UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission File Number: 0-24294
MEDIA ARTS GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0354419
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
521 Charcot Ave., San Jose, California 95131
(Address of principal executive offices and zip code)
Registrant's telephone number: (408) 324-2020
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes /X/ No / /
The number of shares outstanding of the Registrant's Common Stock, $0.01 par
value, was 13,191,373 at December 31, 2000.
This report consists of 17 pages of which this page is number 1.
MEDIA ARTS GROUP, INC.
FORM 10-Q
INDEX
Page No.
---------------
Part I: Financial Information
Item 1: Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of December 31, 2000
and March 31, 2000 3
Condensed Consolidated Statements of Income for the Three Month
and Nine Month Periods Ended December 31, 2000 and 1999 4
Condensed Consolidated Statements of Cash Flows for the Nine
Month Periods Ended December 31, 2000 and 1999 5
Notes to Unaudited Condensed Consolidated Financial Statements 6
Item 2: Management's Discussion and Analysis of Financial Condition and
Results of Operations 8
Item 3: Quantitative and Qualitative Disclosures about Market Risk 14
Part II: Other Information
Item 1: Legal Proceedings 15
Item 2: Changes in Securities 15
Item 3: Defaults upon Senior Securities 15
Item 4: Submission of Matters to a Vote of Security Holders 15
Item 5: Other Information 15
Item 6: Exhibits and Reports on Form 8-K 15
Signatures 16
2
MEDIA ARTS GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, UNAUDITED)
December 31, March 31,
2000 2000
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents......................................... $ 8,438 $ 5,544
Accounts receivable, net.......................................... 35,432 27,844
Inventories....................................................... 27,699 22,102
Prepaid expenses and other current assets......................... 5,430 5,001
Deferred income taxes............................................. 7,575 6,260
----------- -----------
Total current assets.......................................... 84,574 66,751
Property and equipment, net.......................................... 13,526 17,780
Notes receivable, long term.......................................... 470 341
Cash value of life insurance......................................... 2,634 2,569
Other assets......................................................... 1,116 2,371
----------- -----------
Total assets.................................................. $ 102,320 $ 89,812
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.................................................. $ 8,418 $ 8,640
Commissions payable............................................... 1,156 945
Accrued royalties................................................. 850 726
Accrued compensation costs........................................ 1,213 2,710
Accrued expenses.................................................. 579 868
Income taxes payable.............................................. 6,940 4,272
Capital lease obligation, current................................. 231 --
----------- -----------
Total current liabilities..................................... 19,387 18,161
Capital lease obligation, long term.................................. 650 --
Deferred compensation cost........................................... 2,916 3,011
Deferred income tax liability........................................ 477 1,032
Convertible notes.................................................... 1,200 1,200
----------- -----------
Total liabilities............................................. 24,630 23,404
----------- -----------
Stockholders' equity:
Common stock...................................................... 90 90
Additional paid-in capital........................................ 38,427 38,301
Retained earnings................................................. 42,915 32,126
Treasury stock.................................................... (3,742) (4,109)
----------- -----------
Total stockholders' equity.................................... 77,690 66,408
----------- -----------
Total liabilities and stockholders' equity.................... $ 102,320 $ 89,812
=========== ===========
See accompanying notes to condensed consolidated financial statements.
3
MEDIA ARTS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS, UNAUDITED)
Three Months Ended Nine Months Ended
December 31, December 31,
----------------------- -----------------------
2000 1999 2000 1999
---------- ---------- --------- ----------
Net sales......................................... $ 40,124 $ 42,481 $ 104,492 $ 102,850
Cost of sales..................................... 15,904 15,229 39,557 38,129
---------- ---------- --------- ----------
Gross profit................................... 24,220 27,252 64,935 64,721
---------- ---------- --------- ----------
Operating expenses:
Selling and marketing.......................... 7,054 8,254 21,526 26,057
General and administrative..................... 7,001 7,288 23,176 21,607
Write-down of Internet business assets......... -- -- 2,541 --
---------- ---------- --------- ----------
Total operating expenses..................... 14,055 15,542 47,243 47,664
---------- ---------- --------- ----------
Operating income.................................. 10,165 11,710 17,692 17,057
Interest expense.................................. 49 10 55 3
---------- ---------- --------- ----------
Income before income taxes........................ 10,116 11,700 17,637 17,054
Provision for income taxes........................ 3,744 4,619 6,526 6,732
---------- ---------- --------- ----------
Net income........................................ $ 6,372 $ 7,081 $ 11,111 $ 10,322
========== ========== ========= ==========
Net income per share:
Basic ........................................ $ 0.48 $ 0.55 $ 0.84 $ 0.80
Diluted........................................ $ 0.48 $ 0.54 $ 0.84 $ 0.79
Shares used in net income per share computation:
Basic ........................................ 13,177 12,961 13,160 12,939
Diluted........................................ 13,251 13,021 13,224 13,101
See accompanying notes to condensed consolidated financial statements.
