinkade's images. Mr. Kinkade was
granted a 15-year option to purchase 600,000 shares of our Common Stock at
$12.375, the closing price of our 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
our insolvency or upon a change of control. 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 our Common Stock
as of such date. The right
8
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 we
engage 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, we would be prohibited from selling any products based upon his
artwork, other than our then existing product inventory.
The New License Agreement superseded our previous license and royalty
arrangements with Mr. Kinkade. Mr. Kinkade is also compensated as our Art
Director.
RISK FACTORS
DEPENDENCE ON THOMAS KINKADE. If the New License Agreement were
terminated by Mr. Kinkade or if he were unable or unwilling to produce new
artwork for any reason, the loss of Mr. Kinkade's services would have a material
adverse effect on our business and results of operations. Moreover, the
available remedies in the event of a breach of the New License Agreement by Mr.
Kinkade are limited to monetary damages because the license is a personal
service contract. Upon any loss of Mr. Kinkade's services, we may seek to expand
our products based upon Mr. Kinkade's then existing images, to the extent Mr.
Kinkade has not terminated our rights thereto, and/or develop relationships with
other artists and offer products based upon their work. During fiscal 2000, we
began developing relationships with other artists and executed a publishing and
licensing agreement with well known contemporary expressionist artist Howard
Behrens. In addition, subsequent to March 31, 2000, we entered into publishing
and licensing agreement with Simon Bull, a leading contemporary visual artist in
the United Kingdom. We plan to begin marketing and selling products based on the
artwork of Mr. Behrens and Mr. Bull during fiscal 2001. We are continuing to
develop relationships with other artists, however, there can be no assurance
that we will be able to identify other artists or sell products based upon their
work. In addition, we are 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 we expand our distribution would have a material adverse effect on our
business and results of operations.
RISKS ASSOCIATED WITH EXPANSION OF DISTRIBUTION CHANNELS. Our strategy
includes aggressively expanding our distribution channels, and future operating
results will depend, in large part, upon our ability to effectively implement
this strategy. As of March 31, 2000, we had seven company-owned Thomas Kinkade
Stores and 297 independently owned Thomas Kinkade Signature Galleries. We plan
to concentrate on expanding the Signature Gallery program by opening
approximately 100 new Signature Galleries in fiscal 2001. In addition, we intend
to direct our capital and resources towards providing enhanced retail support
services to Signature Gallery owners, enhancing our manufacturing systems and
infrastructure in anticipation of growth and the impending relocation of our
operations and diversification through relationships with other artists and
other visual content owners. As a result, we will continue to de-emphasize
capital-intensive company-owned stores in our retail strategy.
Our planned expansion of the Signature Gallery program is dependent
upon a number of factors, including the ability to identify appropriate owners
and integrate them into our dealership network, as well as the ability of such
owners to locate suitable store sites and effectively promote and sell our
products. We intend to open Signature Galleries in geographic markets where we
have little or no experience and we may encounter competitive challenges that we
have not experienced to date. In addition, we intend to open stores near other
existing Signature Galleries and independent dealers, which will likely lower
sales of our products at such existing sites, but should increase total sales
within the entire geographic district. Furthermore, the laws of certain states
may limit our ability to terminate, cancel or refuse to renew dealer agreements
with dealers operating in such states. Failure by us to achieve our planned
expansion of Signature Galleries or to do so on a profitable basis could have a
material adverse effect on our business and results of operations.
ABILITY TO EFFECTIVELY MANAGE EXPANSION. Our rapid and substantial
growth in sales and our strategy for introducing new products and expanding our
distribution channels could place a significant strain on management and
operations. We have hired several key officers and employees to supplement the
management team. To manage any expansion effectively, we will need to anticipate
the changing demands of our operations and to adapt systems and procedures
accordingly. There can be no assurance that we will anticipate all of the
demands that an expansion of operations will impose on such systems and
9
procedures. To support the planned expansion of our products and distribution
channels, we will have to hire additional manufacturing, sales and
administrative personnel. There can be no assurance that we will be able to hire
such personnel, particularly due to the competitive nature of current labor
markets, or that we will be able to train successfully and supervise such
personnel if hired. In addition, we may need to add labor shifts to our
manufacturing operations or implement other efficiencies to satisfy any
significant future increase in production, including implementing new automation
processes. The failure to increase our operational and manufacturing capacity in
a timely and effective manner while maintaining our product quality and customer
service standards could result in a failure to meet demand on a timely and
satisfactory basis, which would have a material adverse effect on our business
and results of operations. Failure to continue to upgrade operating and
financial control systems or unexpected difficulties encountered during
expansion could have a material adverse effect on our business and results of
operations. There can be no assurance that such systems and controls will be
adequate to sustain and effectively monitor future growth. Moreover, in the
event any overproduction results from our expansion activities, the oversupply
of product could, among other things, reduce the perceived value and
collectibility of our products and therefore reduce demand for our products,
particularly limited editions. Any reductions in sales or margins resulting from
a decrease in demand could have a material adverse effect on our business and
results of operations.
RELOCATION OF COMPANY. During fiscal 2000, we entered into a 15 year
lease of a campus facility to be developed in Morgan Hill, California,
approximately 20 miles south of our current corporate headquarters, commencing
in fiscal 2002. We plan to relocate virtually all of our operating and
administrative facilities from several locations in San Jose, California to this
campus facility. While this move may cause a disruption to our operations, we
anticipate the timing to correspond with the seasonality of our business. In
connection with the move, certain one-time costs will be incurred, including
significant management time and attention. At this time, we do not foresee these
costs to be significant to our operations or financial position. We believe that
this move will be beneficial in the long term by 1) reducing future monthly rent
and reducing exposure to future rent increases in the competitive commercial
real estate market in the Silicon Valley, 2) consolidating operations into a
single campus versus the current operations that are spread out in several areas
of a commercial office park and 3) providing capacity for future growth in
operations. There can be no assurance that the relocation will occur as
scheduled due to the normal uncertainties surrounding construction timelines,
final architectural design and governmental agency approvals. In addition,
relocating our production facilities could result in a temporary loss of
production time and an inability to fulfill customer orders for an unknown
period of time, which may have a material adverse effect on our business and
results of operations.
