<PAGE>
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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 period ended July 3, 1999
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
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
1, 1999: 4,401,886
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<PAGE>
SPECIALTY CATALOG CORP.
INDEX
PART I. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
Item 1. Condensed Consolidated Financial Statements as of July 3, 1999, January 2, 1999 and
July 4, 1998, for the Three Months Ended July 3, 1999 and July 4, 1998 and for the Six
Months Ended July 3, 1999 and July 4, 1998
Condensed Consolidated Statements of Operations 3
Condensed Consolidated Balance Sheets 4
Condensed Consolidated Statements of Cash Flows 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 14
Item 6. Exhibits and Reports on Form 8-K 15
Signatures 16
</TABLE>
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<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 Six months ended
July 3, 1999 July 4, 1998 July 3, 1999 July 4, 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net sales.......................................... $12,264,398 $13,263,194 $25,531,066 $26,571,758
Cost of sales (including buying, occupancy and
order fulfillment costs)...................... 4,160,051 4,745,763 8,720,478 9,579,016
----------- ----------- ----------- -----------
Gross margin....................................... 8,104,347 8,517,431 16,810,588 16,992,742
Selling, general and administrative expenses....... 6,451,643 6,371,392 14,117,732 15,284,684
----------- ----------- ----------- -----------
Income from operations............................. 1,652,704 2,146,039 2,692,856 1,708,058
Interest expense, net.............................. 169,297 214,882 365,110 425,235
----------- ----------- ----------- -----------
Income before income taxes......................... 1,483,407 1,931,157 2,327,746 1,282,823
Income tax provision............................... 619,009 796,246 966,179 522,965
----------- ----------- ----------- -----------
Net income......................................... 864,398 1,134,911 1,361,567 759,858
Other comprehensive loss........................... (14,418) (10,692) (50,704) (3,642)
----------- ----------- ----------- -----------
Comprehensive income............................... $ 849,980 $ 1,124,219 $ 1,310,863 $ 756,216
=========== =========== =========== ===========
Basic earnings per share:
Net income per share......................... $ 0.20 $ 0.22 $ 0.31 $ 0.15
=========== =========== =========== ===========
Weighted average shares outstanding.......... 4,417,718 5,057,001 4,426,344 5,049,693
=========== =========== =========== ===========
Diluted earnings per share:
Net income per share......................... $ 0.18 $ 0.21 $ 0.29 $ 0.14
=========== =========== =========== ===========
Weighted average shares outstanding.......... 4,698,616 5,529,354 4,708,514 5,524,650
=========== =========== =========== ===========
</TABLE>
See notes to condensed consolidated financial statements.
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<PAGE>
SPECIALTY CATALOG CORP.
Condensed Consolidated Balance Sheets
(unaudited)
<TABLE>
<CAPTION>
July 3, January 2, July 4,
1999 1999 1998
----------------- ----------------- ----------------
Assets
Current assets:
<S> <C> <C> <C>
Cash and cash equivalents......................................... $ 1,066,831 $ 721,949 $ 67,042
Accounts receivable, net.......................................... 1,326,640 1,220,741 1,585,677
Merchandise inventories........................................... 4,574,730 5,388,395 5,770,502
Prepaid expenses.................................................. 3,165,881 3,738,846 3,805,301
----------- ----------- -----------
Total current assets.................................... 10,134,082 11,069,931 11,228,522
Property, plant and equipment, net...................................... 3,607,732 2,946,112 2,799,773
Intangible assets, net.................................................. 3,344,187 3,678,158 3,800,637
Deferred income taxes................................................... 3,831,705 4,521,988 5,060,374
Other assets............................................................ 182,362 183,193 239,726
----------- ----------- -----------
Total assets............................................ $21,100,068 $22,399,382 $23,129,032
=========== =========== ===========
Liabilities and Shareholders' Equity
Current liabilities:
Short-term borrowings............................................. $ 4,276,098 $ 5,097,067 $ 4,010,915
Accounts payable and accrued expenses............................. 2,279,068 3,403,414 2,575,572
Liabilities to customers.......................................... 975,783 676,447 947,750
Deferred purchase price obligation................................ -- -- 494,130
Current portion of long-term debt................................. 1,964,471 1,963,319 1,581,459
----------- ----------- -----------
Total current liabilities............................... 9,495,420 11,140,247 9,609,826
