<PAGE>
================================================================================
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 PERIOD ENDED OCTOBER 3, 1998
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 (I.R.S. Employer Identification No.)
Incorporation or Organization)
21 BRISTOL DRIVE
SOUTH EASTON, MASSACHUSETTS 02375
(Address of principal executive offices)
TELEPHONE NUMBER (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 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 [_]
---
As of November 1, 1998, there were 5,057,001 shares of the Registrant's
Common Stock outstanding.
================================================================================
<PAGE>
SPECIALTY CATALOG CORP.
INDEX
PART I. FINANCIAL STATEMENTS
Page No.
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AS
OF OCTOBER 3, 1998 AND JANUARY 3, 1998, FOR THE
THREE MONTHS ENDED OCTOBER 3, 1998 AND SEPTEMBER
27, 1997 AND FOR THE NINE MONTHS ENDED OCTOBER 3, 1998
AND SEPTEMBER 27, 1997
Condensed Consolidated Statements of Operations 3
Condensed Consolidated Balance Sheets 4
Condensed Consolidated Statements of Cash Flows 5-6
Notes to Condensed Consolidated Financial Statements 7-9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 10-15
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 15
SIGNATURES 16
2
<PAGE>
PART I. FINANCIAL STATEMENTS
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SPECIALTY CATALOG CORP.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
OCTOBER 3, 1998 SEPTEMBER 27, 1997 OCTOBER 3, 1998 SEPTEMBER 27, 1997
--------------- ------------------ --------------- ------------------
<S> <C> <C> <C> <C>
Net sales $11,011,492 $9,285,242 $37,583,250 $31,531,937
Cost of sales (including buying,
occupancy and order fulfillment costs) 3,952,927 3,256,985 13,531,943 10,701,088
----------- ---------- ----------- -----------
Gross profit 7,058,565 6,028,257 24,051,307 20,830,849
Operating expenses:
Selling, general & administrative
expense 5,823,443 4,418,988 21,108,127 17,863,094
Restructuring charge 469,558 --- 469,558 ---
----------- ---------- ----------- -----------
Total operating expenses 6,293,001 4,418,988 21,577,685 17,863,094
----------- ---------- ----------- -----------
Income from operations 765,564 1,609,269 2,473,622 2,967,755
Interest expense, net 208,185 157,267 633,420 598,240
----------- ---------- ----------- -----------
Income before income taxes
and extraordinary item 557,379 1,452,002 1,840,202 2,369,515
Income tax provision 237,835 609,840 760,800 995,196
----------- ---------- ----------- -----------
Income before extraordinary item 319,544 842,162 1,079,402 1,374,319
Extraordinary item - loss on early
extinguishment of debt (net
of income tax benefit of
$149,083 for the nine months
ended September 27, 1997) --- --- --- 218,699
----------- ---------- ----------- -----------
Net income $ 319,544 $ 842,162 $ 1,079,402 $ 1,155,620
=========== ========== =========== ===========
Earnings per share - Basic:
Income before extraordinary item $ 0.06 $ 0.17 $ 0.21 $ 0.28
Loss on extraordinary item --- --- --- $ 0.04
----------- ---------- ----------- -----------
Net income per share $ 0.06 $ 0.17 $ 0.21 $ 0.24
=========== ========== =========== ===========
Weighted average shares outstanding 5,057,001 4,967,001 5,052,129 4,866,525
=========== ========== =========== ===========
Earnings per share - Diluted:
Income before extraordinary item $ 0.06 $ 0.15 $ 0.20 $ 0.25
Loss on extraordinary item --- --- --- $ 0.04
----------- ---------- ----------- -----------
Net income per share $ 0.06 $ 0.15 $ 0.20 $ 0.21
=========== ========== =========== ===========
Weighted average shares outstanding 5,517,927 5,543,028 5,520,309 5,523,587
=========== ========== =========== ===========
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE>
SPECIALTY CATALOG CORP.