DEPENDENCE UPON CONSUMER PREFERENCES. Sales of our existing and new
products depend upon continued consumer demand for the Thomas Kinkade brand and
products. Demand for our products can be affected generally by consumer
preferences, which are subject to frequent and unanticipated changes. We are
dependent on our ability to continue to produce appealing and popular Thomas
Kinkade art-based products that anticipate, gauge and respond in a timely manner
to changing consumer demands and preferences. Failure to anticipate and respond
to changes in consumer preferences could lead to, among other things, lower
sales, excess inventories, diminished consumer loyalty and lower margins, all of
which would have a material adverse effect on our business and results of
operations. There can be no assurance that the current level of demand for
products based upon Mr. Kinkade's artwork will be sustained or grow, and any
decline in the demand for such products or failure of demand to grow would have
a material adverse effect on our business and results of operations. In order to
mitigate the potential decline in customer demand for products based upon the
artwork of Thomas Kinkade, and as part of our goal to become the pre-eminent
visual content management company within the art, gift, collectibles and home
decor industries, we are aggressively pursuing publishing and licensing
agreements and other strategic relationships with other artists and visual
content owners, as demonstrated by the recent signings of Howard Behrens and
Simon Bull.
INTRODUCTION OF NEW PRODUCT LINES. A significant element of our
strategy has been to expand the Thomas Kinkade brand into new product lines.
Historically, substantially all of our net sales from Thomas Kinkade products
have been generated through sales of limited edition and open edition wall art
products and other home decorative accessories and gift products. As we develop
new products there can be no assurance that we will be able to successfully
market these potential new products or that any of the new product lines will
gain market acceptance, and such failure could result in lower than anticipated
sales for such products and affect adversely the image and value of the Thomas
Kinkade brand.
INTRODUCTION OF NEW ARTISTS AND OTHER VISUAL CONTENT OWNERS. A
significant component of our overall business strategy is to develop publishing
and licensing agreements and other strategic relationships with artists and
visual content owners other than Thomas Kinkade. Historically, virtually all of
our net sales have been generated from products based on the
10
artwork of Thomas Kinkade. In order to become the pre-eminent visual content
management company within the art, gift, collectibles and home decor industries
and to mitigate our reliance on Thomas Kinkade, we are aggressively pursuing
publishing and licensing agreements and other strategic relationships with other
artists and visual content owners. During fiscal 2000 we entered into a
publishing and licensing agreement with well known contemporary expressionist
artist Howard Behrens. In addition, subsequent to March 31, 2000, we entered
into a publishing and licensing agreement with Simon Bull, a leading
contemporary visual artist in the United Kingdom. We believe that our extensive
existing distribution network, and our ability to develop such, will be a
significant factor in the success of new artists and visual content owners.
However, as we develop relationships with other artists and visual content
owners, there can be no assurance that there will be consumer acceptance of
these artists or visual content owners or that we will achieve the same level of
success as we have experienced with Thomas Kinkade.
RELIANCE ON THIRD PARTIES. We rely on third parties to distribute a
majority of our products, manufacture certain of our products and supply
certain materials and components for use in our own manufacturing processes.
The substantial majority of our product distribution, as well as our
interaction with the end consumer, is conducted by independent dealers,
including Signature Gallery owners whose stores may bear the Thomas Kinkade
name. We have entered into licensing agreements with Signature Gallery owners
granting them limited use of the Thomas Kinkade name. However, the failure of
these dealers to properly represent our products could damage our reputation
or the reputation of Thomas Kinkade and adversely affect our ability to build
the Thomas Kinkade brand. Most of our three-dimensional products and gift
items are manufactured by third parties under licensing or manufacturing
arrangements. The failure of any of these third party vendors to produce
products that meet our specifications could result in lower sales or
otherwise adversely affect consumer perceptions of our brands and products.
In addition, we rely on third party vendors to supply frames, paper, canvas,
paint and other materials and components for our limited edition and other
wall art products. Although we maintain relationships with several framing
suppliers, in the past we have experienced shortages in framing supplies.
There can be no assurance that we will not encounter similar shortages in the
future and any prolonged shortage in frames or other materials could have a
material adverse effect on our business and results of operations.
CHANGES IN ECONOMIC CONDITIONS AND CONSUMER SPENDING. The home
decorative accessories, collectibles and gift product industries are subject to
cyclical variations. Purchases of these products are discretionary for consumers
and, therefore, such purchases tend to decline during periods of recession in
the national or regional economies and may also decline at other times. Our
success depends in part upon a number of economic factors relating to
discretionary consumer spending, including employment rates, business
conditions, future economic prospects, interest rates and tax rates. In
addition, our business is sensitive to consumer spending patterns and
preferences. Shifts in consumer discretionary spending away from home decorative
accessories, collectibles or gift products, as well as general declines in
consumer spending, could have a material adverse effect on our business and
results of operations.
DEPENDENCE ON MANAGEMENT. We are dependent upon the efforts of our
executive officers and other key personnel and on our ability to continue to
attract and retain qualified personnel in the future. The loss of certain of our
executive officers and key personnel or our inability to attract and retain
qualified personnel in the future could have a material adverse effect on our
business and results of operations. We currently maintain key man insurance on
the lives of certain key personnel including insurance on Thomas Kinkade in the
amount of $60 million.
SEASONALITY AND FLUCTUATIONS IN OPERATING RESULTS. See Item 7.
"Seasonality and Fluctuations in Operating Results."
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. Our 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. We intend to open Thomas Kinkade
Signature Galleries in geographic markets where we have little or no experience
and, as a result, we may encounter competitive challenges that we have not
experienced to date. Such competition could have a material adverse effect on
our business and results of operations. Some of our competitors have
substantially greater resources than us, including name recognition and capital
resources, have more
11
diversified product offerings and sell their products through broader
distribution channels than us. Our business depends substantially on our 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, 2000, we had 555 employees, including 198 in
manufacturing and distribution, 189 in sales and marketing, 50 in retail sales
and administration and 118 in corporate administration. We believe that our
labor relations are satisfactory and we have never experienced a work stoppage.
ITEM 2. PROPERTIES
Our manufacturing, distribution, sales and marketing, administration
and executive offices are located in 10 leased facilities in San Jose, Los Gatos
and Monterey, California with an aggregate of approximately 216,000 square feet.
As of March 31, 2000, our retail operations were located in seven leased sites
throughout the United States ranging from 600 to 1,500 square feet, with an
aggregate of approximately 7,000 square feet.
ITEM 3. LEGAL PROCEEDINGS
We are not a party to any legal proceedings which, individually or in
the aggregate, are believed to be material to the our business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS.
None.