Long-term debt.......................................................... 2,880,049 3,671,167 4,652,331
Other long-term liabilities............................................. 213,869 151,619 158,376
Commitments and contingencies
Shareholders' equity:
Common stock, $.01 par value: 10,000,000 shares authorized;
4,411,586, 4,481,986 and 5,057,001 shares issued and
outstanding at July 3, 1999, January 2, 1999 and July 4,
1998, respectively........................................... 52,397 52,397 50,570
Additional paid-in capital...................................... 16,159,570 16,159,570 15,916,252
Deferred compensation........................................... (39,613) (48,363) (57,113)
Accumulated other comprehensive income (loss)................... (34,778) 15,926 (147)
Accumulated deficit............................................. (5,027,973) (6,389,540) (7,201,063)
----------- ----------- -----------
11,109,603 9,789,990 8,708,499
Less treasury stock, at cost, 828,188 shares at July 3, 1999,
757,788 shares at January 2, 1999 and 0 shares at July 4,
1998......................................................... (2,598,873) (2,353,641) --
----------- ----------- -----------
Total shareholders' equity 8,510,730 7,436,349 8,708,499
----------- ----------- -----------
Total liabilities and shareholders' equity..... $21,100,068 $22,399,382 $23,129,032
=========== =========== ===========
</TABLE>
See notes to condensed consolidated financial statements.
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<PAGE>
SPECIALTY CATALOG CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
Six months ended
July 3, 1999 July 4, 1998
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income...................................................... $ 1,361,567 $ 759,858
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization............................... 404,688 356,563
Amortization of deferred compensation....................... 8,750 8,749
Deferred income taxes....................................... 700,427 499,676
Changes in operating assets and liabilities:
Accounts receivable........................................ (124,055) (462,088)
Merchandise inventories.................................... 789,544 492,589
Prepaid expenses........................................... 569,347 (460,626)
Other assets............................................... (9,874) 50,788
Accounts payable and accrued expenses...................... (1,091,280) (550,675)
Liabilities to customers................................... 299,336 (49,193)
Income taxes............................................... -- (215,305)
Other long-term liabilities................................ -- 25,002
------------ ------------
Net cash provided by operating activities....................... 2,908,450 455,338
------------ ------------
Cash flows from investing activities:
Purchases of property, plant and equipment................ (830,697) (829,910)
------------ ------------
Net cash used in investing activities........................... (830,697) (829,910)
------------ ------------
Cash flows from financing activities:
Advances (repayments) on short-term borrowings, net...... (730,389) 211,682
Repayment of long-term debt.............................. (713,164) (351,717)
Repurchase of treasury stock............................. (245,232) --
Issuance of common stock................................. -- 10,752
Repayment of capital lease obligations................... (38,007) (34,381)
------------ ------------
Net cash used in financing activities........................... (1,726,792) (163,664)
------------ ------------
Effect of exchange rate changes on cash and cash equivalents.... (6,079) 1,438
------------ ------------
Increase (decrease) in cash and cash equivalents................ 344,882 (536,798)
Cash and cash equivalents, beginning of year.................... 721,949 603,840
------------ ------------
Cash and cash equivalents, end of year.......................... $ 1,066,831 $ 67,042
============ ============
</TABLE>
Summary of Non-Cash Transactions:
During the three months ended April 3, 1999, the Company recorded capital
lease obligations of $100,257 related to the purchase of data processing
equipment.
During the three months ended April 4, 1998, 35,000 stock options were
exercised for which the Company recorded a deduction in its income tax payable
and an increase in additional paid in capital of $67,024.
See notes to condensed consolidated financial statements.
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<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 2, 1999, and the consolidated
financial statements and footnotes included therein. Certain information and
footnote disclosures normally included in 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 six months ended
July 3, 1999 are not necessarily indicative of the results for the entire fiscal
year ending January 1, 2000.
The financial statements for the three and six months ended July 3, 1999 and
July 4, 1998 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 2, 1999.