CONDENSED CONSOLIDATED BALANCE SHEETs
(unaudited)
<TABLE>
<CAPTION>
ASSETS OCTOBER 3, 1998 JANUARY 3, 1998
--------------- ---------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 351,146 $ 603,840
Accounts receivable, net 1,315,704 1,123,176
Inventories 6,901,079 6,258,928
Prepaid expenses 3,899,183 3,344,675
----------- -----------
Total current assets 12,467,112 11,330,619
----------- -----------
Property, plant and equipment, net 2,862,838 2,162,803
----------- -----------
Intangible assets, net 3,846,436 3,942,547
----------- -----------
Deferred income taxes 4,839,432 5,560,050
----------- -----------
Other assets 192,991 297,086
----------- -----------
Total assets $24,208,809 $23,293,105
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 2,712,098 $ 3,123,100
Liabilities to customers 1,024,418 996,943
Line of credit 5,580,592 3,784,952
Income taxes --- 282,329
Current portion of long-term debt 1,277,122 1,567,666
Deferred purchase price --- 492,510
----------- -----------
Total current liabilities 10,594,230 10,247,500
----------- -----------
Long-term debt 4,396,487 5,012,092
Other long-term liabilities 159,175 167,755
Commitments and contingencies
Stockholders' equity:
Common stock 50,570 50,220
Additional paid-in capital 15,916,252 15,838,826
Deferred compensation (52,738) (65,862)
Accumulated other comprehensive income 26,352 3,495
Accumulated deficit (6,881,519) (7,960,921)
----------- -----------
Total stockholders' equity 9,058,917 7,865,758
----------- -----------
Total liabilities and stockholders' equity $24,208,809 $23,293,105
=========== ===========
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE>
SPECIALTY CATALOG CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
OCTOBER 3, 1998 SEPTEMBER 27, 1997
--------------- ------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,079,402 $ 1,155,620
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 539,318 218,056
Deferred income taxes 720,618 471,532
Amortization of deferred compensation 13,124 13,125
Extraordinary loss due to early extinguishment of debt --- 98,504
Changes in operating assets and liabilities:
Accounts receivable (182,792) (333,668)
Inventories (621,425) (470,202)
Prepaid expenses (489,472) 1,264,277
Other assets 101,731 51,784
Accounts payable and accrued expenses (428,060) (854,002)
Liabilities to customers 27,475 191,290
Income taxes (282,329) 4,621
Other long-term liabilities 37,503 ---
----------- ----------
Net cash provided by operating activities 515,093 1,810,937
----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment (982,270) (602,633)
----------- ----------
Net cash used in investing activities (982,270) (602,633)
----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock 10,753 ---
Repayment of capital lease obligation (46,083) ---
Proceeds from line of credit, net 1,721,719 2,027,760
Repayment of long term debt (969,011) ---
Repayment of deferred purchase price obligation (505,140) ---
Issuance of long term debt --- 5,000,000
Repayment of subordinated debt --- (4,224,683)
Repayment of BNP debt --- (5,400,000)
----------- ----------
Net cash provided by (used in) financing activities 212,238 (2,596,923)
----------- ----------
Effect of exchange rate changes on cash and cash equivalents 2,245 ---
----------- ----------
Decrease in cash and cash equivalents (252,694) (1,388,619)
Cash and cash equivalents, beginning of period 603,840 1,392,344
----------- ----------
Cash and cash equivalents, end of period $ 351,146 $ 3,725
=========== ==========
</TABLE>
See notes to condensed consolidated financial statements.
5
<PAGE>
SPECIALTY CATALOG CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(unaudited)
SUMMARY OF NONCASH TRANSACTIONS:
During the nine months ended October 3, 1998, an officer of the Company
exercised 35,000 stock options for which the Company recorded a deduction in its
income tax payable and an increase in additional paid in capital of $67,024.
In April 1997, $495,000 of junior subordinated debt and $5,000 of accrued
interest was converted into $2,653 of common stock and $497,343 of additional
paid-in capital as a result of a cashless exercise of warrants.
In March 1997, $131,146 of note receivable from a stockholder was offset
against the portion of the subordinated notes owed to that stockholder.
See notes to condensed consolidated financial statements.
6
<PAGE>
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 Annual Report on Form 10-K of Specialty Catalog Corp.
(the "Company") for the fiscal year ended January 3, 1998, 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 generally accepted accounting principles have been
condensed or omitted pursuant to the Securities and Exchange Commission rules
and regulations. The results of operations for the three and nine months ended
October 3, 1998 are not necessarily indicative of the results for the entire
fiscal year ending January 2, 1999.
The financial statements for the three and nine months ended October 3,
1998 and September 27, 1997 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 financial statements are those set
forth in Note 1 of the financial statements included in the Company's Annual
Report on Form 10-K for the year ended January 3, 1998.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive
Income," which became effective for the Company for periods beginning after
December 15, 1997. SFAS No. 130 establishes standards for reporting and
displaying comprehensive income and its components (revenues, expenses, gains
and losses) in a full set of general purpose financial statements. SFAS No. 130
requires that a company (a) classify items of other comprehensive income by
their nature in a financial statement and (b) display the accumulated balance of
other comprehensive income separately from retained earnings and additional
paid-in-capital in the equity section of the balance sheet. Reclassification of
financial statements for earlier periods provided for comparative purposes is
required. The Company adopted this statement during the first quarter of 1998.
Comprehensive income consists solely of accumulated foreign currency translation
adjustments in connection with the Company's United Kingdom subsidiary. During
the three and nine months ended October 3, 1998, the Company has recognized
other comprehensive income of $26,497 and $22,857, respectively.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information" which
became effective for the Company for periods beginning after December 15, 1997.
