================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 _____________ FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended September 30, 2000 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) (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 November 1, 2000: 4,337,886. ================================================================================ SPECIALTY CATALOG CORP. INDEX PART I. FINANCIAL STATEMENTS Page No. -------- Item 1. Condensed Consolidated Financial Statements as of September 30, 2000, January 1, 2000 and October 2, 1999, for the Thirteen Weeks Ended September 30, 2000 and October 2, 1999 and for the Thirty-Nine Weeks Ended September 30, 2000 and October 2, 1999 Condensed Consolidated Statements of Operations 3-4 Condensed Consolidated Balance Sheets 5 Condensed Consolidated Statements of Cash Flows 6 Notes to Condensed Consolidated Financial Statements 7-12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13-16 Item 3. Quantitative and Qualitative Disclosures About Market Risk 16 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 17 Signatures 18 2 PART I. FINANCIAL STATEMENTS Item 1. Condensed Consolidated Financial Statements SPECIALTY CATALOG CORP. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited) Thirteen Weeks Ended September 30, 2000 October 2, 1999 ------------------ --------------- Revenues: Net sales ................................................................ $ 11,702,415 $ 10,131,275 Shipping & handling income ............................................... 1,737,723 1,483,292 Royalties ................................................................ 35,657 58,045 ------------ ------------ Total revenues ................................................................. 13,475,795 11,672,612 Cost of sales (including buying, occupancy and order fulfillment costs) ......................................................... 5,248,668 4,465,604 ------------ ------------ Gross profit ................................................................... 8,227,127 7,207,008 Operating expenses ............................................................. 7,387,415 6,881,143 Depreciation and amortization .................................................. 437,633 291,000 ------------ ------------ Income from operations ......................................................... 402,079 34,865 Interest expense, net .......................................................... 288,069 188,336 ------------ ------------ Income (loss) before income taxes .............................................. 114,010 (153,471) Income tax provision (benefit) ................................................. 46,738 (78,945) ------------ ------------ Net income (loss) .............................................................. 67,272 (74,526) Other comprehensive income (loss) .............................................. (24,544) 39,126 ------------ ------------ Comprehensive income (loss) .................................................... $ 42,728 $ (35,400) ============ ============ Earnings per share - Basic EPS: Net income (loss) per share .............................................. $ 0.02 $ (0.02) ============ ============ Weighted average shares outstanding ...................................... 4,337,886 4,399,955 ============ ============ Earnings per share - Diluted EPS: Net income (loss) per share .............................................. $ 0.01 $ (0.02) ============ ============ Weighted average shares outstanding ...................................... 4,643,556 4,399,955 ============ ============ See notes to condensed consolidated financial statements. 3 SPECIALTY CATALOG CORP. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED) (unaudited) Thirty-Nine Weeks Ended September 30, 2000 October 2, 1999 ------------------ --------------- Revenues: Net sales .......................................................... $ 40,068,861 $ 35,476,487 Shipping & handling income ......................................... 5,964,446 5,139,027 Royalties .......................................................... 174,325 243,899 ------------ ------------ Total revenues ........................................................... 46,207,632 40,859,413 Cost of sales (including buying, occupancy and order fulfillment costs) ................................................... 17,317,930 15,196,736 ------------ ------------ Gross profit ............................................................. 28,889,702 25,662,677 Operating expenses ....................................................... 25,566,465 22,239,266 Depreciation and amortization ............................................ 1,253,663 695,690 ------------ ------------ Income from operations ................................................... 2,069,574 2,727,721 Interest expense, net .................................................... 707,309 553,446 ------------ ------------ Income before income taxes ............................................... 1,362,265 2,174,275 Income tax provision ..................................................... 558,507 887,234 ------------ ------------ Net income ............................................................... 803,758 1,287,041 Other comprehensive income (loss) ........................................ (101,081) (11,578) ------------ ------------ Comprehensive income ..................................................... $ 702,677 $ 1,275,463 ============ ============ Earnings per share - Basic EPS: Net income per share ............................................... $ 0.19 $ 0.29 ============ ============ Weighted average shares outstanding ................................ 4,343,208 4,417,548 ============ ============ Earnings per share - Diluted EPS: Net income per share ............................................... $ 0.17 $ 0.27 ============ ============ Weighted average shares outstanding ................................ 