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-
1 required that costs incurred in the development of internal use software be
capitalized and amortized over a period of time. The Company adopted SOP 98-1
in the first quarter of 1998. During the three months ended July 3, 1999 and
July 4, 1998, the Company capitalized approximately $344,000 and $87,000,
respectively, of costs associated with a new comprehensive catalog information
system, of which approximately $144,000 and $49,000, respectively, were internal
payroll and payroll related costs. During the six months ended July 3, 1999 and
July 4, 1998, the Company capitalized approximately $604,000 and $217,000,
respectively, of costs, of which approximately $251,000 and $116,000,
respectively, were internal payroll and payroll related costs.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This statement
is effective for all fiscal quarters of all fiscal years beginning after June
15, 2000. The Company has not yet determined the effect, if any, of adopting
SFAS No. 133 on the consolidated financial statements.
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.
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<PAGE>
SPECIALTY CATALOG CORP.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
<TABLE>
<CAPTION>
For the three months ended For the six months ended
July 3, 1999 July 4, 1998 July 3, 1999 July 4, 1998
-------------- -------------- --------------- --------------
Net Net Net Net
Income Shares Income Shares Income Shares Income Shares
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Basic earnings per share $864 4,418 $1,135 5,057 $1,362 4,426 $760 5,050
Effect of dilutive options -- 281 -- 472 -- 282 -- 475
---- ----- ------ ----- ------ ----- ---- -----
Diluted earnings per share $864 4,699 $1,135 5,529 $1,362 4,708 $760 5,525
==== ===== ====== ===== ====== ===== ==== =====
</TABLE>
Options to purchase 677,601 shares of common stock ranging from $5.33 to
$7.15 per share were not included in computing diluted EPS for the three and six
months ended July 3, 1999 because their effects were antidilutive. Options to
purchase 545,735 shares of common stock ranging from $6.50 to $7.15 per share
were not included in computing diluted EPS for the three and six months ended
July 4, 1998 because their effects were also antidilutive.
4. Restructuring Charges
During the third quarter of 1998, a restructuring charge of $469,558 was
recorded to reflect the reorganization of certain management positions. Included
in accrued expenses at July 3, 1999 are accrued restructuring charges of
$10,721.
5. Business Segments and Financial Information by Geographic Location
Specialty Catalog Corp. has three reportable segments: SC Direct, SC
Publishing and Daxbourne International Limited. SC Direct primarily sells
women's wigs and hairpieces through its Paula Young(R) catalog. SC Direct also
offers African-American women a broad selection of quality wigs, hairpieces,
apparel and related products through its Especially Yours(R) catalog. In
addition, SC Direct sells apparel, hats and other fashion accessories through
its Paula's Hatbox(R) catalog. SC Publishing distributes catalogs under its
Western Schools(R) brand and specializes in providing continuing education
courses to nurses and CPAs. 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 financial statements included in the Company's Annual
Report on Form 10-K for the year ended January 2, 1999. 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. SC Direct
and SC Publishing 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.
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<PAGE>
SPECIALTY CATALOG CORP.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
A summary of information about the Company's operations by segment for the
three and six months ended July 3, 1999 and July 4, 1998 follows (intersegment
eliminations are inter-company receivables and investments in subsidiaries):
<TABLE>
<CAPTION>
SC Intersegment
--
SC Direct Publishing Daxbourne Eliminations Total
--------- ---------- --------- ------------ -----
<S> <C> <C> <C> <C> <C>
For the three months ended July 3, 1999
Net sales................................. $ 9,761,402 $1,258,202 $1,244,794 -- $12,264,398
Gross margin.............................. 6,271,952 953,908 878,487 -- 8,104,347
Selling, general and administrative (1)... 5,021,525 693,872 736,246 -- 6,451,643
Depreciation and amortization (1)......... 98,766 11,145 96,843 -- 206,754
Operating profit.......................... 1,250,427 260,036 142,241 -- 1,652,704
Interest expense, net..................... 112,488 -- 56,809 -- 169,297
Income tax provision...................... 466,576 106,618 45,815 -- 619,009
Segment assets............................ 16,819,527 4,107,961 4,709,419 $(4,536,839) 21,100,068
Capital expenditures...................... 806,908 7,067 16,722 -- 830,697
For the three months ended July 4, 1998
Net sales................................. $11,050,821 $ 964,785 $1,247,588 -- $13,263,194
Gross margin.............................. 6,960,795 677,892 878,744 -- 8,517,431
Selling, general and administrative (1)... 5,057,798 617,706 695,888 -- 6,371,392
Depreciation and amortization (1)......... 79,517 5,473 97,622 -- 182,612
Operating profit.......................... 1,902,997 60,186 182,856 -- 2,146,039
Interest expense, net..................... 136,581 -- 78,301 -- 214,882
Income tax provision...................... 724,229 24,677 47,340 -- 796,246
Segment assets............................ 17,758,843 3,655,896 5,229,108 $(3,514,815) 23,129,032
Capital expenditures...................... 804,995 -- 24,915 -- 829,910
</TABLE>
(1) Depreciation and amortization is included in selling, general and
administrative expense in the condensed consolidated statements of
operations under "selling, general and administrative expenses" for the
three months ended July 3, 1999 and July 4, 1998.