4
MEDIA ARTS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS, UNAUDITED)
Nine Months Ended
December 31,
------------------------------
2000 1999
----------- -------------
Cash flows from operating activities:
Net income..................................................... $ 11,111 $ 10,322
Adjustments to reconcile to net cash provided
by operating activities:
Depreciation and amortization............................... 4,255 2,908
Loss from write-down of Internet business assets............ 2,541 --
Loss on disposal of fixed assets............................ 66 --
Amortization of stock based compensation.................... 71 --
Deferred income taxes....................................... (1,870) (31)
Provision for returns and allowances........................ (512) 408
Provision for losses on accounts receivable................. 566 (316)
Changes in assets and liabilities:
Accounts receivable....................................... (7,305) (9,788)
Inventories............................................... (5,597) (2,748)
Prepaid expenses and other current assets................. (1,049) 20
Other assets.............................................. (1,016) (763)
Accounts payable.......................................... 869 2,249
Commissions payable....................................... 211 148
Accrued royalties......................................... 124 (104)
Accrued compensation costs................................ (1,497) 707
Accrued expenses.......................................... (289) (413)
Income taxes payable...................................... 2,668 4,245
Deferred compensation cost................................ (95) 1,061
----------- -----------
Net cash provided by operating activities 3,252 7,905
----------- -----------
Cash flows from investing activities:
Acquisitions of property and equipment......................... (2,597) (10,729)
Proceeds from disposals of galleries........................... 2,188 844
Proceeds from payments on notes receivable..................... 680 822
Purchase of note receivable.................................... (600) --
Increase in cash surrender value of life insurance............. (65) (730)
----------- -----------
Net cash used in investing activities............................ (394) (9,793)
----------- -----------
Cash flows from financing activities:
Repayment of capital lease obligation.......................... (60) --
Proceeds from issuance of common stock......................... 96 472
Purchases of common stock...................................... -- (486)
----------- -----------
Net cash provided by (used in) financing activities.............. 36 (14)
----------- -----------
Net increase (decrease) in cash and cash equivalents............. 2,894 (1,902)
Cash and cash equivalents at beginning of period................. 5,544 6,361
----------- -----------
Cash and cash equivalents at end of period....................... $ 8,438 $ 4,459
=========== ===========
See accompanying notes to condensed consolidated financial statements.
5
MEDIA ARTS GROUP, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The consolidated financial statements of Media Arts Group, Inc. (the "Company")
include the accounts of its wholly owned subsidiaries, Lightpost Publishing,
Inc., Thomas Kinkade Stores, Inc. and Exclaim Technologies, Inc. ("Exclaim").
The Company primarily designs, manufactures, markets and retails branded
art-based home accessories, collectibles and gift products based on the works of
licensed artists including Thomas Kinkade, Howard Behrens and Simon Bull. The
Company's primary products are canvas and paper lithographs as well as other
forms of fine-art reproductions.
The condensed interim consolidated financial statements of Media Arts Group,
Inc. have been prepared by the Company without audit. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to rules and regulations of the Securities and Exchange
Commission. The information included in this report should be read in
conjunction with the Company's audited consolidated financial statements and
notes thereto included in the Company's Annual Report on Form 10-K.
In the opinion of management, the accompanying unaudited interim condensed
consolidated financial statements reflect all material adjustments
(consisting solely of normal recurring adjustments) necessary for a fair
presentation of the financial position, operating results and cash flows for
the periods presented. Certain prior period balances have been reclassified
to conform to the current period presentation. The results of the interim
period ended December 31, 2000 are not necessarily indicative of the results
that may be expected for the entire fiscal year which ends March 31, 2001.