4,666,078 4,700,615 ============ ============ See notes to condensed consolidated financial statements. 4 SPECIALTY CATALOG CORP. CONDENSED CONSOLIDATED BALANCE SHEETS September 30, January 1, October 2, 2000 2000 1999 ----- ----- ---- Assets (unaudited) (audited) (unaudited) Current assets: Cash and cash equivalents ........................................... $ 739,757 $ 1,136,847 $ 273,729 Accounts receivable, net ............................................ 1,461,900 1,206,490 1,639,414 Inventories ......................................................... 5,935,067 5,626,304 6,725,544 Prepaid expenses .................................................... 4,293,724 4,012,538 3,649,776 ------------ ------------ ------------ Total current assets ...................................... 12,430,448 11,982,179 12,288,463 ------------ ------------ ------------ Property, plant and equipment, net ........................................ 4,537,618 4,326,710 4,217,286 Intangible assets, net .................................................... 3,972,786 4,563,627 4,575,949 Deferred income taxes ..................................................... 4,433,416 4,338,843 4,302,828 Other assets .............................................................. 200,684 211,918 163,643 ------------ ------------ ------------ Total assets .............................................. $ 25,574,952 $ 25,423,277 $ 25,548,169 ============ ============ ============ Liabilities and Shareholders' Equity Current liabilities: Accounts payable and accrued expenses ............................... $ 5,394,205 $ 4,261,400 $ 3,895,973 Liabilities to customers ............................................ 1,352,320 1,169,256 1,486,928 Short-term borrowings ............................................... 6,213,482 6,401,238 6,876,604 Income taxes payable ................................................ 359,716 449,577 375,156 Current portion of long-term debt ................................... 1,788,653 2,125,000 1,512,539 ------------ ------------ ------------ Total current liabilities ................................. 15,108,376 14,406,471 14,147,200 ------------ ------------ ------------ Long-term debt ............................................................ 1,797,674 2,900,000 2,666,301 Other long-term liabilities ............................................... 262,056 377,875 383,440 Commitments and contingencies Shareholders' equity: Common stock ........................................................ 52,397 52,397 52,397 Additional paid-in capital .......................................... 16,159,570 16,159,570 16,159,570 Deferred compensation ............................................... -- -- (35,238) Accumulated other comprehensive income (loss) ....................... (152,331) (51,250) 4,348 Accumulated deficit ................................................. (4,785,612) (5,590,054) (5,102,499) ------------ ------------ ------------ 11,274,024 10,570,663 11,078,578 Less treasury stock, at cost, 901,388 shares at September 30, 2000, 888,388 shares at January 1, 2000 and 861,388 shares at October 2, 1999 .............................................. (2,867,178) (2,831,732) (2,727,350) ------------ ------------ ------------ Total shareholders' equity ................................ 8,406,846 7,738,931 8,351,228 ------------ ------------ ------------ Total liabilities and shareholders' equity ....... $ 25,574,952 $ 25,423,277 $ 25,548,169 ============ ============ ============ See notes to condensed consolidated financial statements. 5 SPECIALTY CATALOG CORP. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) Thirty-Nine Weeks Ended September 30, 2000 October 2, 1999 ------------------ --------------- Cash flows from operating activities: Net income .................................................. $ 803,758 $ 1,287,041 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization ......................... 1,253,663 695,690 Deferred income tax expense ........................... (72,948) 445,620 Amortization of deferred compensation ................. -- 13,125 Changes in operating assets and liabilities: Accounts receivable, net ............................ (294,342) (375,265) Inventories ......................................... (378,852) (1,329,969) Prepaid expenses .................................... (293,295) 207,535 Other assets ........................................ (17,336) 6,103 Accounts payable and accrued expenses ............... 1,196,499 181,509 Liabilities to customers ............................ 183,064 526,353 Income taxes payable ................................ (58,494) 75,118 Other long-term liabilities ......................... (29,169) -- ----------- ----------- Net cash provided by operating activities ................... 2,292,548 1,732,860 ----------- ----------- Cash flows from investing activities: Purchases of property, plant and equipment ........... (1,189,923) (1,395,404) Acquisition, net of liabilities assumed .............. -- (1,059,209) ----------- ----------- Net cash used in investing activities ....................... (1,189,923) (2,454,613) ----------- ----------- Cash flows from financing activities: Advances (repayments) on short-term borrowings, net .. (26,198) 1,781,992 Purchases of treasury stock .......................... (35,446) (373,709) Repayments of long-term debt ......................... (1,338,293) (1,439,375) Repayments of capital lease obligations .............. (97,080) (58,968) ----------- ----------- Net cash used in financing activities ....................... (1,497,017) (90,060) ----------- ----------- Effect of exchange rate changes on cash and cash equivalents (2,698) (12,329) ----------- ----------- Decrease in cash and cash equivalents ....................... (397,090) (824,142) Cash and cash equivalents, beginning of year ................ 