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<PAGE>
SPECIALTY CATALOG CORP.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
<TABLE>
<CAPTION>
SC
-- Intersegment
SC Direct Publishing Daxbourne Eliminations Total
----------- ----------- --------- ------------ -----
For the six months ended July 3, 1999
<S> <C> <C> <C> <C> <C>
Net sales................................. $20,061,732 $2,835,371 $2,633,963 -- $25,531,066
Gross margin.............................. 12,790,547 2,156,329 1,863,712 -- 16,810,588
Selling, general and administrative (1)... 11,299,146 1,325,063 1,493,523 -- 14,117,732
Depreciation and amortization (1)......... 190,291 22,072 192,327 -- 404,690
Operating profit.......................... 1,491,401 831,266 370,189 -- 2,692,856
Interest expense, net..................... 242,340 -- 122,770 -- 365,110
Income tax provision...................... 512,136 340,835 113,208 -- 966,179
Segment assets............................ 16,819,527 4,107,961 4,709,419 $(4,536,839) 21,100,068
Capital expenditures...................... 806,908 7,067 16,722 -- 830,697
For the six months ended July 4, 1998
Net sales................................. $21,701,349 $2,280,996 $2,589,413 -- $26,571,758
Gross margin.............................. 13,549,861 1,602,157 1,840,724 -- 16,992,742
Selling, general and administrative (1)... 12,717,959 1,203,046 1,363,679 -- 15,284,684
Depreciation and amortization (1)......... 151,903 13,774 195,297 -- 360,974
Operating profit.......................... 831,902 399,111 477,045 -- 1,708,058
Interest expense, net..................... 260,456 -- 164,779 -- 425,235
Income tax provision...................... 234,290 163,635 125,040 -- 522,965
Segment assets............................ 17,758,843 3,655,896 5,229,108 $(3,514,815) 23,129,032
Capital expenditures...................... 804,995 -- 24,915 -- 829,910
</TABLE>
(1) Depreciation and amortization is included in selling, general and
administrative expense in the condensed consolidated statements of
operations under "selling, general and administrative expenses" for the six
months ended July 3, 1999 and July 4, 1998.
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<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 for Specialty Catalog Corp. (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, 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) contingencies and risks associated with the year
2000 problem. 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 January 2, 1999. 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.
Three Months Ended July 3, 1999 Compared to the Three Months Ended July 4, 1998
The Company's net sales decreased to $12.3 million for the three months ended
July 3, 1999 from $13.3 million for the three months ended July 4, 1998, a
decrease of $1.0 million, or 7.5%. SC Direct's net sales were $1.3 million
lower than the prior year's second quarter net sales, primarily due to (i) a
decrease of $1.5 million in net sales from its Paula Young(R) catalog, primarily
as a result of less sales to new customers due to a reduction in advertising
expenditures and (ii) a decrease of approximately $215,000 in net sales from the
Christine Jordan(R) catalog as a result of the Company's decision to no longer
circulate the Christine Jordan(R) catalog, but continue to sell the branded
products through its Paula Young(R) catalog. These net sales decreases were
offset by an increase of approximately $341,000 in net sales from SC Direct's
Especially Yours(R) catalog and an increase of approximately $133,000 in net
sales from SC Direct's Paula's Hatbox(R) catalog. SC Publishing's net sales
were approximately $293,000 higher than the prior year's second quarter net
sales, primarily due to improved customer response rates.