NOTE 2 - NET INCOME PER SHARE
The following summarizes the effects of the assumed issuance of dilutive
securities on weighted average shares for basic net income per share (in
thousands):
Three Months Nine Months
Ended December 31, Ended December 31,
----------------------- -----------------------
2000 1999 2000 1999
---------- ---------- --------- ----------
Weighted average number of
shares - basic ............................... 13,177 12,961 13,160 12,939
Incremental shares from assumed
issuance of stock options...................... 74 60 64 162
---------- ---------- --------- ----------
Weighted average number of
shares - diluted............................... 13,251 13,021 13,224 13,101
========== ========== ========= ==========
6
MEDIA ARTS GROUP, INC.
NOTE 3 - INVENTORIES
Inventories consisted of (in thousands):
December 31, March 31,
2000 2000
-------------- -----------
Raw materials..................................... $ 10,562 $ 7,642
Work-in-process................................... 3,228 1,727
Finished goods.................................... 13,909 12,733
-------------- -----------
$ 27,699 $ 22,102
============== ===========
NOTE 4 - SALE OF COMPANY OWNED STORES
During the nine months ended December 31, 2000, the Company closed one of its
Company owned stores and sold four to Signature Gallery owners, bringing the
total number of stores sold to 30. Since the Company began selling Company-owned
stores, $1.7 million of inventory and $2.1 million of fixed assets have been
sold. In addition, the Company has received $4.5 million in notes receivable in
connection with these sales. The terms on the notes are generally five to seven
years and bear interest of 8.5% per annum. The Company has not recognized any
gains on the sales of Company-owned stores due to the significant notes
receivable that have been taken. The Company 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 the Company intends to sell are substantially
complete and the likelihood of a net gain from store sales is virtually certain.
Deferred gains total $2.7 million as of December 31, 2000. Due to the
uncertainty of the collectibility of the notes and eventual recognition of
gains, the Company has reported the net of the notes receivable and deferred
gains as other assets at December 31, 2000.
NOTE 5 - COMPREHENSIVE INCOME
To date, the Company has not had any transactions that are required to be
reported in comprehensive income as compared to its reported net income.
NOTE 6 - OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION
The Company has three operating segments: wholesale, retail and Internet
application service provider ("ASP"). The wholesale segment includes sales to
the Company's branded distribution channel (which includes Company-owned Thomas
Kinkade Stores, and independently owned Thomas Kinkade Signature Galleries and
Showcase dealers), other independent dealers and strategic partners such as QVC,
Avon and Hallmark, as well as sales generated from the Company's e-commerce
web-sites, thomaskinkade.com and howardbehrens.com. Media Arts' retail segment
consists of sales by Company-owned Thomas Kinkade Stores. The ASP segment
consists of the operations of Exclaim, which is developing and supporting a
retail operating system, Storefront, which is used by independently owned Thomas
Kinkade Signature Galleries.
The operating segments have management teams that report directly to the Chief
Operating Decision Maker ("CODM"), as defined by Statement of Financial
Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and
Related Information." The CODM evaluates performance and allocates resources to
each operating segment. Information on the Company's reportable segments for the
three and nine months ended December 31, 2000 and 1999 is as follows (in
thousands):
7
MEDIA ARTS GROUP, INC.
