10-Q 1 d10q.txt FORM 10-Q FOR 06/30/2001 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 _________________ FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 0-21499 _________________ SPECIALTY CATALOG CORP. (Exact Name of Registrant as Specified in Its Charter) DELAWARE 04-3253301 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 21 BRISTOL DRIVE SOUTH EASTON, MASSACHUSETTS 02375 (Address of principal executive offices) (Zip Code) (508) 238-0199 (Registrant's telephone number, including area code) 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 twelve 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 Number of shares of the Registrant's Common Stock outstanding as of August 7, 2001: 4,337,886. ================================================================================ 1 SPECIALTY CATALOG CORP. INDEX PART I. FINANCIAL STATEMENTS
Page No. -------- Item 1. Condensed Consolidated Financial Statements as of June 30, 2001, December 30, 2000 and July 1, 2000, for the Thirteen Weeks Ended June 30, 2001 and July 1, 2000 and for the Twenty-Six Weeks Ended June 30, 2001 and July 1, 2000 Condensed Consolidated Statements of Operations 3-4 Condensed Consolidated Balance Sheets 5 Condensed Consolidated Statements of Cash Flows 6 Notes to Condensed Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 PART II. OTHER INFORMATION Item 2. Changes in Securities and Use of Proceeds 15 Item 5. Other Information 16 Item 6. Exhibits and Reports on Form 8-K 17 Signatures 18
2 PART I. FINANCIAL STATEMENTS Item 1. Condensed Consolidated Financial Statements SPECIALTY CATALOG CORP. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
Thirteen Weeks Ended June 30, 2001 July 1, 2000 ------------- ------------ Revenues: Net sales........................................................... $ 13,244,157 $ 14,484,695 Shipping & handling income.......................................... 2,042,875 2,138,392 Royalties........................................................... 13,183 57,119 ------------- ------------ Total revenues......................................................... 15,300,215 16,680,206 Cost of sales (including buying, occupancy and order fulfillment costs)................................................. 5,491,006 5,836,990 ------------- ------------ Gross profit........................................................... 9,809,209 10,843,216 Operating expenses: Operating expenses.................................................. 7,686,578 8,885,760 Depreciation and amortization....................................... 466,304 416,329 ------------- ------------ Total operating expenses............................................... 8,152,882 9,302,089 ------------- ------------ Income from operations................................................. 1,656,327 1,541,127 Interest expense, net.................................................. 206,751 225,683 ------------- ------------ Income before income taxes............................................. 1,449,576 1,315,444 Income tax provision................................................... 593,098 539,329 ------------- ------------ Net income............................................................. 856,478 776,115 Other comprehensive loss - foreign currency translation adjustment..... 97,019 81,204 ------------- ------------ Comprehensive income................................................... $ 759,459 $ 694,911 ============= ============ Earnings per share - Basic EPS: Net income per share............................................. $ 0.20 $ 0.18 ============ ============ Weighted average shares outstanding.............................. 4,337,886 4,340,353 ============ ============ Earnings per share - Diluted EPS: Net income per share............................................. $ 0.19 $ 0.17 ============ ============ Weighted average shares outstanding.............................. 4,592,700 4,615,365 ============ ============
See notes to condensed consolidated financial statements. 3 SPECIALTY CATALOG CORP. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
Twenty-Six Weeks Ended June 30, 2001 July 1, 2000 ------------- ------------ Revenues: Net sales........................................................... $ 27,512,930 $ 28,366,448 Shipping & handling income.......................................... 4,292,347 4,250,034 Royalties........................................................... 37,185 138,666 ------------- ------------ Total revenues......................................................... 31,842,462 32,755,148 Cost of sales (including buying, occupancy and order fulfillment costs)................................................. 11,738,223 11,667,129 ------------- ------------ Gross profit........................................................... 20,104,239 21,088,019 Operating expenses: Operating expenses.................................................. 16,601,179 18,582,052 Depreciation and amortization....................................... 916,460 816,030 ------------- ------------ Total operating expenses............................................... 17,517,639 19,398,082 ------------- ------------ Income from operations................................................. 2,586,600 1,689,937 Interest expense, net.................................................. 470,071 441,682 ------------- ------------ Income before income taxes............................................. 2,116,529 1,248,255 Income tax provision................................................... 866,548 511,769 ------------- ------------ Net income............................................................. 1,249,981 736,486 Other comprehensive loss - foreign currency translation adjustment..... 250,826 76,537 ------------- ------------ Comprehensive income................................................... $ 999,155 $ 659,949 ============= ============ Earnings per share - Basic EPS: Net income per share............................................. $ 0.29 $ 0.17 ============= ============ Weighted average shares outstanding.............................. 4,337,886 4,345,973 ============= ============ Earnings per share - Diluted EPS: Net income per share............................................. $ 0.28 $ 0.16 ============= ============ Weighted average shares outstanding.............................. 4,539,968 4,631,735 ============= ============
See notes to condensed consolidated financial statements. 4 SPECIALTY CATALOG CORP. CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
June 30, December 30, July 1, 2001 2000 2000 ----- ----- ---- Assets Current assets: Cash and cash equivalents.......................................... $ 1,533,346 $ 435,276 $ 608,112 Accounts receivable, net........................................... 1,166,914 1,521,469 1,502,619 Inventories........................................................ 5,132,249 5,324,460 5,667,516 Prepaid expenses................................................... 3,671,451 3,561,311 4,458,275 ------------ ------------ ------------ Total current assets..................................... 11,503,960 10,842,516 12,236,522 ------------ ------------ ------------ Property, plant and equipment, net....................................... 4,042,273 4,391,445 4,561,834 Intangible assets, net................................................... 3,943,288 3,942,508 4,172,925 Deferred income taxes.................................................... 3,862,719 4,273,287 4,001,199 Other assets............................................................. 262,851 253,748 169,507 ------------ ------------ ------------ Total assets............................................. $ 23,615,091 $ 23,703,504 $ 25,141,987 ============ ============ ============ Liabilities and Shareholders' Equity Current liabilities: Accounts payable and accrued expenses.............................. $ 4,023,885 $ 3,656,757 $ 4,953,065 Liabilities to customers........................................... 