SFAS No. 131 establishes standards for the way public companies report selected
information about operating segments in annual financial statements and requires
those companies to report selected information about segments in interim
financial reports issued to shareholders. It also establishes standards for
related disclosures about products and services, geographic areas, and major
customers. SFAS No. 131 supersedes SFAS No. 14, "Financial Reporting
Segments of a Business
7
<PAGE>
SPECIALTY CATALOG CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
Enterprise," but retains the requirement to report information about major
customers. As required, the Company will adopt SFAS No. 131 in the fourth
quarter of 1998.
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 98-1 ("SOP 98-1"), "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use". SOP 98-1
requires that costs incurred in the development of internal use software be
capitalized and amortized over a period of time. Specifically, external direct
costs of materials and services consumed in developing or obtaining internal use
computer software, payroll and payroll related costs for employees who are
directly associated with and who devote time to the internal use computer
software project, and interest cost incurred when developing computer software
for internal use, should be capitalized. Costs to develop or obtain software
that allows for access or conversion of old data by new systems should also be
capitalized. All other data conversion and all training costs on the internal
use software should be expensed as incurred. SOP 98-1 is effective for fiscal
years beginning after December 15, 1998 with earlier application encouraged in
fiscal years for which annual financial statements have not been issued. The
provisions of SOP 98-1 should be applied to internal use software costs incurred
in those fiscal years for all projects, including those projects in progress
upon initial application of SOP 98-1. Costs incurred prior to initial
application of SOP 98-1, whether capitalized or not, should not be adjusted to
the amounts that would have been capitalized had SOP 98-1 been in effect when
those costs were incurred. The Company adopted SOP 98-1 in the first quarter of
1998. During the three and nine months ended October 3, 1998, the Company has
capitalized approximately $97,000 and $314,000, respectively, of costs
associated with a new comprehensive catalog information system, of which
approximately $40,000 and $156,000, respectively, were internal payroll and
payroll related costs.
In April 1998, the AICPA issued Statement of Position 98-5 ("SOP 98-5"),
"Reporting on the Costs of Start-Up Activities". SOP 98-5 requires costs of
start-up activities and organization costs to be expensed as incurred. SOP 98-5
had no impact on the Company's financial condition or results of operations for
the three and nine months ended October 3, 1998.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This statement
is effective for the Company's fiscal year beginning January 3, 1999. The
Company has not yet determined the effect of adopting SFAS No. 133 on the
consolidated financial statements.
3. Reconciliation of Basic and Diluted Earnings per Share
The following data shows the amounts used in computing basic and diluted
earnings per share for income before extraordinary items and the effects of
potentially dilutive securities on the weighted average number of shares
outstanding.
8
<PAGE>
SPECIALTY CATALOG CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
OCTOBER 3, SEPTEMBER 27, OCTOBER 3, SEPTEMBER 27,
---------- ------------- ---------- -------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Income before extraordinary item $ 319,544 $ 842,162 $1,079,402 $1,374,319
BASIC EPS $ 0.06 $ 0.17 $ 0.21 $ 0.28
========== ========== ========== ==========
Basic weighted average shares outstanding 5,057,001 4,967,001 5,052,129 4,866,525
========== ========== ========== ==========
EFFECT OF DILUTIVE SECURITIES
Stock options 460,926 576,027 468,180 583,720
Warrants -- -- -- 73,342
---------- ---------- ---------- ----------
Income before extraordinary item
plus assumed conversions $ 319,544 $ 842,162 $1,079,402 $1,374,319
DILUTED EPS $ 0.06 $ 0.15 $ 0.20 $ 0.25
========== ========== ========== ==========
Diluted weighted average shares
outstanding 5,517,927 5,543,028 5,520,309 5,523,587
========== ========== ========== ==========
</TABLE>
Options to purchase 641,935 and 566,935 shares, respectively, of common
stock ranging in prices from $5.33 to $7.15 per share and from $6.50 to $7.15
per share, respectively, were not included in computing diluted EPS for the
three and nine months ended October 3, 1998 because their effects were anti-
dilutive. Options to purchase 152,500 shares of common stock ranging in prices
from $6.88 to $7.15 per share were not included in computing diluted EPS for the
three months and nine months ended September 27, 1997 because their effects were
anti-dilutive.
Amounts presented for the three and nine months ended September 27, 1997
have been restated for the adoption of FAS 128.
4. Restructuring Charge
In August 1998, the Company announced a reorganization of certain
management positions. In connection with this reorganization, the Company
recorded in the third quarter of 1998 a pre-tax charge of $469,558, consisting
of severance and other severance related benefits for five former employees of
the Company. The Company will pay out the severance and severance related
benefits through August 1999. Included in accrued expenses at October 3, 1998
are accrued restructuring charges of $369,385.