Three Months Ended Nine Months Ended
December 31, December 31,
----------------------- -----------------------
2000 1999 2000 1999
---------- ---------- --------- ----------
Revenues:
External wholesale.............................. $ 38,995 $ 38,838 $ 101,948 $ 87,511
Intersegment wholesale.......................... 537 2,235 1,105 8,423
Retail ......................................... 1,107 3,630 2,485 15,227
ASP ......................................... 22 13 59 112
Eliminations.................................... (537) (2,235) (1,105) (8,423)
---------- ---------- --------- ----------
Total Company..................................... $ 40,124 $ 42,481 $ 104,492 $ 102,850
========== ========== ========= ==========
Operating income (loss):
Wholesale....................................... $ 10,908 $ 15,532 $ 28,180 $ 25,143
Retail ......................................... 79 (962) (1,237) (3,094)
ASP ......................................... (742) (1,924) (9,615) (3,252)
Eliminations.................................... (80) (936) 364 (1,740)
---------- ---------- --------- ----------
Total Company..................................... $ 10,165 $ 11,710 $ 17,692 $ 17,057
========== ========== ========= ==========
Assets:
Wholesale....................................... $ 99,919 $ 80,317
Retail ......................................... 1,651 6,391
ASP ......................................... 1,252 3,019
Eliminations.................................... (502) (1,876)
--------- ----------
Total Company..................................... $ 102,320 $ 87,851
========= ==========
Depreciation and amortization:
Wholesale....................................... $ 959 $ 629 $ 2,957 $ 1,842
Retail ......................................... 17 258 294 938
ASP ......................................... 209 101 1,004 128
---------- ---------- --------- ----------
Total Company..................................... $ 1,185 $ 988 $ 4,255 $ 2,908
========== ========== ========= ==========
Capital Expenditures:
Wholesale....................................... $ 613 $ 3,105 $ 1,403 $ 7,871
Retail ......................................... -- -- 81 72
ASP ......................................... 7 1,309 1,113 2,786
---------- ---------- --------- ----------
Total Company..................................... $ 620 $ 4,414 $ 2,597 $ 10,729
========== ========== ========= ==========
Media Arts currently does not sell to geographic regions outside the United
States, Canada and the United Kingdom. Currently sales to Canada and the United
Kingdom are immaterial. During the three and nine month periods ended December
31, 2000 and 1999 no customer accounted for greater than 10% of net sales.
NOTE 7 - SUBSEQUENT EVENTS
On February 5, 2001, Thomas Kinkade, a member of the Board of Directors,
co-founder and Art Director of the Company, sent a letter to the Company's
Board of Directors in which Mr. Kinkade stated that a major bank has agreed
to act as lead arranger and book manager for the financing of his October 17,
2000 proposal to acquire all of the outstanding shares of the Company not
already owned by him or his affiliates, and that he was now prepared to
engage this bank and proceed with the proposed transaction at a price of
$6.25 per share in cash.
On February 14, 2001, the Special Committee of independent Directors, which
was formed by the Board of Directors of the Company to, among other things,
evaluate Mr. Kinkade's proposal, responded to Mr. Kinkade by a letter in
which the Special Committee stated that the $6.25 proposal is inadequate, but
that the Special Committee will consider any firm offer from Mr. Kinkade or
another third party that is adequate.
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information set forth below should be read in conjunction with the unaudited
condensed consolidated financial statements and notes thereto included in Part I
- Item 1 of this Quarterly Report and the Company's Annual Report on Form 10-K
for the year ended March 31, 2000 which contains the audited financial
statements and notes thereto for the years ended March 31, 2000, 1999 and 1998
and Management's Discussion and Analysis of Financial Condition and Results of
Operations for those respective periods.
8
Forward looking statements in this Quarterly Report on Form 10-Q as well as the
Company's Annual Report on Form 10-K for the year ended March 31, 2000, 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, product development efforts, consumer acceptance of
licensed artwork and of the Company's products based on such work, expansion
of distribution channels for the Company's products and, in particular, the
successful implementation of the Signature Gallery program, successful third
party manufacturing relationships and the continued control of operating
expenses, together with other risks detailed from time to time in the
Company's periodic reports and other information filed with the Securities
and Exchange Commission.
RESULTS OF OPERATIONS
NET SALES
Net sales for the quarter ended December 31, 2000 were $40.1 million, a 5.5%
decrease compared to the $42.5 million reported for the quarter ended
December 31, 1999. The decline in net sales was primarily attributable to a
$2.5 million decrease in retail sales due to the sales of nine, and closure
of one, of the twelve company stores we owned in the prior year as well as a
shift in short-term focus to our retail channel, necessitating a lower
priority for wholesale revenues this quarter. During the quarter, we were
faced with general economic uncertainty, declining same store sales in the
prior two quarters and unsatisfactory accounts receivable days sales
outstanding. We addressed these circumstances by developing a new retail
promotional event involving appearances by Thomas Kinkade at selected
Signature Galleries which substantially reduced the decline in same store
sales, increased product pull-through, lowered retail inventory, improved
accounts receivable and strengthened our cash position. Net sales for the
nine months ended December 31, 2000 were $104.5 million, up 1.6% from $102.9
million during the nine months ended December 31, 1999 primarily attributable
to the increased number of Signature Galleries as well as other branded and
non-branded retail distribution.
GROSS PROFIT
Gross profit decreased by $3.0 million, or 11.1%, to $24.2 million for the three
months ended December 31, 2000 compared to $27.3 million for the three months
ended December 31, 1999. Gross profit was $64.9 million for the nine months
ended December 31, 2000 compared to $64.7 million in the prior year.