Gross margin as a percent of net sales increased to 66.1% for the three months
ended July 3, 1999 from 64.2% for the three months ended July 4, 1998. This
increase in the gross margin rate reflects the Company's efforts to transition
its core Paula Young(R) catalog from an emphasis on reduced prices and
discounting to a focus on product line expansion and innovation, including the
introduction of human hair and human hair blend wigs. Gross margin decreased to
$8.1 million for the three months ended July 3, 1999 from $8.5 million for the
three months ended July 4, 1998, a decrease of approximately $414,000, or 4.9%,
as a result of the reduction in net sales mentioned above, offset by the
increase in gross margin caused by the increase in the gross margin rate
mentioned above.
Selling, general and administrative expenses ("SG&A") increased slightly to
$6.5 million for the three months ended July 3, 1999 from $6.4 million for the
three months ended July 4, 1998, an increase of approximately $80,000, or 1.3%.
-10-
<PAGE>
Interest expense, net decreased to approximately $169,000 for the three months
ended July 3, 1999 from approximately $215,000 for the three months ended July
4, 1998, a decrease of approximately $46,000, or 21.4%. The decrease in
interest expense, net reflects lower average principal amounts outstanding on
the Company's bank facility due to the positive free cash flows generated by the
Company.
Six Months Ended July 3, 1999 Compared to the Six Months Ended July 4, 1998
Net sales decreased to $25.5 million for the six months ended July 3, 1999
from $26.6 million for the six months ended July 4, 1998, a decrease of $1.1
million, or 4.1%. SC Direct's net sales were $1.6 million lower than the prior
year's first half net sales, primarily due to (i) a decrease of $2.3 million in
net sales from its Paula Young(R) catalog, primarily as a result of less sales
to new customers due to a reduction in advertising expenditures, and (ii) a
decrease of approximately $472,000 in net sales from the Christine Jordan(R)
catalog as a result of the Company's decision to no longer circulate the
Christine Jordan(R) catalog, but continue to sell the branded products through
its Paula Young(R) catalog. These net sales decreases were offset by an increase
of $1.1 million in net sales from SC Direct's Especially Yours(R) catalog and an
increase of approximately $52,000 in net sales from SC Direct's Paula's
Hatbox(R) catalog. SC Publishing's net sales were approximately $554,000 higher
than the prior year's first half net sales, primarily due to improved customer
response rates.
Gross margin as a percent of net sales increased to 65.8% for the six months
ended July 3, 1999 from 64.0% for the six months ended July 4, 1998. This
increase in the gross margin rate reflects the Company's efforts to transition
its core Paula Young(R) catalog from an emphasis on reduced prices and
discounting to a focus on product line expansion and innovation, including the
introduction of human hair and human hair blend wigs. The gross margin
decreased to $16.8 million for the six months ended July 3, 1999 from $17.0
million for the six months ended July 4, 1998, a decrease of approximately
$183,000, or 1.1%, as a result of the reduction in net sales mentioned above,
offset by the improvement in the gross margin rate mentioned above.
SG&A expenses decreased to $14.1 million for the six months ended July 3, 1999
from $15.3 million for the six months ended July 4, 1998, a decrease of $1.2
million, or 7.8%. The decrease in SG&A related to lower advertising expenses of
$1.2 million which is primarily a result of the Company's strategic decision to
eliminate certain marginal advertising programs which did not generate new
customers and sales at a sufficient level to justify its expenditures.
Interest expense, net decreased to approximately $365,000 for the six months
ended July 3, 1999 from approximately $425,000 for the six months ended July 4,
1998, a decrease of approximately $60,000, or 14.1%. The decrease in interest
expense, net reflects lower average principal amounts outstanding on the
Company's bank facility due to the positive free cash flows generated by the
Company.
Liquidity and Capital Resources
Cash flows provided by operating activities were $2.9 million for the six
months ended July 3, 1999, offset by approximately $831,000 used in investing
activities and $1.7 million used in financing activities. The major factors
that caused the difference between net income and cash flows from operations
are: depreciation and amortization of approximately $405,000, increases in non-
cash working capital items of approximately $433,000 and an increase in deferred
income taxes of approximately $700,000. The $831,000 in cash used in investing
activities was mainly due to the Company's installation of a new catalog
information system, which amounted to approximately $604,000. The $1.7 million
in cash used in financing activities was due to (i) the repayment of
approximately $730,000 on the Company's short-term borrowings, (ii) the
repayment of long-term debt of approximately $713,000 and (iii) the Company's
repurchase of approximately $245,000 of common stock.