1,136,847 1,097,871 ----------- ----------- Cash and cash equivalents, end of period .................... $ 739,757 $ 273,729 =========== =========== Supplemental disclosures of cash flow information: During the thirty-nine weeks ended September 30, 2000 and October 2, 1999, the Company received federal income tax refunds of $320,000 and $375,000, respectively. Summary of non-cash transactions: During the thirty-nine weeks ended September 30, 2000 and October 2, 1999, the Company recorded capital lease obligations of $10,430 and $290,789, respectively related to the purchase of data processing equipment. See notes to condensed consolidated financial statements. 6 SPECIALTY CATALOG CORP. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 1. Basis of Presentation These unaudited condensed consolidated financial statements should be read in conjunction with the Form 10-K of Specialty Catalog Corp. (the "Company") for the fiscal year ended January 1, 2000, and the consolidated financial statements and footnotes included therein. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with 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 thirteen weeks or for the thirty- nine weeks ended September 30, 2000 are not necessarily indicative of the results for the entire fiscal year ending December 30, 2000. The condensed consolidated financial statements for the thirteen weeks and thirty-nine weeks ended September 30, 2000 and October 2, 1999 are unaudited, but include, in the Company's opinion, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the results for the periods presented. 2. Accounting Policies The accounting policies underlying the condensed consolidated financial statements are those set forth in Note 1 of the consolidated financial statements included in the Company's Form 10-K for the fiscal year ended January 1, 2000. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("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 does not use either derivative financial instruments or enter into hedging activities. The Company has determined that there is no effect on its condensed consolidated financial statements from SFAS No. 133. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements." SAB No. 101 provides guidance on applying generally accepted accounting principles to revenue recognition issues in financial statements. SAB 101 must be adopted in the quarter ended December 31, 2000 and requires companies to report any changes in revenue recognition as a cumulative effect from a change in accounting principle at the time of adoption. The Company has restated its condensed consolidated statements of operations for the thirteen and thirty-nine weeks ended September 30, 2000 and October 2, 1999 by reclassifying all shipping and handling income from cost of sales and operating expenses to revenues. Certain amounts in the 1999 financial statements have been reclassified to conform to the 2000 presentation. 3. Treasury Stock In December 1998, the Company's Board of Directors authorized the Company to repurchase up to $1.0 million of the Company's common stock. As of September 30, 2000, the Company had repurchased 144,100 shares at an average price of $3.56 per share. 7 SPECIALTY CATALOG CORP. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) 4. Adoption of 2000 Stock Incentive Plan On June 22, 2000, the Company adopted the 2000 Stock Incentive Plan (the "Plan"). The Plan authorizes the issuance of up to 750,000 shares of the Company's common stock through the grant of stock options and awards of restricted stock. Each option has a maximum term of ten years from the date of grant, subject to early termination. On June 22, 2000, a total of 415,000 stock options were granted to employees and directors of the Company at a price of $2.50 per share. Options granted under the Company's 1996 Stock Incentive Plan, as amended (the "1996 Plan"), before their termination will remain outstanding according to their terms, but no further options will be granted under the 1996 Plan after June 22, 2000. 5. Reconciliation of Basic and Diluted Earnings per Share The following table (in thousands) shows the amounts used in computing basic and diluted earnings per share for net income and the effects of potentially dilutive options on the weighted average number of shares outstanding. For the thirteen weeks ended For the thirty-nine weeks ended September 30, October 2, September 30, October 2, ------------- --------- ------------- --------- 2000 1999 2000 1999 ---- ---- ---- ---- Net Net Net Net Income Shares Loss Shares Income Shares Income Shares ------ ------ ---- ------ ------ ------ ------ ------ Basic earnings per share $ 67 4,338 $ (75) 4,400 $ 804 4,343 $1,287 4,418 Effect of dilutive options -- 306 -- -- -- 323 -- 283 ------ ------ ------ ------ ------ ------ ------ ------ Diluted earnings per share $ 67 4,644 $ (75) 4,400 $ 804 4,666 $1,287 4,701 ====== ====== ====== ====== ====== ====== ===== ====== Options to purchase 529,951 shares of common stock ranging from $5.33 to $7.15 per share were not included in computing diluted EPS for the thirteen weeks and thirty-nine weeks ended September 30, 2000 because their effects were antidilutive. Options to purchase 966,577 shares of common stock ranging from $0.31 to $7.15 per share were not included in computing diluted EPS for the thirteen weeks ended October 2, 1999 because their effects were antidilutive. Options to purchase 656,351 shares of common stock ranging from $5.33 to $7.15 per share were not included in computing diluted EPS for the thirty-nine weeks ended October 2, 1999 because their effects were antidilutive. 