Consolidated gross margin decreased to 60.4% for the three months ended December
31, 2000 compared to 64.2% for the same period in the prior year. For the nine
months ended December 31, 2000 consolidated gross margin was 62.1% compared to
62.9% for the same period in the prior year. The decline in gross margins was
due to under absorbed overhead resulting from lower than expected sales as well
as a shift in sales to lower margin products.
SELLING AND MARKETING EXPENSES
Selling and marketing expenses were $7.1 million and $21.5 million for the three
and nine month periods ended December 31, 2000 compared to $8.3 million and
$26.1 million for the same periods in the prior year. As a percentage of net
sales, selling and marketing expenses were 17.6% and 20.6% for the three and
nine month periods ended December 31, 2000 compared to 19.4% and 25.3% for the
same periods in the prior year. Selling and marketing expenses decreased in
absolute terms and as a percentage of sales for the three and nine months ended
December 31, 2000 due to reduced compensation costs.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were $7.0 million and $23.2 million for the
three and nine month periods ended December 31, 2000 compared to $7.3 million
and $21.6 million for the same periods in the prior year. Expressed as a
percentage of net sales, general and administrative expenses were 17.4% and
22.2% for the three and nine month periods ended December 31, 2000 compared to
17.2% and 21.0% for the
9
same periods in the prior year. General and administrative expenses remained
relatively constant in absolute terms and as a percentage of sales during the
three months ended December 31, 2000. During the three months ended December
31, 2000, costs were incurred of $1.1 million associated with the ongoing
evaluation of a proposed offer to acquire the company and during the same
period in the prior year, costs of $1.9 million were incurred in connection
with Exclaim's Internet operations. The increase in general and
administrative costs for the nine months ended December 31, 2000, in absolute
terms and as a percentage of sales, was due to increased costs related to
Exclaim during the first six months of the fiscal year of $2.3 million and
the cost of evaluating the proposed offer to acquire the company, offset by
lower compensation costs due to a non-recurring charge in the prior year of
$1.3 million for severance payments relating to cost reductions and certain
settlement payments under key management contracts.
WRITE-DOWN OF INTERNET BUSINESS ASSETS
During the nine months ended December 31, 2000, we significantly reduced the
funding of Exclaim due to the significant cash requirements related to its
software development activities and the inability to obtain outside sources of
capital. We determined that by stopping development of the more costly
Marketplace product and by focussing development efforts on the Storefront
retail operating system, we could significantly reduce Exclaim's operating
expenses and continue supporting our Signature Gallery dealers who were
utilizing the Storefront product for their gallery operations. Accordingly, we
incurred a $2.5 million charge in connection with the write-down of assets
related to the Marketplace product.
WHOLESALE SEGMENT
Net sales to wholesale accounts include sales to our branded distribution
channel, including independently owned Signature Galleries and Showcase
dealers, our company owned Thomas Kinkade Stores, other independent dealers
and strategic partners and revenue generated from licensing arrangements, as
well as revenue generated from our e-commerce web-sites, thomaskinkade.com
and howardbehrens.com. Net sales to wholesale customers before intersegment
eliminations decreased 3.8% to $39.5 million for the three months ended
December 31, 2000 compared to $41.1 million for the same period in the prior
year. At the start of the quarter, we were faced with general economic
uncertainty, declining same store sales in the prior two quarters and
unsatisfactory accounts receivable days sales outstanding. We addressed these
circumstances by developing a new retail promotional event involving
appearances by Thomas Kinkade at selected Signature Galleries which
substantially reduced the decline in same store sales, increased product
pull-through, lowered retail inventory, improved accounts receivable and
strengthened our cash position. Net sales to wholesale customers before
intersegment eliminations for the nine months ended December 31, 2000 were
$103.1 million, up 7.4% from $95.9 million during the same period in the
prior year. Sales to Signature Galleries increased 7.6% to $22.9 million for
the three months ended December 31, 2000 from $21.3 million for the same
period in the prior year due to an increase in the number of Signature
Galleries to 361 as of December 31, 2000 from 282 as of December 31, 1999.