-11-
<PAGE>
The Company is in the process of installing a new catalog information
system purchased from an outside vendor. The system is currently undergoing
modification by the Company's internal staff. The system is scheduled to be
implemented for SC Direct, the main operating subsidiary of the Company, in the
third quarter of 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. The entire cost of
the new system, including new hardware and internal payroll and payroll related
costs, is estimated to be $2.0 million. As of July 3, 1999, $1.7 million of
these costs have been capitalized, of which approximately $344,000 was added
during the three months ended July 3, 1999.
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 Readiness
The Company's current information and computer systems will be affected by
the Year 2000 ("Y2K") issue, which refers to the inability of computerized
systems to process dates beyond December 31, 1999. The Company has formulated a
Y2K Plan to address the Company's Y2K issues. Based on its current assessments
from the Y2K Plan, the Company does not expect at present that it will
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 Y2K issue. If the Company's new computer system
fails with respect to the Y2K 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. It is anticipated that the installation will be completed in the
third quarter of 1999 for SC Direct. The Company estimates that the entire cost
of the new system, including new hardware and internal payroll and payroll
related costs, will be $2.0 million. As of July 3, 1999, $1.7 million of these
costs have been capitalized, of which approximately $344,000 was added during
the three months ended July 3, 1999. If the new catalog information system
cannot be effectively installed, then the Company has scheduled its current
computer vendor to provide a free upgrade in the third quarter of 1999 that will
make the Company's current computer operating system Y2K ready. Also, in
January 1998, the Company successfully converted its financial and accounting
systems to a new software package that has been represented by the vendor to be
Y2K ready.
The foregoing timetable and assessment of costs to become Y2K compliant
reflect management's current best estimates. These estimates are based on many
assumptions, including assumptions about the cost, availability and ability of
resources to locate, remediate and modify affected systems, equipment and
facilities. Based upon its activities to date, the Company does not currently
believe that these factors will cause results to differ significantly from those
estimated. However, the Company cannot reasonably estimate the potential impact
on its financial condition and operations if key third parties including, among
others, suppliers, contractors, financial institutions, non-retail customers and
governments do not become Y2K compliant on a timely basis.
The Company is assessing the state of readiness of its major suppliers and
customers through written inquiry and evaluation of responses. The Company
intends to follow up with those suppliers or customers that indicate material
problems. Alternate suppliers or service providers will be identified for those
whose responses indicate an unusually high risk of a Y2K problem. The Company's
evaluation of business processes that are not related to information systems,
and the development of contingency plans where such evaluation identifies a high
risk of a Y2K problem, should be completed by the third quarter of 1999. The
main risks associated with the Y2K problem are the uncertainties as to whether
the Company's suppliers and vendors can continue to perform their services for
the Company uninterrupted by the Y2K event, and whether the Company's non-retail
customers can continue to
-12-
<PAGE>
operate their businesses uninterrupted by the Y2K event. The Company's
suppliers, if they are unable to remediate their Y2K problems, may be unable to
produce or deliver goods ordered by the Company. The Company depends
significantly upon telephone orders; should the Company's telephone service be
adversely affected, the Company will be unable to receive a high percentage of
its retail orders. The Company also depends in large measure on delivery
services such as the United States Post Office, Federal Express and UPS to
deliver goods to retail customers; accordingly, should one or more of these
delivery services prove unable to make deliveries as a result of Y2K problems,
the Company's cash flow and business would be severely and adversely affected.
Although the state of readiness of the Company's suppliers, delivery services
and non-retail customers will be monitored and evaluated, and contingency plans
will be developed, no assurances can be given as to the eventual state of
readiness of the Company's suppliers and/or customers. Nor can any assurances be
given as to eventual effectiveness of the Company's contingency plans.