12
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
STOCKHOLDERS MATTERS
Media Arts' stock traded on the Nasdaq National Market from our initial
public offering on August 10, 1994 through December 6, 1998 under the Nasdaq
symbol ARTS. On December 7, 1998 we commenced trading on the New York Stock
Exchange under the symbol MDA. The following table sets forth, for the periods
indicated, the high and low closing sales prices for Media Arts' Common Stock as
reported by Nasdaq and the New York Stock Exchange:
Fiscal
Year Ended
March 31, High Low
--------------- -------- --------
1999
----
First Quarter 24 1/4 17 1/2
Second Quarter 19 3/4 9 1/16
Third Quarter 15 5/8 7 3/8
Fourth Quarter 14 5/16 9
2000
----
First Quarter 10 5/16 4
Second Quarter 6 1/2 4 5/16
Third Quarter 4 7/16 3 1/16
Fourth Quarter 9 3 11/16
As of May 31, 2000 there were approximately 458 holders of record of
Media Arts' Common Stock.
We have never paid cash dividends on our Common Stock. We currently
intend to retain earnings, if any, for use in our business and do not anticipate
paying cash dividends in the foreseeable future.
13
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data for the fiscal years ended March 31, 1996,
1997, 1998, 1999 and 2000 has been derived from our audited financial
statements. The selected financial data should be read in conjunction with Item
7. "Management's Discussion and Analysis of Financial Condition and Results of
Operations," and our financial statements of and the notes thereto included
elsewhere in this annual report.
Year Ended March 31,
---------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE AND GALLERY DATA) 2000 1999 1998 1997 1996
- ------------------------------------------------- --------- --------- --------- --------- --------
STATEMENT OF OPERATIONS DATA: (1)
Net sales $ 137,990 $ 126,322 $ 82,650 $ 47,018 $ 39,752
Gross profit 87,918 84,261 55,430 30,258 26,409
Total operating expenses 64,805 55,033 35,238 23,467 20,862
Operating income 23,113 29,228 20,192 6,791 5,547
Income from continuing operations
before extraordinary loss 14,150 18,352 12,275 2,644 2,455
Net income (loss) $ 14,150 $ 18,352 $ 10,979 $ (10,986) $ (673)
Income from continuing operations
before extraordinary loss
per share (Diluted) (2) $ 1.07 $ 1.34 $ 1.04 $ 0.26 $ 0.25
Net income (loss)
per share (Diluted) (2) $ 1.07 $ 1.34 $ 0.93 $ (1.09) $ (0.07)
SELECTED OPERATING DATA:
Number of Thomas Kinkade Stores 7 32 19 16 15
Number of Thomas Kinkade
Signature Galleries (3) 297 169 74 17 -
BALANCE SHEET DATA: (1)
Cash and cash equivalents $ 5,544 $ 6,361 $ 16,401 $ 374 $ 382
Working capital (4) 48,590 41,785 30,676 6,982 3,891
Total assets 89,812 68,146 51,339 23,061 36,658
Long-term obligations (5) $ 5,243 $ 2,108 $ 1,200 $ 7,871 $ 10,196
(1) Restated to reflect (a) loss from discontinued operations of John Hine
Limited of $3.1 million in fiscal 1996, and (b) acquisitions of seven
galleries located in California in fiscal 1996 which have been accounted
for as a pooling of interests.
(2) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of the determination of shares used in computing earnings (loss) per share.
(3) Includes only Signature Galleries which have opened at retail.
(4) Excludes net assets of discontinued operations.
(5) Amount is net of unamortized deferred debt discount.
Quarterly data for the years ended March 31, 1999 and 2000 is presented
under Item 7. "Management's Discussion and Analysis of Financial Condition and
Results of Operations" on page 15 of this Form 10-K.
14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
Media Arts Group, Inc., founded in 1990, primarily manufactures,
markets and distributes lithographs of the artwork of Thomas Kinkade, Painter of
Light(R), and operates in three market segments: wholesale, retail and
business-to-business ("B2B") Internet. Net sales in the wholesale market segment
has grown as a result of increasing consumer awareness and acceptance of Thomas
Kinkade's paintings, as well as expansion of our branded and other distribution
channels. Net sales in the retail market segment have declined significantly due
to the sales of company-owned retail Thomas Kinkade Stores to Thomas Kinkade
Signature Gallery(TM) owners during fiscal 2000. Our B2B Internet segment
consists of the operations of our majority-owned subsidiary, Exclaim
Technologies, Inc. ("Exclaim"). Net sales in the B2B Internet segment were
immaterial due to the continuing development our initial B2B Internet products.
Currently our principal products include limited and open edition canvas and
paper lithograph reproductions of the artwork of Thomas Kinkade. In fiscal 2000,
limited edition canvas and paper lithograph sales accounted for 66.0% of our net
sales. We continue to expand the Thomas Kinkade product lines to include home
decorative accessories, collectibles and gift products featuring the artwork of
Thomas Kinkade. In addition, we have begun aggressively pursuing other artists
and visual content owners in order to begin publishing and licensing their
artwork. During the fourth quarter of fiscal 2000, we signed a five year,
renewable publishing and licensing agreement with Howard Behrens, a well know
contemporary expressionist artist. In addition, subsequent to March 31, 2000, we
entered into a five year, renewable publishing and licensing agreement with
Simon Bull, a leading contemporary visual artist in the United Kingdom.
We currently focus on expansion of controlled branded distribution, by
distributing products through branded independently owned Thomas Kinkade
Signature Galleries, company-owned Thomas Kinkade Stores and other independent
dealers. In 1996, as part of our strategy of expanding branded distribution, we
initiated our Thomas Kinkade Signature Gallery program. The independently owned
and operated galleries exclusively sell products based on the artwork of Thomas
Kinkade. In fiscal 2000, sales to Signature Galleries accounted for 48.1% of
consolidated net sales, compared to 32.0% in fiscal 1999 and 23.9% in fiscal
1998. At the end of fiscal 2000, there were 297 Signature Galleries in operation
and we anticipate opening approximately 100 additional Signature Galleries
through the end of fiscal 2001. Although this program has been successful since
its inception in 1996, there can be no assurance that we will be able to
identify suitable owners for Signature Galleries' planned expansion or that such
owners will become effective distributors for our products.
In 1993, we initiated our company-owned retail Thomas Kinkade Stores,
which exclusively sell Thomas Kinkade products. These stores accounted for 12.2%
of consolidated net sales in fiscal 2000, compared to 21.7% in fiscal 1999 and
24.9% in fiscal 1998. At the end of fiscal 2000, seven company-owned stores were
located in strategic mall locations, downtown shopping areas and high tourist
traffic areas. As part of our retail strategy, in April 1999 we announced our
intention to de-emphasize these capital-intensive, company-owned stores and
evaluate opportunities where Signature Gallery owners may purchase these stores.
During fiscal 2000, we transferred 26 company-owned stores to Signature Gallery
owners. We expect the majority of the remaining seven stores will be converted
into Signature Galleries by the end of fiscal 2001.