Operating income for the wholesale segment before intersegment eliminations
decreased 29.8% to $10.9 million for the three months ended December 31, 2000
compared to $15.5 million for the same period in the prior year. Operating
margin for the wholesale segment before intersegment eliminations decreased to
27.6% for the three months ended December 31, 2000 from 37.8% for the same
period in the prior year. The decrease in operating income and margin was
primarily due to lower than expected net sales and gross margins and $1.1
million in costs associated with the ongoing evaluation of a proposed offer to
acquire the company. Operating income before intersegment eliminations increased
12.1% to $28.2 million during the nine months ended December 31, 2000 compared
to $25.1 million for the same period in the prior year. Operating margin for the
wholesale segment before intersegment eliminations for the nine months ended
December 31, 2000 increased to 27.3% from 26.2% for the same period in the prior
year. The increase in operating income and margin was due primarily to an
improved gross margin during the nine month period
10
resulting from higher sales volumes.
RETAIL SEGMENT
Net sales for the retail segment consist of sales by company owned 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 69.5% to $1.1 million for the three months ended December 31,
2000 compared to $3.6 million for the same period in the prior year. Net sales
for the retail segment for the nine months ended December 31, 2000 decreased
83.7% to $2.5 million from $15.2 million for the same period in the prior year.
The decrease in net sales was due to the transfer of nine, and closure of one,
Thomas Kinkade Stores since December 31, 1999. There were two company owned
stores as of December 31, 2000 compared to twelve as of December 31, 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 collectability 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 December 31, 2000.
Operating income for the retail segment was $79,000 during the three months
ended December 31, 2000 as compared to an operating loss of $962,000 for the
same period in the prior year. Operating losses for the nine months ended
December 31, 2000 decreased 60.0% to $1.2 million from $3.1 million for the same
period in the prior year. The change in operating results is primarily due to
the sales of less profitable company owned stores.
INTERNET APPLICATION SERVICE PROVIDER SEGMENT
Our Internet application service provider ("ASP") segment consists solely of
the operations of Exclaim, which is developing and supporting a retail
operating system, Storefront, which is used by independently owned Thomas
Kinkade Signature Galleries. During the period ended September 30, 2000,
Exclaim was also developing Marketplace, a vertical business-to-business
trade community that would link buyers and sellers together to create supply
chain efficiencies within the fine art, gift and collectibles, furniture and
home decor industries. In September 2000 we significantly reduced the funding
of Exclaim's operations and stopped development of the Marketplace product.
Accordingly, we incurred a $2.5 million charge in connection with the
write-down of assets related to the Marketplace product in the second quarter
of fiscal 2001.
Net sales in the ASP segment for the three months ended December 31, 2000 were
$22,000, up 69.2% from $13,000 for the same period in the prior year. The
increase was due primarily to increased users. Net sales for the nine months
ended December 31, 2000 were $59,000, down 47.3% from $112,000 for the same
period in the prior year. The decrease in the nine month period was due
primarily to Storefront license pricing changes. Net sales for the ASP 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 December 31, 2000, net
sales of Storefront have been made solely to Signature Galleries.
Operating losses for the ASP segment were $742,000 during the three months ended
December 31, 2000, down 61.4% from $1.9 million for the same period in the prior
year. For the nine months ended December 31, 2000 operating losses were $9.6
million, up 195.7% from $3.3 million for the same period in the prior year. The
increase in operating losses were primarily due to the $2.5 million write-down
of Marketplace related assets as well as a significant ramping up of product
development operations of Exclaim in the first six months of fiscal 2001.
11
Operating expenses of the ASP segment consist primarily of salaries and
consulting expenses related to the development of Exclaim's products.
INTEREST EXPENSE
Interest expense was $49,000 and $55,000 for the three and nine month periods
ended December 31, 2000, compared to $10,000 and $3,000 for the same periods in
the prior year. The increase in net interest expense was due to decreased cash
balances throughout the first half of the current period as well as a capital
lease obligation entered into since the prior year.
PROVISION FOR INCOME TAX
The provision for income taxes was $3.7 million and $6.5 million for the three
and nine month periods ended December 31, 2000, compared to $4.6 million and
$6.7 million for the same periods in the prior year. The effective income tax
rate for the three and nine months ended December 31, 2000 was 37.0%, compared
to 39.5% for the same periods in the prior year.