6. Rights Agreement On April 11, 2000, the board of directors of the Company adopted a stockholder rights plan pursuant to a Rights Agreement dated as of April 11, 2000, between the Company and Continental Stock Transfer and Trust Company, as Rights Agent. The Rights Agreement is effective as of April 11, 2000 for all shares of Common Stock outstanding on such date and for all shares of Common Stock issued thereafter and prior to the earliest of the Distribution Date (as defined in the Rights Agreement). Each Right shall be exercisable (as defined in the Rights Agreement) by the registered holder of a Right Certificate to purchase 1/1000/th/ of a share of Series A Preferred Stock of the Company, subject to adjustment, at an exercise price per 1/1000/th/ of a share of Series A Preferred Stock of $15, subject to adjustment. Each 1/1000/th/ of a share of Series A Preferred Stock will have economic attributes (i.e., participation in dividends and voting rights) substantially equivalent to one whole share of the common stock of the Company. The Rights expire on the tenth anniversary of the date of the Rights Agreement unless earlier redeemed or exchanged by the Company as provided in the Rights Agreement. For further information, a detailed description of the Rights Agreement and a copy of the Rights Agreement were included in a current report on Form 8-K, which was filed with the Securities and Exchange Commission on April 13, 2000. 8 SPECIALTY CATALOG CORP. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) 7. Executive Officer Appointment On May 9, 2000, the Company announced the appointment of Joseph J. Grabowski (age 53) as president of the Company effective as of May 8, 2000. On July 1, 2000, Mr. Grabowski assumed the title of CEO, replacing Steven L. Bock whose resignation, effective June 30, 2000, was previously announced. The term of the executive employment agreement (the "Employment Agreement") between the Company and Mr. Grabowski commenced on May 8, 2000 and, unless extended, terminates on May 7, 2002 (the "Initial Term"). Under this Employment Agreement, Mr. Grabowski will receive an annual salary of $300,000, along with other benefits. Mr. Grabowski will be eligible for a performance bonus of up to 100 per cent of his annual salary, based upon the Company's performance as compared against the annual performance plan. Upon executing this agreement, Mr. Grabowski was granted options under the 2000 Stock Incentive Plan to purchase 250,000 shares of common stock of the Company at $2.50 per share. The Company may terminate Mr. Grabowski's employment upon his death or permanent disability, or if he engages in conduct that constitutes "cause" under the Employment Agreement. Mr. Grabowski may terminate his employment for "Good Reason" as defined in the Employment Agreement. In the event Mr. Grabowski's employment is terminated by the Company other than for "cause", Mr. Grabowski will receive a "Termination Payment" as defined in the Employment Agreement. The Employment Agreement contains non-competition and other restrictions effective during the term of employment and for a one-year period thereafter. 8. Business Segments and Financial Information by Geographic Location Specialty Catalog Corp. has six reportable segments: Paula Young(R), Especially Yours(R) and Paula's Hatbox(R) under the SC Direct division, Western Schools(R) and the American Healthcare Institute ("AHI") brand under the SC Publishing division and Daxbourne International Limited. The SC Direct division sells women's wigs and hairpieces using two distinct catalogs: Paula Young(R) and Especially Yours(R). In addition, prior to the end of 1999, SC Direct sold apparel, hats and other fashion accessories through its Paula's Hatbox(R) catalog. The SC Publishing division distributes catalogs under its Western Schools(R) brand and specializes in providing continuing education courses to nurses and accounting professionals. SC Publishing's other segment, American Healthcare Institute, which was acquired by the Company on September 10, 1999, distributes catalogs under its own name and specializes in providing continuing education seminars and conferences to nurses and other mental health professionals. Daxbourne International Limited is a retailer and wholesaler of women's wigs, hairpieces and related products in the United Kingdom. Beginning in the second quarter of fiscal year 2000, the Company changed its reportable segments from SC Direct, SC Publishing, AHI and Daxbourne International Limited to Paula Young(R), Especially Yours(R), Paula's Hatbox(R), Western Schools(R), AHI and Daxbourne International Limited. The change was made to conform the Company's financial reporting to how it now manages its business. As a result, the Company has restated the segment reporting results for the thirteen weeks and thirty-nine weeks ended October 2, 1999 to conform to its new segments. The accounting policies of the reportable segments are the same as those described in Note 1 of the consolidated financial statements included in the Company's Form 10-K for the fiscal year ended January 9 SPECIALTY CATALOG CORP. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) 1, 2000. The Company's reportable segments are strategic business units that offer either different products or operate in different geographic locations. The Company markets its products in two major geographic areas, the United States and the United Kingdom. The SC Direct and SC Publishing divisions market their products and maintain their assets in the United States. Daxbourne International Limited markets its products and maintains its assets in the United Kingdom. 10 SPECIALTY CATALOG CORP. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) A summary of information about the Company's operations by segment for the thirteen weeks ended September 30, 2000 and October 2, 1999 follows (intersegment eliminations are intercompany receivables and investments in subsidiaries): Paula Especially Paula's Corporate Total SC Western Young Yours Hatbox Expenses Direct Schools AHI ----- ----- ------ -------- ------ ------- --- For the thirteen weeks ended September 30, 2000 Net sales.......................... $6,818,273 $1,571,675 $ -- $ -- $ 8,389,948 $ 896,268 $1,128,474 Shipping & handling income......... 