We also market our products through over 4,000 independent dealers
organized into various incentive and commitment levels and through QVC, a cable
television shopping network. Additionally, we have established key strategic
alliances with major partners such as Avon, Hallmark and La-Z-Boy.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the
percentage relationship of certain items from our income statement to net sales.
15
Year Ended March 31,
---------------------------------------
2000 1999 1998
--------- --------- --------
Net sales............................................ 100.0% 100.0% 100.0%
Cost of sales........................................ 36.3 33.3 32.9
--------- --------- --------
Gross margin.................................... 63.7 66.7 67.1
--------- --------- --------
Operating expenses
Selling and marketing........................... 25.5 26.3 23.9
General and administrative...................... 21.4 17.3 18.7
--------- --------- --------
Total operating expenses........................ 46.9 43.6 42.6
--------- --------- --------
Operating income..................................... 16.8 23.1 24.5
Interest income (expense)............................ 0.0 0.4 (2.0)
Gain on sale and leaseback........................... - - 1.2
Foreign exchange losses.............................. - - (0.1)
--------- --------- --------
Income from operations before income taxes........... 16.8 23.5 23.6
Provision for income taxes........................... 6.5 9.0 8.7
--------- --------- --------
Income from operations before extraordinary loss..... 10.3 14.5 14.9
Extraordinary loss, net of income taxes.............. - - (1.6)
--------- --------- --------
Net income........................................... 10.3% 14.5% 13.3%
========= ========= ========
NET SALES. Our net sales were $138.0 million in fiscal 2000, $126.3
million in fiscal 1999 and $82.7 million in fiscal 1998. The increase in net
sales in fiscal 2000 compared to fiscal 1999 was primarily due to an increase in
the number of independent dealers and increased revenue from licensing
arrangements. The increase in net sales in 1999 compared to 1998 was primarily
due to an increase in the number of independent dealers and company-owned
stores, increased marketing and promotional activities, and a product mix
incorporating higher priced products.
We believe that in fiscal 2001 net sales will continue to grow at a
slightly higher rate than fiscal 2000 due to increased distribution in new
markets, as well as the addition of new product offerings from newly licensed
artists.
GROSS PROFIT. Cost of sales consists primarily of raw material and
component costs, manufacturing and supervisory labor, manufacturing overhead
costs and royalties.
Year Ended March 31,
------------------------------------
2000 1999 1998
----- ----- -----
Gross profit (IN MILLIONS)........................... $87.9 $84.3 $55.4
Gross margin......................................... 63.7% 66.7% 67.1%
The anticipated decline in gross margin in fiscal 2000 compared to
fiscal 1999 was primarily due to the loss of retail margin resulting from the
transfer of 26 company-owned Thomas Kinkade Stores to Signature Gallery owners
during fiscal 2000. The slight decline in gross margin in fiscal 1999 compared
to fiscal 1998 was due to a shift in mix towards a higher proportion of
wholesale sales in 1999, partially offset by manufacturing efficiencies gained
due to higher sales volumes.
In fiscal 2001 we may realize economies of scale as unit volumes
increase, however, cost of sales may increase as a percentage of net sales as we
increase the proportion of wholesale sales compared to retail sales and expand
our sales of open edition products.
SELLING AND MARKETING EXPENSES. Selling and marketing expenses consist
primarily of salaries and commissions, as well as advertising and promotional
expenses.
Year Ended March 31,
------------------------------------
2000 1999 1998
----- ----- -----
Selling and marketing expenses (IN MILLIONS)......... $35.3 $33.2 $19.8
Percent of net sales................................. 25.5% 26.3% 23.9%
16
Selling and marketing expenses increased in fiscal 2000 compared to
fiscal 1999 primarily due to higher advertising and promotional costs related to
enhanced retail support for our independent dealers and our company-owned
stores. Selling and marketing expenses increased in fiscal 1999 compared to
fiscal 1998 primarily due to higher sales compensation costs resulting from
increased net sales, the addition of sales personnel and increases in
advertising and promotional costs.
The decrease in selling and marketing expenses as a percent of net
sales in 2000 compared to 1999 was primarily due to effective cost management of
the significant portion of fixed selling and marketing costs. The increase in
selling and marketing expenses as a percent of net sales in fiscal 1999 compared
to fiscal 1998 was due to the addition of sales personnel and increases in
advertising and promotional costs related to enhanced retail support for our
independent dealers and our company-owned stores.
In fiscal 2001 we believe that our efforts to expand distribution and
increase total sales, as well as to distribute the artwork of new artists will
result in increased selling and marketing expenses.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative
expenses consist primarily of salaries and bonuses, rent expense and
professional services such as legal and accounting fees.
Year Ended March 31,
------------------------------------
2000 1999 1998
----- ----- -----
General and administrative expenses (IN MILLIONS).... $29.5 $21.8 $15.5
Percent of net sales................................. 21.4% 17.3% 18.7%
In fiscal 2000, general and administrative expenses increased compared
to fiscal 1999 due primarily to $5.7 million in new Internet business expenses
related to the operations of Exclaim and a non-recurring charge of $1.3 million
for severance payments relating to cost reductions and certain settlement
payments under key management contracts. In fiscal 1999, general and
administrative expenses increased compared to fiscal 1998 primarily due to
increased infrastructure and facility costs related to expansion of capacity.
General and administrative expenses increased as a percent of net sales
in fiscal 2000 compared to fiscal 1999 due to the significant amount of
Exclaim's general and administrative expenses and the non-recurring charge as
compared to the increase in net sales. General and administrative expenses
decreased as a percent of net sales in fiscal 1999 compared to fiscal 1998 due
to economies of scale that result in leveraging relatively fixed costs over a
higher sales base.
In fiscal 2001 we expect that general and administrative expenses will
continue to increase due to our efforts to expand distribution and increase
sales and add infrastructure to support multiple artists.
WHOLESALE SEGMENT. Our net sales to wholesale accounts include sales to
our branded distribution channel, including independently owned Thomas Kinkade
Signature Galleries and Showcase dealers, our company-owned retail Thomas
Kinkade Stores, other independent dealers, sales to QVC and other strategic
partners and revenue generated from licensing arrangements, as well as revenue
generated from our e-commerce web-site, thomaskinkade.com. Net sales to
wholesale customers before inter-company eliminations increased 14.0% to $130.0
million in fiscal 2000 compared to $114.1 million in fiscal 1999. The increase
in net sales for this segment was primarily due to the growth in the number of
Signature Galleries to 297 at the end of fical 2000 compared to 169 at the end
of fiscal 1999 and increased promotional activities and programs during fiscal
2000. Sales to Signature Galleries increased 64.1% to $66.3 million in fiscal
2000 from $40.4 million in fiscal 1999.