1,134,736 925,888 1,163,359 Short-term borrowings.............................................. -- 788,100 5,426,132 Income taxes payable............................................... 458,520 376,914 588,340 Current portion of long-term debt.................................. 1,800,000 1,800,000 2,384,105 ------------ ------------ ------------ Total current liabilities................................ 7,417,141 7,547,659 14,515,001 ------------ ------------ ------------ Long-term debt........................................................... 6,300,000 7,200,000 1,959,053 Other long-term liabilities.............................................. 170,885 227,929 304,499 Commitments and contingencies Shareholders' equity: Common stock....................................................... 52,397 52,397 52,397 Additional paid-in capital......................................... 16,159,570 16,159,570 16,159,570 Accumulated other comprehensive loss............................... (389,776) (138,950) (127,787) Accumulated deficit................................................ (3,227,948) (4,477,923) (4,853,568) ------------ ------------ ------------ 12,594,243 11,595,094 11,230,612 Less treasury stock, at cost, 901,888 shares at June 30, 2001, December 30, 2000 and July 1, 2000............................. (2,867,178) (2,867,178) (2,867,178) ------------ ------------ ------------ Total shareholders' equity.................................. 9,727,065 8,727,916 8,363,434 ------------ ------------ ------------ Total liabilities and shareholders' equity.................. $ 23,615,091 $ 23,703,504 $ 25,141,987 ============ ============ ============
See notes to condensed consolidated financial statements. 5 SPECIALTY CATALOG CORP. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Twenty-Six Weeks Ended June 30, 2001 July 1, 2000 ------------- ------------ Cash flows from operating activities: Net income............................................................. $ 1,249,981 $ 736,486 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization.................................... 916,460 816,030 Deferred income taxes............................................ 421,913 351,587 Changes in operating assets and liabilities: Accounts receivable, net....................................... 328,722 (321,096) Inventories.................................................. 147,847 (89,503) Prepaid expenses............................................... (117,504) (455,066) Other assets................................................... (37,542) 33,388 Accounts payable and accrued expenses.......................... 463,764 734,685 Liabilities to customers....................................... 208,848 (5,897) Income taxes payable........................................... 88,629 155,487 Other long-term liabilities.................................... (8,334) (16,668) ------------ ----------- Net cash provided by operating activities.............................. 3,662,784 1,939,433 ------------ ----------- Cash flows from investing activities: Acquisitions, net of cash acquired and liabilities assumed....... (436,560) -- Purchases of trademarks.......................................... (700) -- Purchases of property, plant and equipment....................... (344,396) (872,648) ------------ ----------- Net cash used in investing activities.................................. (781,656) (872,648) ------------ ----------- Cash flows from financing activities: Repayments on short-term borrowings, net......................... (788,100) (873,758) Repayments of long-term debt..................................... (900,000) (616,728) Purchase of treasury stock....................................... -- (35,446) Repayments of capital lease obligations.......................... (48,710) (67,138) ------------ ----------- Net cash used in financing activities.................................. (1,736,810) (1,593,070) ------------ ----------- Effect of exchange rate changes on cash and cash equivalents........... (46,248) (2,450) ------------ ----------- Increase (decrease) in cash and cash equivalents....................... 1,098,070 (528,735) Cash and cash equivalents, beginning of year........................... 435,276 1,136,847 ------------ ----------- Cash and cash equivalents, end of period............................... $ 1,533,346 $ 608,112 ============ ===========
Supplemental disclosures of cash flow information: During the twenty-six weeks ended July 1, 2000, the Company received federal income tax refunds of $320,000. See notes to condensed consolidated financial statements. 6 SPECIALTY CATALOG CORP. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 1. Basis of Presentation These unaudited condensed consolidated financial statements should be read in conjunction with the Form 10-K of Specialty Catalog Corp. (the "Company") for the fiscal year ended December 30, 2000, and the consolidated financial statements and footnotes included therein. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the Securities and Exchange Commission rules and regulations. The results of operations for the thirteen weeks and twenty-six weeks ended June 30, 2001 are not necessarily indicative of the results for the entire fiscal year ending December 29, 2001. The condensed consolidated financial statements for the thirteen weeks and twenty-six weeks ended June 30, 2001 and July 1, 2000 are unaudited but include, in the Company's opinion, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the results for the periods presented. 2. Accounting Policies The accounting policies underlying the condensed consolidated financial statements are those set forth in Note 1 of the consolidated financial statements included in the Company's Form 10-K for the year ended December 30, 2000. Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities", is effective for all fiscal years beginning after June 15, 2000. SFAS No. 133, as amended, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. Under SFAS No. 133, certain contracts that were not formerly considered derivatives may now meet the definition of a derivative. The Company adopted SFAS No. 133 effective December 31, 2000. On January 19, 2001, the Company and Fleet National Bank, N.A. (the "Bank") entered into an Interest Rate Swap Agreement based on a notional principal balance of $4.5 million. Under the interest rate swap agreement, the Company receives quarterly LIBOR-based interest rate payments from the Bank, and pays interest quarterly at a fixed rate of 5.57% to the Bank, plus a borrowing margin to the Bank. These interest rate payments are settled net with the Bank. The agreement is effective for a period of two years and terminates on January 19, 2003. The interest rate swap is carried at its fair value. Hedge accounting is not applied and changes in the fair value of the swap are included in interest expense, net. At June 30, 2001, the carrying value of the swap was approximately $85,000, which is included in the accrued expenses. Interest expense, net was increased by approximately $38,000 and $85,000 in the thirteen and twenty-six weeks ended June 30, 2001, respectively, which represents the change in the fair value of the swap during these periods. Certain amounts in the 2000 financial statements have been reclassified to conform to the 2001 presentation. 7 SPECIALTY CATALOG CORP. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) 3. Reconciliation of Basic and Diluted Earnings per Share The following table (in thousands) shows the amounts used in computing basic and diluted earnings per share for net income and the effects of potentially dilutive options on the weighted average number of shares outstanding.