1,233,261 293,366 -- -- 1,526,627 179,571 -- ---------- ---------- --------- ----------- ----------- ---------- ---------- Total revenues..................... 8,051,534 1,865,041 -- -- 9,916,575 1,075,839 1,128,474 Gross profit....................... 5,126,540 1,086,007 -- (234,817) 5,977,730 749,461 613,031 Operating expenses................. 3,305,541 1,195,979 -- 995,899 5,497,419 684,628 631,948 Depreciation and amortization...... -- -- -- 301,337 301,337 10,298 38,735 Income (loss) from operations...... 1,820,999 (109,972) -- (1,532,053) 178,974 54,535 (57,652) Interest expense, net.............. -- -- -- 227,031 227,031 -- 1,239 Income tax provision (benefit)..... -- -- -- (19,709) (19,709) 22,361 (24,147) Segment assets..................... -- -- -- 15,625,257 15,625,257 4,612,067 896,697 Capital expenditures............... -- -- -- 299,713 299,713 16,433 11,653 Paula Especially Paula's Corporate Total SC Western Young Yours Hatbox Expenses Direct Schools AHI ----- ----- ------ -------- ------ ------- --- For the thirteen weeks ended October 2, 1999 Net sales........................... $6,653,843 $ 872,775 $ 539,719 $ -- $ 8,066,337 $ 835,588 $ -- Shipping & handling income.......... 1,094,414 160,548 70,618 -- 1,325,580 157,712 -- ---------- ---------- --------- ----------- ----------- ---------- ---------- Total revenues...................... 7,748,257 1,033,323 610,337 -- 9,391,917 993,300 -- Gross profit........................ 4,996,128 613,175 263,715 (243,345) 5,629,673 672,045 -- Operating expenses.................. 2,846,568 683,599 555,319 1,539,742 5,625,228 617,830 -- Depreciation and Amortization....... -- -- -- 186,095 186,095 11,250 -- Income (loss) from Operations....... 2,149,560 (70,424) (291,604) (1,969,182) (181,650) 42,965 -- Interest expense, net............... -- -- -- 132,531 132,531 -- -- Income tax provision (benefit)...... -- -- -- (128,835) (128,835) 17,600 -- Segment assets...................... -- -- -- 16,392,745 16,392,745 4,208,440 406,547 Capital expenditures ............... -- -- -- 527,430 527,430 1,594 -- Total SC Publishing Daxbourne Total ---------- --------- ----- For the thirteen weeks ended September 30, 2000 Net sales.......................... $2,024,742 $1,323,382 $11,738,072 Shipping & handling income......... 179,571 31,525 1,737,723 ---------- ---------- ----------- Total revenues..................... 2,204,313 1,354,907 13,475,795 Gross profit....................... 1,362,492 886,905 8,227,127 Operating expenses................. 1,316,576 573,420 7,387,415 Depreciation and amortization...... 49,033 87,263 437,633 Income (loss) from operations...... (3,117) 226,222 402,079 Interest expense, net.............. 1,239 59,799 288,069 Income tax provision (benefit)..... (1,786) 68,233 46,738 Segment assets .................... 5,508,764 4,440,931 25,574,952 Capital expenditures .............. 28,086 (524) 327,275 Total SC Publishing Daxbourne Total ---------- --------- ----- For the thirteen weeks ended October 2, 1999 Net sales............................ $ 835,588 $1,287,395 $10,189,320 Shipping & handling income........... 157,712 -- 1,483,292 ---------- ---------- ----------- Total revenues....................... 993,300 1,287,395 11,672,612 Gross profit......................... 672,045 905,290 7,207,008 Operating expenses................... 617,830 638,085 6,881,143 Depreciation and Amortization........ 11,250 93,655 291,000 Income (loss) from Operations........ 42,965 173,550 34,865 Interest expense, net................ -- 55,805 188,336 Income tax provision (benefit)....... 17,600 32,290 (78,945) Segment assets ...................... 4,614,987 4,540,437 25,548,169 Capital expenditures ................ 1,594 35,683 564,707 SPECIALTY CATALOG CORP. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) A summary of information about the Company's operations by segment for the thirty-nine weeks ended September 30, 2000 and October 2, 1999 follows (intersegment eliminations are intercompany receivables and investments in subsidiaries): Paula Especially Paula's Corporate Total SC Western Total SC Young Yours Hatbox Expenses Direct Schools AHI Publishing ----- ----- ------ -------- ------ ------- --- ---------- For the thirty-nine weeks ended September 30, 2000 Net sales.............. $23,631,770 $5,298,768 $ -- $ -- $28,930,538 $3,657,563 $3,601,412 $7,258,975 Shipping & handling income................ 4,254,044 972,345 -- -- 5,226,389 709,343 -- 709,343 ----------- ---------- --------- ---------- ----------- ---------- ----------- ---------- Total revenues......... 27,885,814 6,271,113 -- -- 34,156,927 4,366,906 3,601,412 7,968,318 Gross profit........... 17,855,302 3,760,485 -- (702,383) 20,913,404 3,147,462 2,045,087 5,192,549 Operating expenses..... 11,917,753 3,911,601 -- 3,476,815 19,306,169 2,374,546 2,061,687 4,436,233 Depreciation and amortization........... -- -- -- 843,509 843,509 31,150 108,053 139,203 Income (loss) from operations............ 5,937,549 (151,116) -- (5,022,707) 763,726 741,766 (124,653) 617,113 Interest expense, net.. -- -- -- 532,812 532,812 -- 1,239 1,239 Income tax provision (benefit)............. -- -- -- 94,654 94,654 304,124 (51,618) 252,506 Segment assets......... -- -- -- 15,625,257 15,625,257 4,612,067 896,697 5,508,764 Capital expenditures... -- -- -- 1,081,314 1,081,314 16,433 69,977 86,410 Daxbourne Total --------- ----- For the thirty-nine weeks ended September 30, 2000 Net sales.............. $4,053,673 $40,243,186 Shipping & handling income................ 28,714 5,964,446 ----------- ----------- Total revenues......... 4,082,387 46,207,632 Gross profit........... 2,783,749 28,889,702 Operating expenses..... 1,824,063 25,566,465 Depreciation and amortization.......... 270,951 1,253,663 Income (loss) from operations............ 688,735 2,069,574 Interest expense, net.. 173,258 707,309 Income tax provision (benefit)............. 211,347 558,507 Segment assets......... 4,440,931 25,574,952 Capital expenditures... 