9
<PAGE>
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 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, 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) system issues related
to the Year 2000. 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 Commission, including those risks and uncertainties
discussed under the caption "Risk Factors" in the Company's Form 10-K for the
year ended January 3, 1998. The forward-looking statements contained herein
represent the Company's judgment as of the date of this Report on Form 10-Q, and
the Company cautions readers not to place undue reliance on such statements.
THREE MONTHS ENDED OCTOBER 3, 1998 COMPARED TO THREE MONTHS ENDED SEPTEMBER 27,
1997
Net sales increased $1.7 million, or 18.3%, from $9.3 million for the three
months ended September 27, 1997 to $11.0 million for the three months ended
October 3, 1998. This increase was due to (i) the addition of $1.3 million in
net sales from Daxbourne, a leading United Kingdom retailer and wholesaler of
women's wigs and hairpieces, which was acquired by the Company in October 1997
and (ii) the continued success of the Company's Paula's Hatbox and Especially
Yours catalogs, which together increased net sales by approximately $746,000 for
the three months ended October 3, 1998 compared to the three months ended
September 27, 1997. The increase in net sales was offset by a decrease in net
sales from the Company's Paula Young catalogs of approximately $410,000 due to
lower response rates and smaller average order sizes.
Gross margin dollars increased $1.0 million, or 16.7%, from $6.0 million
for the three months ended September 27, 1997 to $7.0 million for the three
months ended October 3, 1998. The gross margin percentage decreased from 64.9%
for the three months ended September 27, 1997 to 64.1% for the three months
ended October 3, 1998. The decrease in gross margin percentage for the three
months ended October 3, 1998 compared to the three months ended September 27,
1997 related primarily to increased sales of hats, accessories and apparel which
have lower margins than wigs and hair pieces.
Selling, general and administrative expenses ("SG&A") increased $1.4
million, or 31.8%, from $4.4 million for the three months ended September 27,
1997 to $5.8 million for the three months ended October 3, 1998. The increase in
SG&A related primarily to (i) the addition of approximately $679,000 of expenses
from Daxbourne for the three months ended October 3, 1998, (ii) additional
catalog production and mailing
10
<PAGE>
expenses of approximately $636,000 for the three months ended October 3, 1998
compared to the three months ended September 27, 1997, due primarily to an
increase in the number of catalogs mailed as well as increased page counts in
the Company's Paula's Hatbox and Especially Yours catalogs and (iii) expenses of
approximately $93,000 for legal and investment banker services in connection
with the Company's efforts to explore various strategic alternatives to maximize
shareholder value, including the possible sale or recapitalization of the
Company. The increase in SG&A expense for the three months ended October 3, 1998
compared to the three months ended September 27, 1997 was offset by (i) a
decrease in advertising expense of approximately $163,000 and (ii) an increase
in shipping and handling income of approximately $111,000.
In August 1998, the Company announced a reorganization of certain
management positions. In connection with this reorganization, the Company
recorded in the third quarter of 1998 a pre-tax charge of $469,558, consisting
of severance and other severance related benefits for five former employees of
the Company. The Company will pay out the severance and severance related
benefits through August 1999. Included in accrued expenses at October 3, 1998
are accrued restructuring charges of $369,385.
Net interest expense increased approximately $51,000, or 32.5%, from
approximately $157,000 for the three months ended September 27, 1997 to
approximately $208,000 for the three months ended October 3, 1998, reflecting
higher principal amounts outstanding under the Company's bank facility due to
additional borrowing to acquire Daxbourne during the fourth quarter of 1997.
NINE MONTHS ENDED OCTOBER 3, 1998 COMPARED TO NINE MONTHS ENDED SEPTEMBER 27,
1997
Net sales increased $6.1 million, or 19.4%, from $31.5 million for the nine
months ended September 27, 1997 to $37.6 million for the nine months ended
October 3, 1998. This increase was due to (i) the addition of $3.9 million in
net sales from Daxbourne, a leading United Kingdom retailer and wholesaler of
women's wigs and hairpieces, which was acquired by the Company in October 1997
and (ii) the continued success of the Company's Paula's Hatbox and Especially
Yours catalogs, which together increased net sales by $2.6 million for the nine
months ended October 3, 1998 compared to the nine months ended September 27,
1997. The increase in net sales was offset by a decrease in net sales from the
Company's Paula Young catalogs of approximately $396,000 due to lower response
rates and smaller average order sizes.
Gross margin dollars increased $3.2 million, or 15.4%, from $20.8 million
for the nine months ended September 27, 1997 to $24.0 million for the nine
months ended October 3, 1998. The gross margin percentage decreased from 66.1%
for the nine months ended September 27, 1997 to 64.0% for the nine months ended
October 3, 1998. The decrease in gross margin percentage related primarily to
(i) expanded promotional pricing on several of the Company's wig and hairpiece
products, which resulted in a decrease in the average order size for the nine
months ended October 3, 1998 compared to the nine months ended September 27,
1997, (ii) increased sales of hats, accessories and apparel which have lower
margins than wigs and hairpieces and (iii) an increase in freight charges as a
result of an increase in the amount of merchandise air freighted for the nine
months ended October 3, 1998 compared to the nine months ended September 27,
1997.