For the thirteen weeks ended For the twenty-six weeks ended June 30, 2001 July 1, 2000 June 30, 2001 July 1, 2000 ------------- ------------ ------------- ------------ Net Net Net Net Income Shares Income Shares Income Shares Income Shares ------ ------ ------ ------ -------- ------ ------ ------ Basic earnings per share $ 856 4,338 $ 776 4,340 $ 1,250 4,338 $ 736 4,346 Effect of dilutive options -- 255 -- 275 -- 202 -- 286 ------ ------ ------ ------ -------- ------ ------ ------ Diluted earnings per share $ 856 4,593 $ 776 4,615 $ 1,250 4,540 $ 736 4,632 ====== ====== ====== ====== ======== ====== ====== ======
Options to purchase 487,551 shares of common stock ranging from $5.33 to $7.15 per share were not included in computing diluted EPS for the thirteen weeks and twenty-six weeks ended June 30, 2001 because their effects were antidilutive. Options to purchase 564,251 shares of common stock ranging from $5.33 to $7.15 per share were not included in computing diluted EPS for the thirteen weeks and twenty-six weeks ended July 1, 2000 because their effects were antidilutive. 4. Acquisition On January 29, 2001, the Company's British subsidiary, Daxbourne International Limited, acquired the women's wig and hairpiece business of the Company's former British licensee. The licensee had been the exclusive British licensee of the Company's Paula Young brand of women's wigs and hairpieces since 1994. During the term of the license agreement the licensee developed and circulated the Paula Young Fashion Wigs catalog using the merchandising and ------------------------ creative resources of the Company, thereby establishing Paula Young as a preeminent brand in Britain with a loyal customer following. The purchase price includes (i) an initial fixed payment of approximately $254,000 on the closing date of the transaction, (ii) a fixed payment of approximately $36,000 due at the beginning of each of fiscal years 2002 and 2003 and (iii) a minimum royalty fee of approximately $73,000 per year due on March 31, 2002 and March 31, 2003, offset by the fixed payments in part (ii). The acquisition agreement also provides for the termination of the 1994 license agreement and transfer of the assets of the Paula Young Fashion Wigs catalog ------------------------ business to Daxbourne. Daxbourne's catalog division will now circulate both catalogs -- continuing to circulate its Jacqueline Collection catalog and the --------------------- Paula Young Fashion Wigs catalog. ------------------------ The agreement also called for continued support services from the British licensee for a period of three months ending on April 30, 2001. Daxbourne International Limited has not completed the allocation of the purchase price among the various asset categories. The purchase price allocation is preliminary and subject to final adjustment. 5. Sale of Assets On May 8, 2001, the Company's subsidiary, SC Publishing, Inc., sold its business of continuing education for accounting professionals to the California Certified Public Accountants Education Foundation. The sales price of $150,000 includes an irrevocable, royalty free, worldwide license to use the trade name Western Schools for accounting courses, all related inventory for existing courses, and title and rights to its accounting courses, both existing and under development. The Company recognized a pre-tax gain, included in selling, general, and administrative expenses, on the sale of these assets of approximately $55,000. SC Publishing is retaining its continuing education business for nurses and other mental health professionals which produced approximately ninety-two percent of the 2000 net revenue of the Western Schools division of SC Publishing. 8 SPECIALTY CATALOG CORP. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) 6. Merger Agreement On April 30, 2001, the Company announced that Mr. Guy Naggar, a British investor and substantial stockholder and director of the Company, has submitted a proposal to acquire for cash, through merger, all of the issued and outstanding shares of common stock of the Company, other than his shares and the shares of others who may join him, for $3.75 a share. On May 4, 2001, the Company entered into a definitive Merger Agreement with Specialty Acquisition Corp., a Delaware corporation owned by Mr. Naggar and several other substantial stockholders of the Company. The Merger Agreement provides for a cash merger in which the holders of common stock of the Company, other than Specialty Acquisition Corp., immediately prior to the merger, will receive $3.75 per share in cash for each share of common stock of Specialty Catalog Corp owned before the merger. The merger is subject to the satisfaction of a number of closing conditions, including, but not limited to, the consummation of financing arrangements and approval by the stockholders of Specialty Catalog Corp. The merger is expected to close in the fall of 2001. Other stockholders, including certain members of the Board of Directors of the Company, have joined Mr. Naggar in the proposed transaction. 7. Business Segments and Financial Information by Geographic Location Specialty Catalog Corp. has five reportable segments: Paula Young and Especially Yours under the SC Direct division, Western Schools and American Healthcare Institute ("AHI") under the SC Publishing division and Daxbourne International Limited. The SC Direct division sells women's wigs and hairpieces using two distinct catalogs: Paula Young and Especially Yours. The SC Publishing division distributes catalogs under its Western Schools brand and specializes in providing continuing education courses to nurses and accounting professionals (see sale of assets in Note 5). SC Publishing's other segment, AHI, distributes catalogs under its own name and specializes in providing continuing education seminars and conferences to nurses and other mental health professionals. Daxbourne International Limited is a retailer and wholesaler of women's wigs, hairpieces and related products in the United Kingdom. The accounting policies of the reportable segments are the same as those described in Note 1 of the consolidated financial statements included in the Company's Form 10-K for the year ended December 30, 2000. The Company's reportable segments are strategic business units that offer either different products or operate in different geographic locations. The Company markets its products in two major geographic areas, the United States and the United Kingdom. The SC Direct and SC Publishing divisions market their products and maintain their assets in the United States. Daxbourne International Limited markets its products and maintains its assets in the United Kingdom. 9 SPECIALTY CATALOG CORP. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) A summary of information about the Company's operations by segment for the thirteen weeks and twenty-six weeks ended June 30, 2001 and July 1, 2000 follows.