The preceding discussion contains forward-looking information within the
meaning of Section 21E of the Exchange Act. This disclosure is also subject to
protection under the Year 2000 Information and Readiness Disclosure Act of 1998,
Public Law 105-271, as a "Year 2000 Statement" and "Year 2000 Readiness
Disclosure" as defined therein. Actual results may differ materially from such
projected information due to changes in the underlying assumptions.
Recently Issued Accounting Pronouncements
In March 1998, the AICPA issued Statement of Position 98-1, "Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-
1"). SOP 98-1 required that costs incurred in the development of internal use
software be capitalized and amortized over a period of time. The Company adopted
SOP 98-1 in the first quarter of 1998. During the three months ended July 3,
1999 and July 4, 1998, the Company capitalized approximately $344,000 and
$87,000, respectively, of costs associated with a new comprehensive catalog
information system, of which approximately $144,000 and $49,000, respectively,
were internal payroll and payroll related costs. During the six months ended
July 3, 1999 and July 4, 1998, the Company capitalized approximately $604,000
and $217,000, respectively, of costs, of which approximately $251,000 and
$116,000, respectively, were internal payroll and payroll related costs.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This statement
is effective for all fiscal quarters of all fiscal years beginning after June
15, 2000. The Company has not yet determined the effect, if any, of adopting
SFAS No. 133 on the consolidated financial statements.
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 debt of $9.1 million as of July
3, 1999 and in foreign currency exchange rates. The Company does not use
derivative financial instruments. The Company is subject to interest rate risk
on its short-term borrowings under its credit facilities. Historically, the
Company has not experienced material gains or losses due to interest rate
changes. Management does not believe that the risk inherent in the variable-rate
nature of these instruments will have a material 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.
The Company's US term loan and US revolving line of credit bear interest
rates based on either a base rate or a LIBOR contract rate. As of July 3, 1999,
the US term loan was under a LIBOR contract rate of 6.81% for $3.5 million. As
of July 3, 1999, $2.0 million of the US revolving line of credit was under LIBOR
contract rates ranging from 6.70% to 6.86% and the remainder of the US revolving
line of credit was at the base rate of 8.00%. The Company's UK term loan and UK
revolving line of credit bear interest rates based on either a Sterling base
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<PAGE>
rate or a LIBOR contract rate. As of July 3, 1999, a majority of both the UK
term loan and UK revolving line of credit were under a LIBOR contract rate of
9.48%.
As of July 3, 1999, the outstanding borrowings on the Company's credit
facilities were $9.1 million. Based on this balance, an immediate change of one
percent in the interest rate would cause a change in interest expense of
approximately $86,000 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 and longer-term variable rate borrowings.
The foreign currencies to which the Company has the most significant
exchange rate exposure are the British Pound, Chinese Yuan and Indonesian
Rupiah. The Company currently expects that most of its wigs and hairpieces will
continue to be manufactured in China and Indonesia in the future. Accordingly,
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. Also, the
implementation of the Euro currency in 1999 is not expected to materially affect
the Company's operations, or its risk profile.
Based on a hypothetical ten percent adverse movement in interest rates and
foreign currency exchange rates, the potential losses in future earnings, fair
value of risk-sensitive financial instruments, and cash flows are not material,
although the actual effects may differ materially from the hypothetical
analysis.
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its annual meeting of shareholders on Tuesday, May 25,
1999. The following represents the results of the voting on proposals submitted
to a vote of shareholders at such meeting:
a. Proposal to elect directors:
Name of Director Number of votes in favor Number of votes withheld
---------------- ------------------------ ------------------------
Steven L. Bock 4,236,492 --
Alan S. Cooper 4,236,492 --
Martin E. Franklin 4,236,492 --
Samuel L. Katz 4,236,492 --
Guy Naggar 4,236,492 --
Andrea Pomerantz Lustig 4,233,992 2,500
All persons name above were re-elected as directors of the Company for a
term of office expiring on the date of the next annual meeting of shareholders,
or special meeting in lieu thereof, and until their respective successors are
duly elected and qualified.
-14-
<PAGE>
b. Proposal to amend the Company's 1996 Stock Incentive Plan to increase
the number of shares authorized for issuance thereunder from 750,000 to
1,000,000.
Votes for Votes against Votes abstaining Not voted
--------- ------------- ---------------- ----------
3,313,193 270,383 79,026 573,890
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.1 Amendment dated as of June 24, 1999 to Employment Agreement between
Registrant and Steven L. Bock, Filed herewith.