Selling, general and administrative expenses increased $3.2 million, or
17.9%, from $17.9 million for the nine months ended September 27, 1997 to $21.1
million for the nine months ended October 3, 1998. The increase in SG&A related
primarily to (i) the addition of $2.1 million of expenses from Daxbourne for the
nine months ended October 3, 1998, (ii) additional catalog production and
mailing expenses of $1.5 million for the nine months ended October 3, 1998
compared to the nine months ended September 27, 1997, due
11
<PAGE>
primarily to an increase in the number of catalogs mailed as well as increased
page counts in the Company's Paula's Hatbox and Especially Yours catalogs and
(iii) expenses of approximately $93,000 for legal and investment banker services
in connection with the Company's efforts to explore various strategic
alternatives to maximize shareholder value, including the possible sale or
recapitalization of the Company. The increase in SG&A expense for the nine
months ended October 3, 1998 compared to the nine months ended September 27,
1997 was offset by (i) a decrease in advertising expense of approximately
$487,000 and (ii) an increase in shipping and handling income of approximately
$366,000.
In August 1998, the Company announced a reorganization of certain
management positions. In connection with this reorganization, the Company
recorded in the third quarter of 1998 a pre-tax charge of $469,558, consisting
of severance and other severance related benefits for five former employees of
the Company. The Company will pay out the severance and severance related
benefits through August 1999. Included in accrued expenses at October 3, 1998
are accrued restructuring charges of $369,385.
In June 1997, SC Publishing, a subsidiary of the Company, sold its business
of continuing education for real estate professionals. The Company recognized a
pre-tax gain, included in SG&A, on the sale of these assets of $121,980.
Net interest expense increased approximately $35,000, or 5.9%, from
approximately $598,000 for the nine months ended September 27, 1997 to
approximately $633,000 for the nine months ended October 3, 1998, reflecting
lower interest rates which were offset by higher principal amounts outstanding
on the Company's bank facility due to additional borrowing to acquire Daxbourne
during the fourth quarter of 1997.
The Company recorded a $218,699 extraordinary loss on the early
extinguishment of debt (net of income tax benefit of $149,083) for the nine
months ended September 27, 1997.
LIQUIDITY AND CAPITAL RESOURCES
During the first nine months of 1998, sources of operating cash flows
consisted primarily of (i) net income of approximately $1.1 million, (ii)
depreciation and amortization of approximately $539,000 and (iii) a decrease in
deferred income taxes of approximately $721,000. These operating cash flow
sources were offset by (i) an increase in accounts receivable of approximately
$183,000, (ii) an increase in inventories of approximately $621,000, (iii) an
increase in prepaid expenses of approximately $489,000 and (iv) a decrease in
accounts payable and accrued expenses of approximately $428,000. Financing cash
flow sources for the nine months ended October 3, 1998 came from line of credit
borrowings of approximately $1.7 million, which were offset by repayments of
approximately $969,000 under the Company's term loan agreements. Cash flows
provided by operating activities were also offset by approximately $982,000 of
cash used in investing activities, primarily due to (i) the construction costs
associated with the Company's build out of its former warehouse space and (ii)
the costs associated with a new comprehensive catalog information system
project.
The Company is in the process of installing a new comprehensive catalog
information system purchased from an outside vendor. The system is currently
undergoing modification, both by the vendor and by the Company's internal staff.
The system is scheduled to be implemented for SC Direct, a subsidiary of the
Company, in early 1999. Following the implementation by SC Direct, it is
anticipated that the system will be modified to deal with the special processing
needs of SC Publishing, another subsidiary of the Company. It is anticipated
that these modifications will take between three and six months to complete,
with full
12
<PAGE>
implementation being completed in mid-1999. The entire cost of the new system,
including new hardware and internal payroll and payroll related costs, is
estimated to be between $1.5 and $1.8 million. As of October 3, 1998,
approximately $977,000 of these costs have been capitalized, of which
approximately $314,000 was added during the nine months ended October 3, 1998.
During March 1998, the Company completed the first phase of renovation of
its former warehouse space in its South Easton facility to allow for further
office expansion. Costs of the renovation and for the purchase of new furniture
and fixtures amounted to approximately $300,000 in the first quarter of 1998.
In August 1998, the Company announced a reorganization of certain
management positions. In connection with this reorganization, the Company
recorded in the third quarter of 1998 a pre-tax charge of $469,558, consisting
of severance and other severance related benefits for five former employees of
the Company. The Company will pay out the severance and severance related
benefits through August 1999. Included in accrued expenses at October 3, 1998
are accrued restructuring charges of $369,385.