Net sales in the wholesale segment before inter-company eliminations of
$114.1 million in fiscal 1999 reflected an increase of 61.9% compared to net
sales of $70.4 million in fiscal 1998. The increase in net sales for this
segment was primarily due to the growth in the number of Signature Galleries to
169 at the end of fiscal 1999 compared to 74 at the end of fiscal 1998, an
increase in the number of company-owned stores to 32 at the end of fiscal 1999
from 19 at the end of fiscal 1998, and increased promotional activities and
programs during fiscal 1999. Sales to Signature Galleries increased 105.1% to
$40.4 million in fiscal 1999 from $19.7 million in fiscal 1998.
17
Operating income for our wholesale segment before inter-company
eliminations increased 7.8% to $35.8 million in fiscal 2000 compared to $33.2
million in fiscal 1999 primarily due to increased net sales offset by a
non-recurring charge of $1.3 million for severance payments relating to cost
reductions and certain settlement payments under key management contracts and
increased advertising and promotional costs related to enhanced retail support
for our independent dealers and our company-owned stores. Operating margin
before inter-company eliminations decreased to 27.5% in fiscal 2000 from 29.1%
in fiscal 1999 as a result of the non-recurring charge and increased advertising
and promotional costs as compared to the increase in net sales.
Operating income for our wholesale segment before inter-company
eliminations increased 77.2% to $33.2 million in fiscal 1999 compared to $18.7
million in fiscal 1998 primarily due to increased net sales offset partially by
increased sales compensation costs resulting from increased net sales, the
addition of sales personnel and increased promotional and advertising costs.
Operating margin for the wholesale segment before inter-company eliminations
increased to 29.1% in fiscal 1999 from 26.6% in fiscal 1998 due to economies of
scale from increased net sales.
RETAIL SEGMENT. Our retail segment consists of sales by company-owned
retail Thomas Kinkade Stores. Our retail segment purchases products from our
wholesale segment at the same price as external wholesale customers. Net sales
for the retail segment decreased 38.5% to $16.8 million in fiscal 2000 compared
to $27.4 million in fiscal 1999. The decrease in net sales was primarily due to
the opening of one company-owned store and the subsequent transfer of 26
company-owned stores to Signature Gallery owners during fiscal 2000. There were
seven company-owned stores at the end of fiscal 2000 compared to 32 at the end
of fiscal 1999. We have not recognized any gains on the sales of company-owned
stores due to the significant notes receivable that have been taken. We will
continue to defer the recognition of gains on past and future sales until such
time that the sales of all company-owned stores which we intend to sell are
substantially complete and the likelihood of a net gain from store sales is
virtually certain. Due to the uncertainty of the collectibility of the notes
receivable taken in connection with these sales and the eventual recognition of
gains, we have reported the net of the notes receivable and deferred gains as
other assets at March 31, 2000.
Retail segment net sales of $27.4 million in fiscal 1999 represents an
increase of 33.0% compared to $20.6 million in fiscal 1998. The increase in net
sales was primarily due to the opening of 13 new company-owned stores during
fiscal 1999, increased marketing efforts and a shift towards higher priced
products. There were 32 company-owned stores at the end of fiscal 1999 compared
to 19 at the end of fiscal 1998.
Operating loss for our retail segment increased 90.3% to $4.0 million
in fiscal 2000 compared to $2.1 million in fiscal 1999. This increase in
operating loss was primarily due to the sale of more profitable stores,
decreased sales and increased per store advertising and promotional activities.
Operating loss for our retail segment was $2.1 million in fiscal 1999
compared to operating income of $1.4 million in fiscal 1998. This change in
operating results was primarily due to increased advertising, promotional and
other costs related to new store openings, as well as increased headcount, rent
and other infrastructure costs related to expansion.
BUSINESS-TO-BUSINESS INTERNET SEGMENT. Our B2B Internet segment
consists solely of the operations of Exclaim, which is developing vertical B2B
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. We believe that
these B2B Internet products may be scalable and may leverage Exclaim into other
highly fragmented industries. Exclaim is currently seeking alternative sources
of financing and if successful, we will discontinue funding Exclaim's
operations. While we continue to fund Exclaim, we intend to evaluate our options
regarding future investments in Exclaim.
Net sales in the B2B Internet segment for fiscal 2000 were $122,000.
There were no B2B Internet segment operations during fiscal 1999. Net sales for
the B2B 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 March 31, 2000, 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 industries outside of fine art, gift and
collectibles. Exclaim is currently developing a B2B Internet-based trading hub,
Marketplace, that will link buyers and sellers together within the art,
18
gift, collectibles, furniture and home decor industries. Subsequent to March 31,
2000, Exclaim launched Marketplace with seven suppliers and manufacturers within
the gift and fine art industries.
Operating losses for the B2B Internet segment were $6.9 million during
fiscal 2000. There were no B2B Internet segment operations during fiscal 1999.
Operating expenses of the B2B Internet segment consist primarily of salaries and
consulting expenses related to the development of Exclaim's existing and future
products.
INTEREST INCOME AND EXPENSE. Interest income was $3,000 in fiscal 2000
and $504,000 in fiscal 1999 compared to interest expense of $1.6 million in
fiscal 1998. The decrease in net interest income in fiscal 2000 as compared to
fiscal 1999 is primarily due to lower cash balances resulting from the
continuing funding of Exclaim. The increase in net interest income in fiscal
1999 as compared to net interest expense in fiscal 1998 was due to lower
interest expense resulting from the repayment of debt using proceeds from our
public offering in February 1998.
GAIN ON SALE AND LEASEBACK. In July 1997, we exercised an option to
purchase a facility we were leasing in San Jose, California. We simultaneously
sold this same 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 was $9.0
million in fiscal 2000, $11.4 million in fiscal 1999 and $7.2 million in fiscal
1998. Our effective income tax rate for fiscal years 2000, 1999 and 1998 was
38.8%, 38.3% and 37.0%.
EXTRAORDINARY LOSS. In fiscal 1998, we recorded a non-cash write-off of
deferred debt discount of $1.3 million, net of income tax benefit of $761,000,
related to the repayment of secured notes using proceeds from our February 1998
public offering.