Paula Especially Corporate Total SC Western Young Yours Expenses Direct Schools ----------- ---------- ----------- ------------ ---------- Thirteen weeks ended June 30, 2001 Net sales (including royalties)........ $ 7,452,638 $2,260,114 $ -- $ 9,712,752 $1,240,122 Shipping & handling income............. 1,418,333 383,314 -- 1,801,647 225,443 ----------- ---------- ----------- ------------ ---------- Total revenues......................... 8,870,971 2,643,428 -- 11,514,399 1,465,565 Gross profit........................... 5,537,821 1,649,359 (57,605) 7,129,575 1,131,069 Operating expenses..................... 3,139,906 1,306,122 1,225,945 5,671,973 817,036 Depreciation and amortization.......... -- -- 299,743 299,743 15,905 ----------- ---------- ----------- ------------ ---------- Income (loss) from operations.......... 2,397,915 343,237 (1,583,293) 1,157,859 298,128 Interest expense, net.................. -- -- 165,472 165,472 -- Income tax provision (benefit)......... -- -- 405,650 405,650 122,233 Segment assets......................... -- -- 16,064,565 16,064,565 5,019,381 Capital expenditures................... -- -- 121,855 121,855 -- Total SC AHI Publishing Daxbourne Total ----------- ---------- ----------- ------------ Thirteen weeks ended June 30, 2001 Net sales (including royalties)........ $ 715,462 $1,955,584 $ 1,589,004 $ 13,257,340 Shipping & handling income............. -- 225,443 15,785 2,042,875 ----------- ---------- ----------- ------------ Total revenues......................... 715,462 2,181,027 1,604,789 15,300,215 Gross profit........................... 423,014 1,554,083 1,125,551 9,809,209 Operating expenses..................... 509,725 1,326,761 687,844 7,686,578 Depreciation and amortization.......... 51,582 67,487 99,074 466,304 ----------- ---------- ----------- ------------ Income (loss) from operations.......... (138,293) 159,835 338,633 1,656,327 Interest expense, net.................. -- -- 41,279 206,751 Income tax provision (benefit)......... (56,700) 65,533 121,915 593,098 Segment assets......................... 101,858 5,121,239 2,429,287 23,615,091 Capital expenditures................... -- -- 3,728 125,583 Paula Especially Corporate Total SC Western Young Yours Expenses Direct Schools ----------- ---------- ----------- ------------ ---------- Thirteen weeks ended July 1, 2000 Net sales (including royalties)........ $ 8,524,780 $2,011,122 $ -- $ 10,535,902 $1,060,013 Shipping & handling income............. 1,575,941 346,658 -- 1,922,599 206,144 ----------- ---------- ----------- ------------ ---------- Total revenues......................... 10,100,721 2,357,780 -- 12,458,501 1,266,157 Gross profit........................... 6,617,353 1,473,943 (57,605) 8,033,691 912,273 Operating expenses..................... 4,036,656 1,202,975 1,247,908 6,487,539 837,623 Depreciation and amortization.......... -- -- 280,423 280,423 10,179 ----------- ---------- ----------- ------------ ---------- Income (loss) from operations.......... 2,580,697 270,968 (1,585,936) 1,265,729 64,471 Interest expense, net.................. -- -- 170,253 170,253 -- Income tax provision (benefit)......... -- -- 443,822 443,822 26,431 Segment assets......................... -- -- 15,395,686 15,395,686 4,501,208 Capital expenditures................... -- -- 411,551 411,551 -- Total SC AHI Publishing Daxbourne Total ----------- ---------- ----------- ------------ Thirteen weeks ended July 1, 2000 Net sales (including royalties)........ $ 1,659,645 $2,719,658 $ 1,286,254 $ 14,541,814 Shipping & handling income............. -- 206,144 9,649 2,138,392 ----------- ---------- ----------- ------------ Total revenues......................... 1,659,645 2,925,802 1,295,903 16,680,206 Gross profit........................... 1,005,635 1,917,908 891,617 10,843,216 Operating expenses..................... 963,319 1,800,942 597,279 8,885,760 Depreciation and amortization.......... 35,475 45,654 90,252 416,329 ----------- ---------- ----------- ------------ Income (loss) from operations.......... 6,841 71,312 204,086 1,541,127 Interest expense, net.................. -- -- 55,430 225,683 Income tax provision (benefit)......... 2,657 29,088 66,419 539,329 Segment assets......................... 808,717 5,309,925 4,436,376 25,141,987 Capital expenditures................... 21,050 21,050 7,364 439,965
10 SPECIALTY CATALOG CORP. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited)
Paula Especially Corporate Total SC Western Total SC Young Yours Expenses Direct Schools AHI Publishing ----- ----- -------- ------ ------- --- ---------- Twenty-six weeks ended June 30, 2001 Net sales (including royalties).. $15,708,242 $4,520,234 $ -- $20,228,476 $2,970,577 $1,201,325 $4,171,902 Shipping & handling income....... 2,924.121 778,087 -- 3,702,208 562,741 -- 562,741 ----------- ---------- ---------- ----------- ---------- ---------- ---------- Total revenues................... 18,632,363 5,298,321 -- 23,930,684 3,533,318 1,201,325 4,734,643 Gross profit..................... 11,454,274 3,206,602 (116,354) 14,544,522 2,645,876 699,370 3,345,246 Operating expenses............... 6,867,057 2,784,848 2,729,005 12,380,910 1,701,005 1,153,522 2,854,527 Depreciation and amortization.... -- -- 591,213 591,213 29,111 99,209 128,320 ----------- ---------- ---------- ----------- ---------- ---------- --------- Income (loss) from operations.... 4,587,217 421,754 (3,436,572) 1,572,399 915,760 (553,361) 362,399 Interest expense, net............ -- -- 385,557 385,557 -- 104 104 Income tax provision (benefit)... -- -- 485,377 485,377 375,462 (226,921) 148,541 Segment assets................... -- -- 16,064,565 16,064,565 5,019,381 101,858 5,121,239 Capital expenditures............. -- -- 215,310 215,310 57,695 9,164 66,859 Paula Especially Corporate Total SC Western Total SC Young Yours Expenses Direct Schools AHI Publishing ----- ----- -------- ------ ------- --- ---------- Twenty-six weeks ended July 1, 2000 Net sales (including royalties).. $16,813,497 $3,727,093 $ -- $20,540,590 $2,761,295 $2,472,938 $5,234,233 Shipping & handling income....... 3,020,783 678,979 -- 3,699,762 529,772 21 529,793 ----------- ---------- ---------- ----------- ---------- ---------- ---------- Total revenues................... 19,834,280 4,406,072 -- 24,240,352 3,291,067 2,472,959 5,764,026 Gross profit..................... 12,723,789 2,674,480 (116,315) 15,281,954 2,431,504 1,477,715 3,909,219 Operating expenses............... 8,587,566 2,715,620 2,832,164 14,135,350 1,723,423 1,475,399 3,198,822 Depreciation and amortization.... -- -- 542,174 542,174 20,851 69,319 90,170 ----------- ---------- ---------- ----------- ---------- ---------- ---------- Income (loss) from operations 4,136,223 (41,140) (3,490,653) 604,430 687,230 (67,003) 620,227 Interest expense, net............ -- -- 325,457 325,457 -- -- -- Income tax provision (benefit)........................ -- -- 114,363 114,363 281,763 (27,471) 254,292 Segment assets................... -- -- 15,395,686 15,395,686 4,501,208 808,717 5,309,925 Capital expenditures............. -- -- 791,601 791,601 -- 58,324 58,324
Daxbourne Total --------- ----- Twenty-six weeks ended June 30, 2001 Net sales (including royalties).......... $3,149,737 $27,550,115 Shipping & handling income............... 27,398 4,292,347 ------------ ------------- Total revenues........................... 3,177,135 31,842,462 Gross profit............................. 2,214,471 20,104,239 Operating expenses....................... 1,365,742 16,601,179 Depreciation and amortization............ 196,927 916,460 ------------ ---------- Income (loss) from operations........... 651,802 2,586,600 Interest expense, net................... 84,410 470,071 Income tax provision (benefit).......... 232,630 866,548 Segment assets.......................... 2,429,287 23,615,091 Capital expenditures.................... 62,227 344,396 Daxbourne Total --------- ----- Twenty-six weeks ended July 1, 2000 Net sales (including royalties)......... $2,730,291 $28,505,114 Shipping & handling income.............. 20,479 4,250,034 ------------- ------------- Total revenues.......................... 2,750,770 32,755,148 Gross profit............................ 1,896,846 21,088,019 Operating expenses...................... 1,247,880 18,582,052 Depreciation and amortization........... 183,686 816,030 ------------- ------------- Income (loss) from operations 465,280 1,689,937 Interest expense, net.................. 116,225 441,682 Income tax provision 143,114 511,769 (benefit).............................. Segment assets......................... 4,436,376 25,141,987 Capital expenditures................... 22,723 872,648
11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations In addition to the historical information contained herein, this Quarterly Report on Form 10-Q for the Company may contain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 ("Exchange Act"), including, but not limited to, the Company's expected future revenues, operations and expenditures, estimates of the potential markets for the Company's products, assessments of competitors and potential competitors and projected timetables for the market introduction of the Company's products. Investors are cautioned that forward-looking statements are inherently uncertain. Actual performance and results of operations may differ materially from those projected or suggested in the forward-looking statements due to certain risks and uncertainties, including, but not limited to, the following risks and uncertainties: (i) the Company's indebtedness and future capital requirements, (ii) increasing postal rates, paper prices and media costs, (iii) limited sources of fiber used to make the Company's products, (iv) the limited number of suppliers of the Company's products, (v) the Company's dependence upon foreign suppliers, especially in China, Indonesia and Korea, (vi) the customary risks of doing business abroad, including fluctuations in the value of currencies, (vii) the potential development of a cure for hair loss and cancer treatment improvements, (viii) the effectiveness of the Company's catalogs and advertising programs, (ix) the Company's competition, (x) the impact of acquisitions on the Company's prospects and (xi) the completion of the transaction contemplated by the merger agreement. Additional information concerning certain risks and uncertainties that could cause actual results to differ materially from those projected or suggested in the forward-looking statements is contained in the Company's filings with the Securities and Exchange Commission, including those risks and uncertainties discussed under the caption "Risk Factors" in the Company's Form 10-K for the year ended December 30, 2000. The forward-looking statements contained herein represent the Company's judgment as of the date of this Quarterly Report on Form 10-Q, and the Company cautions readers not to place undue reliance on such statements. Thirteen Weeks Ended June 30, 2001 Compared to the Thirteen Weeks Ended July 1, 2000 Revenues decreased to $15.3 million for the thirteen weeks ended June 30, 2001 from $16.7 million for the thirteen weeks ended July 1, 2000, a decrease of approximately $1.4 million or 8.4 percent. This change in revenues was due to decreases in SC Direct's and AHI's revenues of approximately $944,000 and $944,000, respectively, offset by increases in Western Schools and Daxbourne's revenues of approximately $199,000 and $309,000, respectively. The