22,199 1,189,923 Paula Especially Paula's Corporate Total SC Western Total SC Young Yours Hatbox Expenses Direct Schools AHI Publishing ----- ----- ------ -------- ------ ------- --- ---------- For the thirty-nine weeks ended October 2, 1999 Net sales............. $21,793,544 $3,990,812 $2,343,713 $ -- $28,128,069 $3,670,959 $ -- $3,670,959 Shipping & handling income............... 3,558,718 588,535 331,895 -- 4,479,148 659,879 -- 659,879 ----------- ---------- ---------- ----------- ----------- ---------- ----------- ---------- Total revenues........ 25,352,262 4,579,347 2,675,608 -- 32,607,217 4,330,838 -- 4,330,838 Gross profit.......... 16,544,516 2,753,820 1,263,076 (722,086) 19,839,326 3,054,350 -- 3,054,350 Operating expenses.... 10,012,973 2,763,873 2,038,154 3,338,189 18,153,189 2,146,797 -- 2,146,797 Depreciation and amortization......... -- -- -- 376,386 376,386 33,322 -- 33,322 Income from operations.......... 6,531,543 (10,053) (775,078) (4,436,661) 1,309,751 874,231 -- 874,231 Interest expense, net. -- -- -- 374,871 374,871 -- -- -- Income tax provision.. -- -- -- 383,301 383,301 358,435 -- 358,435 Segment assets........ -- -- -- 16,392,745 16,392,745 4,208,440 406,547 4,614,987 Capital expenditures.. -- -- -- 1,334,338 1,334,338 8,661 -- 8,661 Daxbourne Total --------- ----- For the thirty-nine weeks ended October 2, 1999 Net sales............. $3,921,358 $35,720,386 Shipping & handling income............... -- 5,139,027 ---------- ----------- Total revenues........ 3,921,358 40,859,413 Gross profit.......... 2,769,001 25,662,677 Operating expenses.... 1,939,280 22,239,266 Depreciation and amortization......... 285,982 695,690 Income from operations.......... 543,739 2,727,721 Interest expense, net. 178,575 553,446 Income tax provision.. 145,498 887,234 Segment assets........ 4,540,437 25,548,169 Capital expenditures.. 52,405 1,395,404 12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations In addition to the historical information contained herein, this Quarterly Report on Form 10-Q for the Company may contain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 ("Exchange Act"), including, but not limited to, the Company's expected future revenues, operations and expenditures, estimates of the potential markets for the Company's products, assessments of competitors and potential competitors and projected timetables for the market introduction of the Company's products. Investors are cautioned that forward-looking statements are inherently uncertain. Actual performance and results of operations may differ materially from those projected or suggested in the forward-looking statements due to certain risks and uncertainties, including, but not limited to, the following risks and uncertainties: (i) the Company's indebtedness and future capital requirements, (ii) increasing postal rates, paper prices and media costs, (iii) limited sources of fiber used to make the Company's products, (iv) the limited number of suppliers of the Company's products, (v) the Company's dependence upon foreign suppliers, especially in China, Indonesia and Korea, (vi) the customary risks of doing business abroad, including fluctuations in the value of currencies, (vii) the potential development of a cure for hair loss and cancer treatment improvements, (viii) the effectiveness of the Company's catalogs and advertising programs, (ix) the Company's competition and (x) the impact of acquisitions on the Company's prospects. 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 fiscal year ended January 1, 2000. The forward-looking statements contained herein represent the Company's judgment as of the date of this Quarterly Report on Form 10-Q, and the Company cautions readers not to place undue reliance on such statements. Thirteen Weeks Ended September 30, 2000 Compared to the Thirteen Weeks Ended October 2, 1999 Revenues increased to $13.5 million for the thirteen weeks ended September 30, 2000 from $11.7 million for the thirteen weeks ended October 2, 1999, an increase of $1.8 million or 15.4 per cent. This increase was due to the addition of $1.1 million in net sales from American Healthcare Institute ("AHI"), which was acquired by the Company in September 1999, and increases in SC Direct's, Western Schools(R) and Daxbourne's net sales of approximately $324,000, $61,000 and $36,000, respectively. The remainder of the revenue increase resulted from the approximately proportionate increase in shipping & handling income of approximately $254,000 due to the increase in Company net sales mentioned above. The increase in SC Direct's net sales was primarily due to net sales increases in the Paula Young(R) and Especially Yours(R) catalogs in the amount of approximately $165,000 and $699,000, respectively, due primarily to increased number of orders from increased circulation of its catalogs to existing customers and to new customers generated by the Company's advertising programs and sales over the Internet and to changes in the product mix in both catalogs. The increase in SC Direct's net sales was offset by a decrease of approximately $540,000 in net sales from its Paula Hatbox(R) catalog, as a result of the Company's decision in the fourth quarter of 1999 to no longer circulate this catalog. Gross margin as a percentage of revenues decreased to 61.1 per cent for the thirteen weeks ended September 30, 2000 from 61.7 per cent for the thirteen weeks ended October 2, 1999 due to minor merchandise mix changes. Gross margin increased to $8.2 million for the thirteen weeks ended September 30, 2000 from $7.2 million for the thirteen weeks ended October 2, 1999, an increase of $1.0 million or 13.9 per cent. This increase was due to the increase in revenues discussed above, offset by the decrease in gross margin rate discussed above. 