In September 1998, the Company announced that it has retained Patricof &
Co. Capital Corp. to explore various strategic alternatives to maximize
shareholder value, including the possible sale or recapitalization of the
Company. Patricof & Co. Capital Corp. is an international investment banking
firm headquartered in New York City with affiliated offices throughout Europe.
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
additional significant acquisitions, could require new external financing.
YEAR 2000 COMPLIANCE
The Company's current information and computer systems will be affected by
the Year 2000 issue, which refers to the inability of computerized systems to
process dates beyond December 31, 1999. The Company has formulated a Year 2000
Plan to address the Company's Year 2000 issues. Based on its current assessments
from the Year 2000 Plan, the Company expects that it will not experience a
disruption of its operations as a result of the change to the new millennium.
The Company is in the process of installing a new comprehensive catalog
information system purchased from an outside vendor, who has represented that
the software addresses the Year 2000 issue. It is anticipated that the
installation will be completed in early 1999. The Company estimates that the
entire cost of the new system, including new hardware and internal payroll and
payroll related costs, will be between $1.5 and $1.8 million. As of October 3,
1998, approximately $977,000 of these costs have been capitalized, of which
approximately $314,000 was added during the nine months ended October 3, 1998.
Based on its current assessments and its initial plan, which are based
in part upon some preliminary information concerning the Year 2000 status from a
small group of the Company's critical suppliers and vendors, the Company expects
that it will not experience a disruption of its operations after December 31,
1999. However, there can be no assurance that the suppliers and vendors of the
Company will be successful in taking corrective action in a timely manner. The
Company anticipates initiating more extensive inquiries with significant
suppliers and vendors during the fourth quarter of 1998 and first quarter of
1999 to determine the extent to which the Company is vulnerable to those third
parties' failure to remediate their own Year 2000 issues. (Refer to the listed
risks and uncertainties on page 10 of this report.)
13
<PAGE>
The Company has not yet established a formal contingency plan, but intends
to formulate one to address unavoided or unavoidable risks and expect to have
the contingency plan formulated by early 1999. Initially, the Company has
determined that if the new comprehensive catalog information system cannot be
effectively installed, the Company has the ability to receive a free upgrade
from its current vendor making the current computer operating system Year 2000
compliant. The current vendor has stated that it would need approximately 60
days to complete the upgrade.
If the Company's new computer system fails with respect to the Year 2000
issue, there could be a material adverse impact on the business operations or
financial performance of the Company, including its ability to take customer
orders, ship products, invoice customers and collect payments. Additionally,
there can be no assurance that systems of certain of the Company's suppliers and
vendors will be converted on a timely basis, which could have a material adverse
impact on the business operations or financial performance of the Company.
The preceding discussion contains forward looking information within the
meaning of Section 21E of the Exchange Act. Actual results may differ
materially from such projected information due to changes in the underlying
assumptions.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive
Income," which became effective for the Company for periods beginning after
December 15, 1997. SFAS No. 130 establishes standards for reporting and
displaying comprehensive income and its components (revenues, expenses, gains
and losses) in a full set of general purpose financial statements. SFAS No. 130
requires that a company (a) classify items of other comprehensive income by
their nature in a financial statement and (b) display the accumulated balance of
other comprehensive income separately from retained earnings and additional
paid-in-capital in the equity section of the balance sheet. Reclassification of
financial statements for earlier periods provided for comparative purposes is
required. The Company adopted this statement during the first quarter of 1998.
Comprehensive income consists solely of accumulated foreign currency translation
adjustments in connection with the Company's United Kingdom subsidiary. During
the three and nine months ended October 3, 1998, the Company has recognized
other comprehensive income of $26,497 and $22,857, respectively.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information" which
became effective for the Company for periods beginning after December 15, 1997.
SFAS No. 131 establishes standards for the way public companies report selected
information about operating segments in annual financial statements and requires
those companies to report selected information about segments in interim
financial reports issued to shareholders. It also establishes standards for
related disclosures about products and services, geographic areas, and major
customers. SFAS No. 131 supersedes SFAS No.14, "Financial Reporting Segments of
a Business Enterprise," but retains the requirement to report information about
major customers. As required, the Company will adopt SFAS No. 131 in the fourth
quarter of 1998.