COMPARABLE STORE SALES
Comparable store sales for the three months ended December 31, 2000 decreased
3.5% from the same period in the prior year based on voluntarily reported
sales figures from 235 comparable independent Signature Gallery dealers and
company owned stores. The decline in comparable store sales is due primarily
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. The
comparable store sales decline in the quarter was significantly less than the
prior two quarters' due to the development of a new retail promotional event
involving appearances by Thomas Kinkade at selected Signature Galleries. In
order to further enhance comparable store sales, we will continue to slow the
addition of stores within existing districts and to focus our future retail
expansion in new geographical markets where there is no existing Signature
Gallery presence. We believe comparable Signature district sales are another
meaningful indicator of the condition of our retail market. Comparable
district sales for the three months ended December 31, 2000 increased 22.0%
from the same period in the prior year for the 141 reporting comparable
districts.
RECENT DEVELOPMENTS
On February 5, 2001, Thomas Kinkade, a member of the Board of Directors,
co-founder and Art Director of the Company, sent a letter to the Company's
Board of Directors in which Mr. Kinkade stated that a major bank has agreed
to act as lead arranger and book manager for the financing of his October 17,
2000 proposal to acquire all of the outstanding shares of the Company not
already owned by him or his affiliates, and that he was now prepared to
engage this bank and proceed with the proposed transaction at a price of
$6.25 per share in cash.
On February 14, 2001, the Special Committee of independent Directors, which
was formed by the Board of Directors of the Company to, among other things,
evaluate Mr. Kinkade's proposal, responded to Mr. Kinkade by a letter in
which the Special Committee stated that the $6.25 proposal is inadequate, but
that the Special Committee will consider any firm offer from Mr. Kinkade or
another third party that is adequate.
SEASONALITY; FLUCTUATIONS IN QUARTERLY RESULTS
Our business has experienced, and is expected to continue to experience,
significant seasonal fluctuations in net sales and income. Our net sales
historically have been highest in the December quarter and lower in the
subsequent March and June quarters. We believe that the seasonal effect is due
to customer buying patterns, particularly with respect to holiday purchases, and
is typical of the home decorative accessories, collectibles and gift product
industries. We expect these seasonal trends to continue in the foreseeable
future.
Our quarterly operating results have fluctuated significantly in the past and
may continue to fluctuate as a result of numerous factors including:
- 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 (specifically the art and related products of
Howard Behrens, Simon Bull and Robert Lyn Nelson),
- Our ability to achieve our expansion plans,
- The timing, mix and number of new product releases,
12
- The continued successful implementation of the Signature Gallery program
and expansion of distribution generally,
- The successful entrance into new distribution channels and new retail
concepts,
- 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, net sales in any quarter are substantially
dependent on orders booked in that quarter. Our results of operations may also
fluctuate based on extraordinary events. Accordingly, the results of operations
in any quarter will not necessarily be indicative of the results that may be
achieved for a full fiscal year or any future quarter. Fluctuations in operating
results may also result in volatility in the price of our common stock.
LIQUIDITY AND CAPITAL RESOURCES
Our primary source of funds during the first nine months of fiscal 2001 has been
from operating income. Our working capital as of December 31, 2000 was $65.2
million, compared to $48.6 million as of March 31, 2000.
Net cash provided by operations for the first nine months of fiscal 2001 was
$3.3 million, consisting primarily of net income of $11.1 million,
depreciation of $4.3 million, an increase in income taxes payable of $2.7
million and a loss from the write-down of Exclaim assets of $2.5 million,
offset by a $7.3 million increase in accounts receivable and a $5.6 million
increase in inventory. Accounts receivable increased primarily as a result of
seasonal factors as well as a slower than expected retail economic
environment. Inventory increased due primarily to seasonal increases, lower
than expected wholesale sales and the addition of new artists. Net cash
provided by operations for the first nine months of fiscal 2000 was $7.9
million consisting primarily of net income adjusted by increases in accounts
receivable, inventory and accounts payable.
Net cash used in investing activities was $400,000 for the first nine months
of fiscal 2001 and primarily related to capital expenditures for property and
equipment and investment in Internet related technologies offset by net cash
generated by the sales, collections and related financing of galleries sold
to Signature Gallery dealers. Net cash used in investing activities was $9.8
million in the first nine months of fiscal 2000 primarily related to
investment in Internet related technologies and capital expenditures for
property and equipment. We anticipate that total capital expenditures in
fiscal 2001 will be approximately $14 million, and will relate to building
design and engineering costs and leasehold improvements in connection with
the development of our leased property in Morgan Hill, California, as well as
continued manufacturing, infrastructure and management information systems
upgrades.