13 Operating expenses increased to $7.8 million for the thirteen weeks ended September 30, 2000 from $7.2 million for the thirteen weeks ended October 2, 1999, an increase of approximately $653,000 or 9.1 per cent. This increase was due primarily to: (i) additional catalog production and advertising expenses of approximately $681,000 and $346,000, respectively, mainly related to the acquisition of AHI as well as increased circulation of catalogs mailed to the Paula Young(R) and Especially Yours(R) customers and to inactive Paula Young(R) customers in an effort to reactivate these names, (ii) increased depreciation and amortization expense of approximately $147,000 related to the implementation of the Company's catalog information system in August 1999, and (iii) approximately $520,000 in additional payroll and benefit costs, mainly related to the AHI acquisition as well as an increase in in-house telemarketing and customer service personnel. The increase in operating expenses was offset by: (i) a reduction in external telemarketing and customer service costs of approximately $264,000, and (ii) a prior year's restructuring charge described below. In August 1999, the Company announced the resignation of its chief executive officer. In connection with the resignation and search for a new chief executive officer, the Company recorded a pre-tax charge of $500,000, consisting of severance and other severance related benefits and recruiting fees. Also, in September 1999, the Company recorded a pre-tax charge of $276,946 related to costs incurred in connection with certain acquisitions that the Company decided not to pursue. Interest expense, net of interest income, increased to approximately $288,000 for the thirteen weeks ended September 30, 2000 from approximately $188,000 for the thirteen weeks ended October 2, 1999, an increase of approximately $100,000 or 53.2 per cent. The increase was attributable to higher interest rates during the third quarter of 2000 compared to the third quarter of 1999, offset by lower average principal amounts outstanding on the Company's bank facility. Thirty-Nine Weeks Ended September 30, 2000 Compared to the Thirty-Nine Weeks Ended October 2, 1999 Revenues increased to $46.2 million for the thirty-nine weeks ended September 30, 2000 from $40.9 million for the thirty-nine weeks ended October 2, 1999, an increase of $5.3 million or 13.0 per cent. This increase was due to the addition of $3.6 million in net sales from AHI, which was acquired by the Company in September 1999, and increases in SC Direct's and Daxbourne's net sales of approximately $802,000 and $132,000, respectively, offset by lower Western Schools(R) net sales of approximately $13,000. The remainder of the revenue increase resulted from the approximately proportionate increase in shipping & handling income of approximately $825,000 due to the increase in Company net sales mentioned above. The increase in SC Direct's net sales was primarily due to net sales increases in the Paula Young(R) and Especially Yours(R) catalogs in the amount of $1.8 million and $1.3 million, respectively, due primarily to increased number of orders from increased circulation of its catalogs to existing customers and to new customers generated by the Company's advertising programs and sales over the Internet and to changes in the product mix in both catalogs. The increase in SC Direct's net sales was offset by a decrease of $2.3 million in net sales from its Paula Hatbox(R) catalog, as a result of the Company's decision in the fourth quarter of 1999 to no longer circulate this catalog. Gross margin as a percentage of revenues decreased to 62.5 per cent for the thirty-nine weeks ended September 30, 2000 from 62.8 per cent for the thirty-nine weeks ended October 2, 1999 due to minor merchandise mix changes. Gross margin increased to $28.9 million for the thirty-nine weeks ended September 30, 2000 from $25.7 million for the thirty-nine weeks ended October 2, 1999, an increase of $3.2 million or 12.5 per cent. This increase was due to the increase in revenues discussed above, offset by the decrease in gross margin rate discussed above. 14 Operating expenses increased to $26.8 million for the thirty-nine weeks ended September 30, 2000 from $22.9 million for the thirty-nine weeks ended October 2, 1999, an increase of $3.9 million or 17.0 per cent. This increase was due primarily to: (i) additional catalog production and advertising expenses of approximately $2.0 million and $488,000, respectively, mainly related to the acquisition of AHI as well as increased circulation of catalogs mailed to the Paula Young(R) and Especially Yours(R) customers and to inactive Paula Young(R) customers in an effort to reactivate these names, (ii) approximately $439,000 related to costs incurred in connection with the bonus paid to the former chief executive officer and the terminated sale of the Company's common stock to Golub Associates, Inc., (iii) increased depreciation and amortization of approximately $558,000 related to the implementation of the Company's catalog information system in August 1999, and (iv) $1.4 million in additional payroll and benefit costs, mainly related to the AHI acquisition and an increase in in-house telemarketing and customer service personnel. The increase in operating expenses was offset by: (i) a reduction in outside telemarketing and customer service costs of approximately $245,000, and (ii) a prior year's restructuring charge described below. In August 1999, the Company announced the resignation of its chief executive officer. In connection with the resignation and search for a new chief executive officer, the Company recorded a pre-tax charge of $500,000, consisting of severance and other severance related benefits and recruiting fees. Also, in September 1999, the Company recorded a pre-tax charge of $276,946 related to costs incurred in connection with certain acquisitions that the Company decided not to pursue. Interest expense, net of interest income, increased to approximately $707,000 for the thirty-nine weeks ended September 30, 2000 from approximately $553,000 for the thirty-nine weeks