14
<PAGE>
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 98-1 ("SOP 98-1"), "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use". SOP 98-1
requires that costs incurred in the development of internal use software be
capitalized and amortized over a period of time. Specifically, external direct
costs of materials and services consumed in developing or obtaining internal use
computer software, payroll and payroll related costs for employees who are
directly associated with and who devote time to the internal use computer
software project, and interest cost incurred when developing computer software
for internal use, should be capitalized. Costs to develop or obtain software
that allows for access or conversion of old data by new systems should also be
capitalized. All other data conversion and all training costs on the internal
use software should be expensed as incurred. SOP 98-1 is effective for fiscal
years beginning after December 15, 1998 with earlier application encouraged in
fiscal years for which annual financial statements have not been issued. The
provisions of SOP 98-1 should be applied to internal use software costs incurred
in those fiscal years for all projects, including those projects in progress
upon initial application of SOP 98-1. Costs incurred prior to initial
application of SOP 98-1, whether capitalized or not, should not be adjusted to
the amounts that would have been capitalized had SOP 98-1 been in effect when
those costs were incurred. The Company adopted SOP 98-1 in the first quarter of
1998. During the three and nine months ended October 3, 1998, the Company has
capitalized approximately $97,000 and $977,000, respectively, of costs
associated with a new comprehensive catalog information system, of which
approximately $40,000 and $156,000, respectively, were internal payroll and
payroll related costs.
In April 1998, the AICPA issued Statement of Position 98-5 ("SOP 98-5"),
"Reporting on the Costs of Start-Up Activities". SOP 98-5 requires costs of
start-up activities and organization costs to be expensed as incurred. SOP 98-5
had no impact on the Company's financial condition or results of operations for
the three and nine months ended October 3, 1998.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This statement
is effective for the Company's fiscal year beginning January 3, 1999. The
Company has not yet determined the effect of adopting SFAS No. 133 on the
consolidated financial statements.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.02 Third Amendment to the Credit and Guaranty Agreement and Second
Amendment to the Credit Agreement Dated as of September 30, 1998 between
Specialty Catalog Corp., SC Corporation, d/b/a SC Direct, SC Publishing,
Inc., Daxbourne International Limited and BankBoston, N.A.
27.1 Financial Data Schedule (for EDGAR filing purposes only), Filed
herewith.
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the three month
period October 3, 1998.
15
<PAGE>
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.
SPECIALTY CATALOG CORP.
Dated: November 16, 1998 /s/ Steven L. Bock
------------------------------------
Steven L. Bock
Chairman, Chief Executive Officer
and President
Dated: November 16, 1998 /s/ J. William Heise
------------------------------------
J. William Heise
Senior Vice President, Chief
Financial Officer (Principal
Accounting and Financial Officer)
16
<PAGE>
Exhibit 10.02
===============================================================================
THIRD AMENDMENT TO
CREDIT AND GUARANTY AGREEMENT
AND
SECOND AMENDMENT TO
CREDIT AGREEMENT
Dated as of September 30 1998
Between
SPECIALTY CATALOG CORP.
SC CORPORATION, d/b/a SC DIRECT
SC PUBLISHING, INC.
DAXBOURNE INTERNATIONAL LIMITED
and
BANKBOSTON, N.A.
===============================================================================
<PAGE>
THIRD AMENDMENT TO CREDIT AND GUARANTY AGREEMENT
AND
SECOND AMENDMENT TO CREDIT AGREEMENT
This THIRD AMENDMENT TO CREDIT AND GUARANTY AGREEMENT and SECOND AMENDMENT
TO CREDIT AGREEMENT is entered into as of September 30, 1998 by and among
SPECIALTY CATALOG CORP., a Delaware corporation (the "Company"), SC CORPORATION,
a Delaware corporation d/b/a SC DIRECT ("SC Direct"), and SC PUBLISHING, INC., a
Delaware corporation ("SC Publishing") (each a "U.S. Borrower" and collectively
the "U.S. Borrowers") and DAXBOURNE INTERNATIONAL LIMITED, (Registered No.
3369640), a private company limited by shares formed under the laws of England
and Wales (the "U.K. Borrower") (the U.S. Borrowers and U.K. Borrower each a
"Borrower" and collectively, the "Borrowers") and BANKBOSTON, N.A., a national
banking association (the "Bank").
Recitals
--------
The Borrowers and the Bank are parties to a Credit and Guaranty Agreement
dated as of March 12, 1997 (as amended, the "U.S. Credit Agreement") and a
Credit Agreement dated as of October 3, 1997 (as amended, the "U.K. Credit
Agreement") (each a "Credit Agreement" and collectively, the "Credit
Agreements") and desire to amend the Credit Agreements in various respects. All
capitalized terms used herein and not otherwise defined shall have the meanings
set forth in the Credit Agreements.