COMPARABLE STORE SALES. Comparable store sales for fiscal 2000
increased 0.7% from fiscal 1999 based on voluntarily reported sales figures from
66 comparable independent Signature Gallery dealers. With the inclusion of 14
comparable company-owned stores transferred to Signature Gallery dealers and two
remaining comparable company-owned stores, comparable store sales for fiscal
2000 declined 5.7% from fiscal 1999. The decline in comparable store sales is
due primarily to the announced and ongoing sales of company-owned stores and the
resulting significant employee turnover. In addition, the decline is also due to
the continued retail development of Signature districts, which involves
Signature Gallery dealers adding additional Signature Galleries within their
existing district, thereby leveraging off the existing infrastructure of the
initial store. While we are seeing increased sales in each Signature Gallery
district, the increase in the number of stores in a particular district will
likely reduce sales from the first, or original, store in that district. We
believe comparable Signature district sales better reflect the condition of our
retail market. Comparable district sales for fiscal 2000 increased 38.3% from
fiscal 1999 for the 51 reporting comparable districts.
LIQUIDITY AND CAPITAL RESOURCES
Our primary source of funds in fiscal 2000 was from our operations.
Working capital at March 31, 2000 was $48.6 million, compared to $41.8 million
at March 31, 1999.
Net cash provided by operations was $10.7 million, $1.8 million and
$11.7 million for fiscal 2000, 1999 and 1998. Cash provided by operations in
2000 consisted of net income adjusted by increases in accounts receivable,
inventories and other assets, offset by increases in accounts payable and
deferred compensation costs. Accounts receivable increased in fiscal 2000
primarily as a result of the significant increase in branded distribution,
whereby Signature and Showcase customers receive preferential payment terms.
The increase in inventories in 2000 was attributed to increased distribution
and the purchase of full edition sizes of the new releases during the first
half of the year, as well as an increase in product offerings, including new
frame choices. Other assets increased in fiscal 2000 due to notes receivable
taken on the sale of 26 company-owned stores. The increase in accounts
payable was due to the timing and amounts of vendor payments in the last
quarter of fiscal 2000. The increase in deferred compensation costs was
attributable to the increased amount of compensation deferred by deferred
compensation plan participants during fiscal 2000.
19
Net cash provided by operations for fiscal 1999 was $1.8 million, which
consisted of net income adjusted by increases in inventories, accounts
receivable, deferred income taxes and prepaid expenses and other current assets,
as well as decreases in accrued compensation costs. The increase in inventories
in fiscal 1999 was attributed to increased distribution and the increased number
of company-owned stores. Accounts receivable increased in fiscal 1999 due to the
timing of releases during the fourth quarter of fiscal 1999, and because of an
increase in branded distribution, whereby Signature and Showcase customers
receive preferential payment terms. Prepaid expenses and other assets increased
in fiscal 1999 due to an increase in prepaid promotional expenses. The decrease
in accrued compensation costs was attributed to the timing and amounts of
compensation payments in the last quarter of fiscal 1999.
Net cash provided by operations for fiscal 1998 was $11.7 million,
which consisted of $10.8 million provided by continuing operations and $890,000
provided by discontinued operations. Net cash provided by continuing operations
in fiscal 1998 consisted primarily of income from continuing operations adjusted
by increases in accrued compensation costs, income taxes payable and accounts
payable and receipt of an income tax refund partly offset by increases in
accounts receivable and inventory.
Net cash used in investing activities was $11.7 million in fiscal 2000,
$9.2 million in fiscal 1999 and $1.6 million in fiscal 1998. Net cash used in
investing activities in fiscal 2000 consisted primarily of $12.7 million
invested in the development of Exclaim's B2B Internet products, our e-commerce
web-site (thomaskinkade.com) and capital expenditures for property and
equipment. Net cash used in investing activities in 1999 consisted primarily of
$8.0 million for the purchase of computer systems and software products,
leasehold improvements for newly opened Thomas Kinkade Stores and property and
equipment for manufacturing and fulfillment capacity. Net cash used in investing
activities in 1998 consisted of $3.2 million for purchases of property and
equipment, partially offset by net proceeds of $1.6 million under a sale and
leaseback transaction. We anticipate that total capital expenditures in fiscal
2001 will be approximately $12 million and will relate to continued
manufacturing, infrastructure and management information systems upgrades and to
building design and engineering costs in connection with the development of, and
relocation to, our leased property in Morgan Hill, California.
Net cash provided by financing activities was $215,000 in fiscal 2000
and $5.9 million in fiscal 1998. Net cash used in financing activities was $2.7
million in fiscal 1999. Net cash provided by financing activities in fiscal 2000
related to proceeds of $733,000 generated from the issuance of our Common Stock
through the exercise of stock options offset by the expenditure of $518,000 for
the purchase of 74,300 shares of our Common Stock under our stock repurchase
program at an average price of $6.96 per share. Cash used in financing
activities in fiscal 1999 related primarily to the expenditure of $3.7 million
for the purchase of 278,600 shares of our Common Stock under our stock
repurchase program at an average price of $13.27 per share. This expenditure was
partially offset by proceeds of $1.0 million generated from the issuance of our
Common Stock through the exercise of stock options and warrants. Net cash
provided by financing activities in 1998 was the result of $18.0 million
generated by a secondary offering of common stock, partially offset by repayment
of $2.7 million of borrowings under credit lines and the repayment of $9.5
million under notes payable.
We have a $20 million secured bank line-of-credit facility that may be
increased to $30 million if our rolling four quarter consolidated earnings
before interest, taxes, depreciation and amortization exceeds $30 million for
two consecutive quarters. The line-of-credit bears interest at either the bank's
current reference rate or the effective LIBOR rate plus 1.5%, at our discretion.
There were no outstanding borrowings under this credit facility as of March 31,
2000.
Exclaim is currently seeking alternative sources of financing and if
successful, we will discontinue funding Exclaim's operations. While we continue
to fund Exclaim, we intend to evaluate our options regarding future investments
in Exclaim.
We intend to relocate our offices and manufacturing facilities to a
leased campus facility to be developed in Morgan Hill, California, approximately
20 miles south of our present location, during fiscal 2002. While this move may
cause a disruption to our operations, we anticipate the timing to correspond
with the seasonality of our business. In connection with the move, we will incur
certain one-time costs, including significant management time and attention. At
this time, we do not foresee these costs to be significant to our operations or
financial position. We believe that this move will be beneficial in the long
term by 1) reducing our future monthly rent and reducing exposure to future rent
increases in the competitive commercial real estate market in the Silicon
Valley, 2) consolidating our operations into a single campus versus our current
operations that are spread out in several areas of a commercial office park and
3) providing capacity for future growth in our operations.