ended October 2, 1999, an increase of approximately $154,000 or 27.9 per cent. The increase was attributable to higher interest rates during the thirty-nine weeks ended September 30, 2000 compared to the thirty-nine weeks ended October 2, 1999, offset by lower average principal amounts outstanding on the Company's bank facility. Liquidity and Capital Resources For the thirty-nine weeks ended September 30, 2000 net cash flow used by the Company was approximately $397,000. Cash flows provided by operating activities for the thirty-nine weeks ended September 30, 2000 was $2.3 million, offset by $1.2 million in investing activities and $1.5 million in financing activities. The major factors that caused the difference between net income and net cash flows provided by operations for the thirty-nine weeks ended September 30, 2000 were increases in: (i) cash working capital items of approximately $308,000, and (ii) depreciation and amortization expense of $1.3 million, offset by a decrease in deferred income tax expense of approximately $73,000. The Company used $1.2 million in investing activities for computer and equipment purchases. The $1.5 million in net cash used in financing activities was primarily due to: (i) the repayment of $1.3 million of long-term debt, (ii) the repayment of approximately $97,000 of capital leases, (iii) the repayment of approximately $35,000 of treasury stock, and (iv) the repayment of approximately $26,000 of short-term borrowings. The Company's cash flow from operations and available credit facilities are considered adequate to fund planned business operations and both the short-term and long-term capital needs of the Company. However, certain events, such as an additional significant acquisition, could require new external financing. Recently Issued Accounting Pronouncements In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("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 15 Company does not use either derivative financial instruments or enter into hedging activities. The Company has determined that there is no effect on its condensed consolidated financial statements from SFAS No. 133. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements." SAB No. 101 provides guidance on applying generally accepted accounting principles to revenue recognition issues in financial statements. SAB 101 must be adopted in the quarter ended December 31, 2000 and requires companies to report any changes in revenue recognition as a cumulative effect from a change in accounting principle at the time of adoption. The Company has restated its condensed consolidated statements of operations for the thirteen and thirty-nine weeks ended September 30, 2000 and October 2, 1999 by reclassifying all shipping and handling income from cost of sales and operating expenses to revenue. Item 3. Quantitative and Qualitative Disclosures About Market Risk The Company's primary exposures to market risks include fluctuations in interest rates on its short-term and long-term borrowings of $9.8 million as of September 30, 2000 under its credit facility and in foreign currency exchange rates. The Company does not use derivative financial instruments. 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 adverse effect on the Company's consolidated financial statements. However, no assurance can be given that such a risk will not have a material adverse effect on the Company's consolidated financial statements in the future. The Company's term loan and line of credit bear interest rates based on either a base rate or a LIBOR contract rate. The Company's UK term loan and the UK line of credit bear interest rates based on either a Sterling base rate or a LIBOR contract rate. As of September 30, 2000, the outstanding balance on all of the Company's credit facilities was $9,799,809. Based on this balance, an immediate change of one per cent in the interest rate would cause a change in interest expense of approximately $98,000 on an annual basis. The Company's objective in maintaining these variable rate borrowings is the flexibility obtained regarding early repayment without penalties and lower overall cost as compared with fixed-rate borrowings. The foreign currencies to which the Company has the most significant exchange rate exposure are the British Pound, Chinese Yuan, Indonesian Rupiah and Korean Won. The Company expects that most of its wigs and hairpieces will continue to be manufactured in China, Indonesia and Korea in the future. Although a substantial portion of the Company's transactions with these countries occurs in US dollars, the Company's operations may be 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. 16 PART II. OTHER INFORMATION ITEM 6. Exhibits and Reports on Form 8-K (a) Exhibits 10.1 Employment Agreement dated as of May 8, 2000 between the Registrant and Joseph Grabowski. Filed as Exhibit 10.1 to Specialty Catalog Corp.'s Form 10-Q for the Quarter Ended April 1, 2000. 10.2 Eighth Amendment to Credit and Guaranty Agreement and Seventh Amendment to Credit Agreement dated as of May 12, 2000 between Fleet National Bank and the Registrant. Filed as Exhibit 10.2 to Specialty Catalog Corp.'s Form 10-Q for the Quarter Ended April 1, 2000. 10.3 Rights Agreement between Specialty Catalog Corp. and Continental Stock Transfer and Trust Company, as Rights Agent. Filed as Exhibit 4.1 to Specialty Catalog Corp.'s Form 8-K, dated April 11, 2000 27.1 Financial Data Schedule (for EDGAR filing purposes only). Filed herewith. (b) Reports on Form 8-K during the thirteen weeks ended September 30, 2000: None. 17 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SPECIALTY CATALOG CORP. Dated: November 14, 2000 By: /s/ Joseph Grabowski ---------------------------- Joseph Grabowski Chief Executive Officer and President Dated: November 14, 2000 By: /s/ Thomas McCain ---------------------------- Thomas McCain Senior Vice President, Chief Financial Officer, Secretary and Treasurer 18