overall revenue decrease in SC Direct was caused by reducing the number of catalogs circulated during the thirteen weeks ended June 30, 2001 compared to the thirteen weeks ended July 1, 2000. The Paula Young business sales decreased by $1.2 million, offset by a revenue increase in the Especially Yours business of approximately $286,000. This total revenue decrease was offset by a decrease in merchandise return rates resulting from the Company's initiatives during the latter half of fiscal year 2000 to implement several marketing, creative, operational and merchandising changes. AHI's revenue decrease was caused by the elimination of unprofitable seminars during the thirteen weeks ended June 30, 2001 compared to the thirteen weeks ended July 1, 2000. Daxbourne's revenue increase primarily related to the acquisition of the Paula Young UK business in January 2001 which had revenues of approximately $167,000 for the thirteen weeks ended June 30, 2001. Gross profit as a percentage of revenues decreased to 64.1 percent for the thirteen weeks ended June 30, 2001 from 65.0 percent for the thirteen weeks ended July 1, 2000 as a result of merchandise sales mix changes. Gross profit decreased to $9.8 million for the thirteen weeks ended June 30, 2001 from $10.8 million for the thirteen weeks ended July 1, 2000, a decrease of approximately $1.0 million or 9.3 percent. 12 This decrease was due to the decrease in revenues discussed above as well as the decrease in the gross profit rate also discussed above. Operating expenses decreased to $8.2 million for the thirteen weeks ended June 30, 2001 from $9.3 million for the thirteen weeks ended July 1, 2000, a decrease of approximately $1.1 million or 11.8 percent. As mentioned above, the decrease in operating expenses was due to the Company's decision to reduce catalog circulation. Interest expense, net of interest income, decreased to approximately $207,000 for the thirteen weeks ended June 30, 2001 from approximately $226,000 for the thirteen weeks ended July 1, 2000, a decrease of approximately $19,000 or 8.4 percent. The decrease was attributable to lower interest rates on variable rate borrowings not hedged by the interest rate swap agreement during the thirteen weeks ended June 30, 2001 compared to the thirteen weeks ended July 1, 2000, offset by the loss recorded on the fair value of the interest rate swap agreement of approximately $38,000 and by higher average principal amounts outstanding on the Company's bank facility. Twenty-Six Weeks Ended June 30, 2001 Compared to the Twenty-Six Weeks Ended July 1, 2000 Revenues decreased to $31.8 million for the twenty-six weeks ended June 30, 2001 from $32.8 million for the twenty-six weeks ended July 1, 2000, a decrease of $1.0 million or 3.1 percent. This change in revenues was due to decreases in SC Direct's and AHI's revenues of approximately $310,000 and $1.3 million, respectively, offset by increases in Western Schools and Daxbourne's revenues of approximately $242,000 and $426,000, respectively. The overall revenue decrease in SC Direct was caused by reducing the number of catalogs circulated during the twenty-six weeks ended June 30, 2001 compared to the twenty-six weeks ended July 1, 2000. The Paula Young business sales decreased by $1.2 million, offset by a revenue increase in the Especially Yours business of approximately $892,000. This total revenue decrease was offset by a decrease in merchandise return rates resulting from the Company's initiatives during the latter half of fiscal year 2000 to implement several marketing, creative, operational and merchandising changes. AHI's revenue decrease was caused by the elimination of unprofitable seminars during the twenty-six weeks ended June 30, 2001 compared to the twenty-six weeks ended July 1, 2000. Daxbourne's revenue increase primarily related to the acquisition of the Paula Young UK business in January 2001 which had revenues of approximately $214,000 for the twenty-six weeks ended June 30, 2001. Gross profit as a percentage of revenues decreased to 63.1 percent for the twenty-six weeks ended June 30, 2001 from 64.4 percent for the twenty-six weeks ended July 1, 2000 as a result of merchandise sales mix changes. Gross profit decreased to $20.1 million for the twenty-six weeks ended June 30, 2001 from $21.1 million for the twenty-six weeks ended July 1, 2000, a decrease of approximately $1.0 million or 4.7 percent. This decrease was due to the decrease in revenues discussed above as well as the decrease in the gross profit rate also discussed above. Operating expenses decreased to $17.5 million for the twenty-six weeks ended June 30, 2001 from $19.4 million for the twenty-six weeks ended July 1, 2000, a decrease of approximately $1.9 million or 9.8 percent. The decrease was due to the Company's decision to reduce catalog circulation and advertising promotions. Interest expense, net of interest income, increased to approximately $470,000 for the twenty-six weeks ended June 30, 2001 from approximately $442,000 for the twenty-six weeks ended July 1, 2000, an increase of approximately $28,000 or 6.3 percent. The increase was attributable to the loss recorded on the fair value of the interest rate swap agreement of approximately $85,000 and by higher average principal amounts outstanding 13 on the Company's bank facility, offset by lower interest rates on variable rate borrowings not hedged by the interest rate swap agreement during the twenty-six weeks ended June 30, 2001 compared to the twenty-six weeks ended July 1, 2000. Liquidity and Capital Resources Net cash flows provided by the Company for the twenty-six weeks ended June 30, 2001 were $1.1 million. Cash flows provided by operating activities for the twenty-six weeks ended