20
Our working capital requirements in the foreseeable future will change
depending on operating results, rate of expansion or any other changes to our
operating plan needed to respond to competition, acquisition opportunities or
unexpected events. We believe that our current cash and cash equivalent balance
together with net income from operations and existing borrowing capacity under
our line-of-credit will be sufficient to meet working capital requirements for
at least the next 12 months. We may consider alternative financing, such as
issuance of additional equity or convertible debt securities or obtaining
further credit facilities, if market conditions make such alternatives
financially attractive for funding expansion.
SEASONALITY AND FLUCTUATIONS IN OPERATING 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. In addition, our quarterly operating results
have fluctuated significantly in the past and may continue to fluctuate as a
result of numerous factors. These factors include, but are not limited to:
- - The demand for the art of Thomas Kinkade and our Thomas Kinkade
products (including new product categories and series),
- - Consumer acceptance of the art and related products of new artists and
other visual content owners,
- - Our ability to achieve our expansion plans,
- - The timing, mix and number of new product releases,
- - The continued successful implementation of the Signature Gallery
program and expansion of distribution generally,
- - The successful entrance into new distribution channels,
- - The increased operating expenses of Exclaim as it pursues expansion of
its B2B Internet initiatives,
- - The reduction in our ownership of Exclaim in the event of obtaining
alternative financing,
- - 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 ability to absorb other operating costs.
In addition, since a significant portion of our net sales are generated
from orders received in the quarter, sales in any quarter are substantially
dependent on orders booked in that quarter. Results of operations may also
fluctuate based on extraordinary events. 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. Fluctuations in operating
results may also result in volatility in the price of our Common Stock.
The following table sets forth our unaudited summary quarterly data for
fiscal 1999 and 2000.
21
Year Ended March 31, 1999 Year Ended March 31, 2000
-------------------------------------- -------------------------------------
(UNAUDITED, IN THOUSANDS EXCEPT PER June September December March June September December March
SHARE AMOUNTS) Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
- ----------------------------------- ------- --------- --------- --------- ------- --------- -------- --------
Net sales $26,339 $ 29,595 $ 39,020 $ 31,368 $25,745 $34,624 $42,481 $35,140
Gross profit 17,273 20,387 26,148 20,453 15,918 21,551 27,252 23,197
Total operating expenses 11,162 13,706 16,454 13,711 15,291 16,831 15,542 17,141
Operating income 6,111 6,681 9,694 6,742 627 4,720 11,710 6,056
Net income 3,871 4,273 5,902 4,306 388 2,853 7,081 3,828
Net income per share (diluted) $ 0.27 $ 0.31 $ 0.44 $ 0.32 $ 0.03 $ 0.22 $ 0.54 $ 0.28
June September December March June September December March
As a Percentage of Sales Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
- ----------------------------------- ------- --------- --------- --------- ------- --------- -------- --------
Net sales 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Gross profit 65.6 68.9 67.0 65.2 61.8 62.2 64.2 66.0
Total operating expenses 42.4 46.3 42.2 43.7 59.4 48.6 36.6 48.8
Operating income 23.2 22.6 24.8 21.5 2.4 13.6 27.6 17.2
Net income 14.7% 14.4% 15.1% 13.7% 1.5% 8.2% 16.7% 10.9%
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 now that the
Year 2000 has commenced, these code fields need to accept four digit entries to
distinguish years beginning with "19" from those beginning with "20." As a
result, computer systems and/or software products used by many companies have
been upgraded to comply with such Year 2000 requirements.
Our Year 2000 Project (the "Project") was completed by December 31,
1999. The scope and content of the Project included:
- - 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. To date, no significant Year 2000 problems
have occurred, and 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 in the future. 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 "Year 2000 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. 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. To date, none
of our key vendors have had significant Year 2000 problems which have impacted
our operations.
22
OUTLOOK
CAUTIONARY STATEMENTS RELATING TO FORWARD-LOOKING INFORMATION. MEDIA
ARTS AND ITS REPRESENTATIVES MAY, FROM TIME TO TIME, MAKE WRITTEN OR ORAL
FORWARD-LOOKING STATEMENTS. THOSE STATEMENTS RELATE TO DEVELOPMENTS, RESULTS,
CONDITIONS OR OTHER EVENTS WE EXPECT OR ANTICIPATE WILL OCCUR IN THE FUTURE.
WITHOUT LIMITING THE FOREGOING, THOSE STATEMENTS MAY RELATE TO FUTURE REVENUES,
EARNINGS, MARKET CONDITIONS AND THE COMPETITIVE ENVIRONMENT. FORWARD-LOOKING
STATEMENTS ARE BASED ON MANAGEMENT'S THEN CURRENT VIEWS AND ASSUMPTIONS AND, AS
A RESULT, ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES, INCLUDING THOSE SET
FORTH UNDER THE CAPTION "RISK FACTORS" ON PAGE 9 OF THIS ANNUAL REPORT, THAT
COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED.
Cost of sales consists primarily of raw material and component costs,
manufacturing and supervisory labor, manufacturing overhead costs and royalties.
Although we may realize economies of scale as unit volumes increase, cost of
sales may increase as a percentage of net sales as we expand the proportion of
wholesale sales compared to retail sales, as well as expansion of our 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 expense
and professional services such as legal and accounting fees. We expect that
efforts to expand distribution and increase total sales will result in increased
selling and marketing and general and administrative expenses.
As part of our strategy of continued expansion of branded distribution
and developing new brands through new artists and other visual content owners,
we expect to focus on the following activities during fiscal 2001:
- - Develop licensing and publishing agreements and other strategic
relationships with artists and other visual content owners,
- - Develop retail and promotional infrastructure in order to provide enhanced
support to our dealers,
- - Seek opportunities to increase retail distribution worldwide,
- - Secure alternative financing for the continued funding of Exclaim and
- - Continue to de-emphasize our company-owned retail stores.
As a result of implementing these strategies we anticipate that our
fiscal 2001 operating results will include:
- - A small increase in revenues due to new products, not based on the artwork
of Thomas Kinkade, which we believe will begin to mitigate our reliance on
Thomas Kinkade;
- - An increase in wholesale selling, general and administrative expenses
resulting from our artist diversification efforts;
- - An offsetting reduction of general and administrative expenses resulting
from a change in ownership of Exclaim which would result in no longer
consolidating Exclaim's operations in our financial statements;
- - A reduction in our retail sales which will have the effect of offsetting
growth in net sales;
- - A corresponding slight reduction in gross margin due to the loss of retail
margin; and
- - A corresponding reduction in retail selling, general and administrative
expenses.
ITEM 7(A). FINANCIAL MARKET RISKS
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 March 31, 2000 and 1999. We are subject to
fluctuating interest rates that may impact, adversely or otherwise, our results
from operations or cash flows for our 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.