NOW, THEREFORE, the Borrowers and the Bank hereby amend the Credit
Agreements as follows:
Section 1. Definitions. Section 1.1 of the Credit Agreements is hereby
-----------
amended as follows:
(a) The definition of "Consolidated EBITDA" is hereby deleted in its
entirety and a new definition substituted therefor as follows:
"`Consolidated EBITDA' shall mean for any period the sum of
-------------------
(a) Consolidated Net Income plus (b) all amounts deducted in
----
computing Consolidated Net Income in respect of (i) interest
expense on Indebtedness, (ii) taxes based on or measured by
income, and (iii) depreciation and amortization expense, in each
case for the period under review; provided, however, that in
-----------------
<PAGE>
calculating Consolidated Net Income, the restructuring charge
incurred by the Company and its Subsidiaries relating to
severance packages for certain senior employees during the
quarter ended September 30, 1998, in an aggregate amount not to
exceed $500,000, shall not be treated as an expense during such
quarter but shall be treated as an expense in future quarters as
and when such severance amounts are paid in cash."
(b) The definition of "Consolidated Operating Cash Flow" is hereby
deleted in its entirety and a new definition substituted therefor as
follows:
"`Consolidated Operating Cash Flow' shall mean (a) Consolidated
--------------------------------
EBITDA less (b) the sum of (i) Capital Expenditures plus (ii)
consolidated cash payments for taxes for the applicable period;
provided, however, in calculating Consolidated Operating Cash
-------- -------
Flow for any period, there shall not be deducted as a Capital
Expenditure amounts expended for Excluded Capital Expenditures
during such period."
(c) The definition of "1996 Financial Statements" is hereby deleted
in its entirety and a new definition substituted therefor as follows:
"`1997 Financial Statements' shall mean the Consolidated Balance
-------------------------
Sheet of the Company and its Subsidiaries as of January 3, 1998
and the related Consolidated Statements of Operations,
Stockholders" Equity (Deficit) and Cash Flows for the year then
ended and notes to such financial statements, audited by Deloitte
& Touche LLP."
(d) A new definition of Excluded Capital Expenditures shall be added
in alphabetical order, as follows:
"`Excluded Capital Expenditures' shall mean (a) Capital
-----------------------------
Expenditures in the following amounts for the quarters indicated:
Q4 97 Q1 98 Q2 98 Q3 98
----- ----- ----- -----
$376,000 $358,000 $110,000 $56,000
and (b) up to $400,000 in the aggregate for Capital Expenditures
for MIS upgrades and telemarketing costs during the fourth
quarter of fiscal 1998 and the first quarter of fiscal 1999."
2
<PAGE>
Section 2. Representations and Warranties; No Default. The U.S. Borrowers
------------------------------------------
hereby confirm to the Bank the representations and warranties of the U.S.
Borrowers set forth in Article 5 of the U.S. Credit Agreement as amended as of
the date hereof, as if set forth herein in full (provided, however that
references therein to the 1996 Financial Statements shall be deemed to refer to
the 1997 Financial Statements). The U.K. Borrower hereby confirms to the Bank
the representations and warranties of the U.K. Borrower set forth in Article 5
of the U.K. Credit Agreement as amended as of the date hereof, as if set forth
herein in full. The Borrowers hereby certify that no Default exists under the
Credit Agreements. The Borrowers hereby further certify that SC Licensing is
not a party to any agreement other than the SC Licensing Transfer Documents.
Section 3. Miscellaneous. The Borrowers agree to pay on demand all the
-------------
Bank's reasonable expenses in preparing, executing and delivering this Third
Amendment to Credit and Guaranty Agreement and Second Amendment to Credit
Agreement, and all related instruments and documents, including, without
limitation, the reasonable fees and out-of-pocket expenses of the Bank's special
counsel, Goodwin, Procter & Hoar LLP. This Third Amendment to Credit and
Guaranty Agreement and Second Amendment to Credit Agreement shall be a Bank
Agreement under each of the Credit Agreements and shall be governed by and
construed and enforced under the laws of The Commonwealth of Massachusetts
(except to the extent it effects any amendment of the U.K. Credit Agreement, as
to which English law shall apply).
3
<PAGE>
IN WITNESS WHEREOF, the U.S. Borrowers, the U.K. Borrower and the Bank have
caused this Third Amendment to Credit and Guaranty Agreement and Second
Amendment to Credit Agreement to be executed by their duly authorized officers
as of the date first set forth above.
SPECIALTY CATALOG CORP.
By: /s/ Steven L. Bock
------------------------------------
Name: Steven L. Bock
Title: CEO
SC CORPORATION d/b/a SC DIRECT
By: /s/ Steven L. Bock
------------------------------------
Name: Steven L. Bock
Title: CEO
SC PUBLISHING, INC.
By: /s/ Steven L. Bock
------------------------------------
Name: Steven L. Bock
Title: CEO
DAXBOURNE INTERNATIONAL LIMITED
By: /s/ Steven L. Bock
------------------------------------
Name: Steven L. Bock
Title: Director
By: /s/ Richard Lipton
------------------------------------
Name: Richard Lipton
Title: Director
BANKBOSTON, N.A.
By: /s/ Barbara D. Searle
------------------------------------
Name: Barbara D. Searle
Title: Vice President
4
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