June 30, 2001 were $3.7 million, offset by uses of approximately $782,000 in investing activities and $1.7 million in financing activities. The major factors that caused the difference between net income and net cash flows provided by operations for the twenty-six weeks ended June 30, 2001 were increases in: (i) depreciation and amortization expense of approximately $916,000, (ii) deferred income taxes of approximately $422,000 and (iii) cash working capital items of $1.1 million. The Company used approximately $782,000 in investing activities, of which approximately $345,000 was for computer and equipment purchases and approximately $437,000 was used to acquire the Paula Young UK license from the Company's former British licensee. The $1.7 million in net cash used in financing activities was primarily due to: (i) the repayment of $900,000 of long-term debt, (ii) the repayment of short-term borrowings of approximately $788,000, and (iii) the repayment of approximately $49,000 of capital leases. On December 27, 2000, the Company entered into a $12.25 million credit agreement (the "Agreement") with Fleet National Bank, N.A. (the "Bank") for the purpose of refinancing its existing senior debt and to provide for the working capital needs of the Company. The new credit facility, which may be increased to $13.0 million in 2002, replaces the Company's former credit facilities with the Bank. The Agreement includes a $9.0 million five-year term note (the "Term Loan") and a $3.25 million two-year revolving credit agreement (the "Line of Credit"). The amount available on the Line of Credit increases as principal amortization payments on the Term Loan are paid, such that the total Agreement remains at $12.25 million over the two years of the Line of Credit agreement. The Line of Credit provides for revolving credit loans and letters of credit with floating rates based on margins over LIBOR or prime at the Company's option. The Term Loan is for five years and is amortized at the rate of $450,000 a quarter beginning January 1, 2001. As of June 30, 2001, $8.1 million of the Term Loan was under LIBOR contract rates ranging from 6.1681 percent to 7.0 percent (including the Bank's lending margin). At June 30, 2001, $2.8 million was available under the Line of Credit. The Agreement is collateralized by a first perfected security interest in all tangible and intangible assets of the Company, subject to certain permitted liens. The Agreement is subject to certain consolidated covenants, including but not limited to, leverage and debt service coverage ratios, minimum earnings requirements, limitation on capital expenditures, excess cash flow recapture, and a restriction on the payment of cash dividends on the Company's common stock. The Company's cash flow from operations and available credit facilities are considered adequate to fund planned business operations and both the short-term and long-term capital needs of the Company. However, certain events, such as an additional significant acquisition, could require new external financing. Recently Issued Accounting Pronouncements SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", is effective for all fiscal years beginning after June 15, 2000. SFAS No. 133, as amended, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. Under SFAS No. 133, certain contracts that were not formerly 14 considered derivatives may now meet the definition of a derivative. The Company adopted SFAS No. 133 effective December 31, 2000. On January 19, 2001, the Company and the Bank entered into an Interest Rate Swap Agreement based on a notional principal balance of $4.5 million. Under the interest rate swap agreement, the Company receives quarterly LIBOR-based interest rate payments from the Bank, and pays interest quarterly at a fixed rate of 5.57% to the Bank, plus a borrowing margin to the Bank. These interest rate payments are settled net with the Bank. The agreement is effective for a period of two years and terminates on January 19, 2003. The interest rate swap is carried at its fair value. Hedge accounting is not applied and changes in the fair value of the swap are included in interest expense, net. At June 30, 2001, the carrying value of the swap was approximately $85,000, which is included in accrued expenses. Interest expense, net was increased by approximately $38,000 and $85,000 in the thirteen and twenty-six weeks ended June 30, 2001, respectively, which represents the change in the fair value of the swap during these periods. Quantitative and Qualitative Disclosures About Market Risk The Company's primary exposures to market risks include fluctuations in interest rates on its short-term and long-term borrowings of $8.1 million as of June 30, 2001 under its credit facility. Management does not believe that the risk inherent in the variable-rate nature of these instruments will have a material adverse effect on the Company's consolidated financial statements. However, no assurance can be given that such a risk will not have a material adverse effect on the Company's financial statements in the future. As of June 30, 2001, the outstanding balance on all of the Company's credit facilities was $8.1 million. Based on this balance less the amount covered by the interest rate swap agreement, an immediate change of one percent in the interest rate would cause a change in interest expense of approximately $36,000 on an annual basis. The Company's objective in maintaining these variable rate borrowings is the flexibility obtained regarding early repayment without penalties and lower overall cost as compared with fixed-rate borrowings. The foreign currencies to which the Company has the most significant exchange rate exposure are the British Pound, Chinese