Net cash provided by financing activities was $36,000 in the first nine months
of fiscal 2001 and related to the exercise of options for our common stock and
the issuance of common stock through our Employee Stock Purchase Plan, offset by
payments under a capital lease obligation. During the first nine months of
fiscal 2000 net cash used for financing activities was $14,000 due primarily to
purchasing shares of our common stock under our stock repurchase program offset
by the exercise of options for our common stock.
We have a $30 million secured bank line-of-credit facility that we increased
from $20 million during the three months ended December 31, 2000 pursuant to
provisions in the line-of-credit agreement. 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 December 31, 2000.
13
We have significantly reduced the funding of Exclaim due to the reduction of
Exclaim's operations to focus solely on the Storefront retail operating system
product. Accordingly, we foresee future funding of Exclaim to be immaterial to
our operations or financial position.
We intend to relocate our offices and manufacturing facilities to a leased
campus facility currently under development in Morgan Hill, California, during
early 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.
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 response 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 our working
capital requirements through calendar year 2001. We may consider alternative
financing, such as issuance of addition equity or convertible debt securities
or obtaining further credit facilities, if market conditions make such
alternatives financially attractive for funding expansion.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk for changes in interest rates relates primarily to
our investment portfolio and borrowings. We do not use derivative financial
instruments in our investment portfolio and our investment portfolio only
includes highly liquid instruments purchased with an original maturity of 90
days or less and are considered to be cash equivalents. We did not have
short-term investments as of December 31, 2000 and March 31, 2000. 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 (in
thousands):
December 31, March 31,
2000 2000
----------- -----------
Assets:
Cash and cash equivalents...................... $ 8,438 $ 5,544
Average interest rate.......................... 4.1% 3.6%
Liabilities:
Bank line-of-credit............................ $ -- $ --
Interest rate (bank reference rate)............ 9.5% 9.0%
Capital lease obligation....................... $ 881 $ --
Fixed interest rate............................ 8.9% --
Convertible note payable to related party...... $ 1,200 $ 1,200
Fixed interest rate............................ 8.0% 8.0%
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
A complaint was filed on October 24, 2000 in Santa Clara County Superior
Court by James Boersma, on behalf of himself and all others similarly
situated, against Media Arts and its Board of Directors. Breach of fiduciary
duty is alleged in this purported class action, stemming from the proposal by
Thomas Kinkade to offer to acquire the outstanding shares of the Company not
already owned by him. As of February 14, 2001, no offer has yet been made by
Mr. Kinkade. The Company intends to defend against this lawsuit vigorously.
ITEM 2. CHANGES IN SECURITIES - Not Applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES - None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - None
ITEM 5. OTHER INFORMATION
On February 5, 2001, Thomas Kinkade sent a letter to the Company's Board of
Directors in which Mr. Kinkade stated that a major bank has agreed to act as
lead arranger and book manager for the financing of his proposal to acquire
all of the outstanding shares of the Company not already owned by him or his
affiliates, and that he was now prepared to engage this bank and proceed with
the proposed transaction at a price of $6.25 per share in cash.
On February 14, 2001, the Special Committee responded to Mr. Kinkade by a
letter in which the Special Committee stated that the $6.25 proposal is
inadequate, but that the Special Committee will consider any firm offer from
Mr. Kinkade or another third party that is adequate.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit 10.43 - Lease Agreement between TBI - Mission West, LLC and the
Company, dated June 30, 2000.
(b) Exhibit 99 - Letter from Special Committee to Thomas Kinkade dated
February 14, 2001.
(c) Reports on Form 8-K - None
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MEDIA ARTS GROUP, INC.
(Registrant)
By /s/ Craig Fleming
-----------------------------------
Craig Fleming
Chairman, President &
Chief Executive Officer
(Principal Executive Officer)
By /s/ Michael J. Catelani
-----------------------------------
Michael J. Catelani
Vice President of Finance
(Principal Financial Officer &
Principal Accounting Officer)
Date: February 14, 2001
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EXHIBIT INDEX
Exhibit Number
--------------
10.43 Lease Agreement between TBI - Mission West, LLC and the Company, dated
June 30, 2000.
99 Letter from Special Committee to Thomas Kinkade dated February 14, 2001.
17