23
(IN THOUSANDS) March 31,
----------------------
2000 1999
--------- ---------
ASSETS
Cash and cash equivalents.................................... $ 5,544 $ 6,361
Average interest rate........................................ 3.64% 4.20%
LIABILITIES
Bank line-of-credit.......................................... $ - $ -
Interest rate (bank reference rate at March 31, 2000,
prime rate plus 0.5% at March 31, 1999)................... 9.00% 8.25%
Convertible note payable to related party.................... $ 1,200 $ 1,200
Fixed interest rate.......................................... 8.00% 8.00%
ITEM 8. FINANCIAL STATEMENT AND SUPPLEMENTARY DATA
The Financial Statements and supplemental data 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
24
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Members of the Board of Directors as of June 29, 2000 were as follows:
Kenneth E. Raasch co-founded Media Arts, through a preceding company in
1990 and has been the Chairman of the Board of Directors since its inception. In
addition, he was President and Chief Executive Officer of the company from March
1990 to May 1997 and Chief Executive Officer from May 1997 until October 1997.
Mr. Raasch has been an independent consultant to the company since May 1999.
Currently, Mr. Raasch is the Chairman of the Board of Directors of OnVANTAGE,
Inc. Prior to joining the Media Arts, Mr. Raasch was the President and majority
shareholder of First Med Corp., Inc., a medical billing and management company,
from August 1988 until January 1990 when it was sold to Medaphis Corp., a public
company.
Thomas Kinkade co-founded Media Arts, through a preceding company in
1990 and has been the Art Director and a member of the Board of Directors
since its inception in March 1990. Mr. Kinkade has provided artwork to the
company for its productions since the company's inception. In addition, Mr.
Kinkade's role includes providing strategic vision for the Thomas Kinkade
brand, assisting in product development and communicating the company's brand
message through public appearances and books. Prior to March 1990, Mr.
Kinkade was a self-employed artist.
Raymond A. Peterson has been the Vice Chairman of the Board of
Directors since January 1999. He was interim Corporate Secretary from August
1999 to November 1999 and interim Chief Financial Officer from December 1999 to
March 2000. He was the President and Chief Executive Officer of the company from
June 1998 to July 1999. He was the Senior Vice President and Chief Financial
Officer of the company from May 1993 to May 1998. Mr. Peterson is currently an
independent consultant to the company. He was the Chief Executive Officer of
Peterson, Sense & Company, a certified public accounting firm, for the previous
15 years, during which time he provided accounting, tax and financial planning
services for the company. Prior to that, Mr. Peterson was the Corporate Tax
Manager for Raychem Corporation, a multi-national manufacturing corporation, and
a Senior Tax Accountant with Peat Marwick & Mitchell, currently KPMG.
Craig A. Fleming has been the President and Chief Executive Officer of
the company since July 1999 and a member of the Board of Directors since August
1999. From June 1998 to July 1999, Mr. Fleming was the President and Chief
Executive Officer of Lightpost Publishing, Inc., and President of Thomas Kinkade
Stores, Inc., both of which are wholly-owned subsidiaries of the company. He was
President of the company from May 1997 to October 1997 and the President and
Chief Executive Officer from October 1997 to May 1998. He was the Vice President
of Sales for the company from November 1996 to May 1997. Prior to joining the
company, Mr. Fleming held executive positions with Dorling Kindersley, National
Motor Club, Fuller Brush, Kirby Company and Melaleuca, Inc.
Michael L. Kiley has been a member of the Board of Directors since
January 1997. He was Vice Chairman of the Board of Directors from June 1997 to
January 1999. Mr. Kiley has been an independent consultant to the company since
April 1997. In 1978, he founded Home Church and has served as Pastor since that
time. Prior to founding Home Church, Mr. Kiley co-owned Business Exchange, Inc.,
a cooperative buying company servicing over 400 business owners.
Norman A. Nason has been a member of the Board of Directors since April
1993. Mr. Nason is President of Saratoga Commercial Real Estate Brokerage
Corporation and Saratoga Management Corporation, companies that he founded in
1976.
W. Michael West has been a member of the Board of Directors since
September 1998. Mr. West currently serves as Chairman of the Board of Directors
of VINA Technologies. In addition, he serves on the Boards of Directors of
several private companies and on advisory boards of three non-profit
organizations. From September 1997 to January 1998, he served as Executive Vice
President of Lucent Technologies following its acquisition of Octel
Communications Corporation. From September 1986 to September 1997, he served at
Octel Communications Corporation as Vice Chairman of the Board of Directors and
President and Chief Operating Officer from 1995 to 1998 and Executive Vice
President, Worldwide Sales and Marketing from 1986 to 1995. Prior to 1986 Mr.
West served as an executive in the Rolm Corporation and his last position held
was General Manager of the National Sales Division.
25
The information regarding executive officers and additional information
regarding directors required by this Item is incorporated by reference from the
definitive proxy statement for the company's 2000 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 "SECTION 16(a) BENEFICIAL
OWNERSHIP REPORTING COMPLIANCE"
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference from
the Proxy Statement under the caption "EXECUTIVE COMPENSATION."
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 "SECURITY OWNERSHIP OF MANAGEMENT AND
PRINCIPAL SHAREHOLDERS."
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."
26
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......................................................... 28
Consolidated Balance Sheets at March 31, 2000 and 1999.................................... 29
Consolidated Income Statements for the years ended March 31, 2000, 1999 and 1998.......... 30
Consolidated Statements of Stockholders' Equity for the years ended March 31, 2000, 1999
and 1998................................................................................ 31
Consolidated Statements of Cash Flows for the years ended March 31, 2000, 1999 and
1998.................................................................................... 32
Notes to Consolidated Financial Statements................................................ 33
2. Financial Statement Schedules:
For the years ended March 31, 2000, 1999 and 1998
Schedule VIII. Valuation and Qualifying Accounts and Reserves............................. 43
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 44. 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
27
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) on page 27 present fairly, in all
material respects, the financial position of Media Arts Group, Inc. and its
subsidiaries at March 31, 2000 and March 31, 1999, and the results of their
operations and their cash flows for each of the three years in the period
ended March 31, 2000 in conformity with accounting principles generally
accepted in the United States. In addition, in our opinion, the financial
statement schedules listed in the index appearing under Item 14(a)(2) on page
27 present fairly, in all material respects, the information set forth
therein when read in conjunction with the related consolidated financial
statements. These financial statements and financial statement schedules are
the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements and financial statement
schedules based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States,
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 expre