27.1 Financial Data Schedule (for EDGAR filing purposes only), Filed
herewith.
(b) Reports on Form 8-K
No reports on Form 8-K have been filed during the three and six months
ended July 3, 1999.
-15-
<PAGE>
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 2, 1999 By: /s/ Steven L. Bock
--------------------------------
Steven L. Bock
Chairman, President and
Chief Executive Officer
Dated: August 2, 1999 By: /s/ Thomas K. McCain
--------------------------------
Thomas K. McCain
Senior Vice President and
Chief Financial Officer
-16-
<PAGE>
EXHIBIT 10.1
FIRST AMENDMENT
TO
EMPLOYMENT AGREEMENT
First Amendment dated as of June 24, 1999 (the "First Amendment") to the
---------------
Amended and Restated Employment Agreement by and between Specialty Catalog
Corp., a Delaware corporation ("Specialty"), SC Corporation, a Delaware
---------
corporation ("SC"; together with Specialty, sometimes referred to as the
--
"Corporation"), each having its offices at 21 Bristol Drive, South Easton,
-----------
Massachusetts, and Steven L. Bock, an individual having an address at 10
Graystone Lane, Weston, Massachusetts (the "Executive"), dated as of October 15,
---------
1996 (as further amended and in effect from time to time, the "Employment
----------
Agreement"). Terms not otherwise defined herein which are defined in the
- ---------
Employment Agreement shall have the same respective meanings herein as therein.
WHEREAS, the Corporation and Executive have agreed to modify certain terms
and conditions of the Employment Agreement as specifically set forth in this
First Amendment;
NOW, THEREFORE, in consideration of the premises and the mutual agreements
contained herein and for other good and valuable consideration, the receipt and
sufficiency of which are hereby acknowledged, the parties hereto hereby agree as
follows:
(S)1. Amendments to Section 1(c) of the Employment Agreement. Section
------------------------------------------------------
1(c) of the Employment Agreement is hereby amended and restated in its entirety
by inserting the following new Section 1(c):
(c) Subject to earlier termination as hereinafter provided, the
term of this Agreement shall commence on the Effective Date and shall end
(unless notice of expiration shall not have been timely given by the
Corporation or Executive, as hereinafter provided in this Section 1(c)) at
the close of business on December 31, 1999 (as such term may be extended or
earlier terminated, the "Term"). The Corporation may cause the Term to
----
expire at December 31, 1999 by giving notice of expiration in writing to
Executive on or before June 30, 1999. Executive may cause the Term to
expire at December 31, 1999 by giving notice of expiration in writing to
the Corporation on or before July 31, 1999. Either the Corporation or
Executive may cause the Term to expire at the end of any calendar year
ending on or after December 31, 2000 by giving not less than six months'
notice of expiration in writing to the other party. For purposes of this
Employment Agreement, a "Term Year" shall be a period during the Employment
Term commencing on January 1, 1997 (or any anniversary thereof) and ending
on the date immediately preceding the next anniversary of such date, it
being understood that, for purposes of this Agreement, the portion of any
calendar year following the last full calendar year of the Term shall be
deemed a Term Year, except that vacation pursuant to Section 2.(d) for any
Term Year of less than a full calendar year in duration shall be prorated.
<PAGE>
-2-
(S)2. Ratification, Etc. Except as expressly amended hereby, the
------------ ---
Employment Agreement and all documents, instruments and agreements related
thereto, are hereby ratified and confirmed in all respects and shall continue in
full force and effect. The Employment Agreement and this First Amendment shall
be read and construed as a single agreement. All references in the Employment
Agreement or any related agreement or instrument to the Employment Agreement
shall hereafter refer to the Employment Agreement as amended hereby.
IN WITNESS WHEREOF, the parties hereto have executed this First Amendment
as a document under seal as of the date first above written.
SPECIALTY CATALOG CORP.
By: /s/ David E. Cicurel
--------------------
Name: David E. Cicurel
Title: Director
SC CORPORATION
By: /s/ David E. Cicurel
--------------------
Name: David E. Cicurel
Title: Director
/s/ Steven L. Bock
------------------
STEVEN L. BOCK
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