Yuan, Indonesian Rupiah and Korean Won. The Company expects that most of its wigs and hairpieces will continue to be manufactured in China, Indonesia and Korea in the future. Although a substantial portion of the Company's transactions with these countries occurs in US dollars, the Company's operations are subject to fluctuations in the value of these countries' currencies. Although to date such exchange rate exposures have not had a significant effect on the Company's business operations, no assurance can be given that such exchange rate exposures will not have a material adverse effect on the Company's business operations in the future. PART II. OTHER INFORMATION Item 2. Changes in Securities and Use of Proceeds Rights Agreement Amendment On April 11, 2000, the board of directors of Specialty Catalog adopted a stockholder rights plan pursuant to a rights agreement dated as of April 11, 2000, between Specialty Catalog and Continental Stock Transfer and Trust Company, as rights agent. The rights agreement is effective as of April 11, 2000 for all shares of common stock of Specialty Catalog outstanding on such date and for certain shares 15 of common stock issued thereafter. Pursuant to the rights agreement, at any time a person (other than an "exempt person") becomes the beneficial owner of 15% or more of Specialty Catalog's common stock, a "right" is exercisable by the registered holder of a right certificate to purchase 1/1000th of a share of series A preferred stock of Specialty Catalog, subject to adjustment, at an exercise price per 1/1000th of a share of series A preferred stock of $15, subject to adjustment. Each 1/1000th of a share of series A preferred stock will have economic attributes (i.e., participation in dividends and voting rights) substantially equivalent to one whole share of the common stock of Specialty Catalog. The rights expire on the tenth anniversary of the date of the rights agreement unless earlier redeemed or exchanged by Specialty Catalog as provided in the rights agreement. Prior to the execution of the merger agreement, Specialty Catalog entered into an amendment to the rights agreement. In accordance with the amendment, the definition of "exempt person" was amended to include any person or persons, or persons later joining such person or group of persons, who, prior to the time they become the beneficial owner of 15% or more of Specialty Catalog's common stock, receives the approval of the board of directors of Specialty Catalog for the underlying transaction or transactions which results in the beneficial ownership of 15% or more of Specialty Catalog's common stock. Mr. Naggar, and the other stockholders who joined him in the proposed transaction in connection with the merger agreement, are "exempt persons" because the merger agreement and the transactions contemplated thereby have received the approval of our board of directors prior to the time that those stockholders became the beneficial owner of more than 15% of Specialty Catalog's common stock as a result of such transactions. See "Item 5. Other Information - Merger Agreement" below. ITEM 5. Other Information Merger Agreement On April 30, 2001, the Company announced that Mr. Guy Naggar, a British investor and substantial stockholder and director of the Company, has submitted a proposal to acquire for cash, through merger, all of the issued and outstanding shares of common stock of the Company, other than his shares and the shares of others who may join him, for $3.75 a share. On May 4, 2001, the Company entered into a definitive Merger Agreement with Specialty Acquisition Corp., a Delaware corporation owned by Mr. Naggar and several other substantial stockholders of the Company. The Merger Agreement provides for a cash merger in which the holders of common stock of the Company, other than Specialty Acquisition Corp., immediately prior to the merger, will receive $3.75 per share in cash for each share of common stock of Specialty Catalog Corp owned before the merger. The merger is subject to the satisfaction of a number of closing conditions, including, but not limited to, the consummation of financing arrangements and approval by the stockholders of Specialty Catalog Corp. The merger is expected to close in the fall of 2001. Other stockholders, including certain members of the Board of Directors of the Company, have joined Mr. Naggar in the proposed transaction. 16 ITEM 6. Exhibits and Reports on Form 8-K (a) Exhibits 2.1 Agreement and Plan of Recapitalization and Merger by and between Specialty Acquisition Corp. and Specialty Catalog Corp. dated May 4, 2001. Filed as Exhibit 2.1 to Specialty Catalog Corp.'s Form 10- Q, dated May 15, 2001. 4.1 Rights Agreement, dated as of April 11, 2000, between Specialty Catalog Corp. and Continental Stock Transfer and Trust Company, As Rights Agent. Filed as Exhibit 4.1 to Specialty Catalog Corp.'s Form 8-K, dated April 13, 2000. 4.2 Amendment No. 1 to the Rights Agreement, dated as of March 26, 2001, between Specialty Catalog Corp. and Continental Stock Transfer and Trust Company, As Rights Agent. Filed as Exhibit 99 (d) (16) to Specialty Catalog Corp.'s Form 13E-3/A, dated July 23, 2001. (b) Reports on Form 8-K One report on Form 8-K was filed on May 7, 2001 to report that the Company has entered into a merger agreement. See the Merger Agreement note of the condensed consolidated financial statements. 17 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SPECIALTY CATALOG CORP. Dated: August 10, 2001 By: /s/ Joseph Grabowski ------------------------------ President and Chief Executive Officer Dated: August 10, 2001 By: /s/ Thomas McCain ------------------------------ Thomas McCain Senior Vice President and Chief Financial Officer 18