RULE NO. 424(b)(4) REGISTRATION NO. 333-10793 PROSPECTUS 1,500,000 SHARES LOGO SPECIALTY CATALOG CORP. SPECIALTY Catalog CORP. COMMON STOCK All of the 1,500,000 shares of Common Stock ("Common Stock") offered hereby are being sold by Specialty Catalog Corp. ("Company"). Prior to this offering ("Offering"), there has been no public market for the Common Stock of the Company and there can be no assurance that any such market will develop. The initial public offering price of the shares is $6.50. See "Underwriting" for information relating to the factors considered in determining the initial public offering price of the Common Stock. The Common Stock has been approved for quotation on the Nasdaq National Market under the symbol "CTLG". ---------------- THE SHARES OFFERED HEREBY ARE SPECULATIVE IN NATURE, INVOLVE A HIGH DEGREE OF RISK AND SUBSTANTIAL DILUTION. SEE "RISK FACTORS" AT PAGE 9 HEREOF AND DILUTION AT PAGE 16 HEREOF. ---------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- PRICE UNDERWRITING PROCEEDS TO DISCOUNTS AND TO PUBLIC COMMISSIONS(1) COMPANY(2) - -------------------------------------------------------------------------------- Per Share................................. $6.50 $0.52 $5.98 - -------------------------------------------------------------------------------- Total(3).................................. $9,750,000 $780,000 $8,970,000 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- (1) Does not include a 2.5% nonaccountable expense allowance which the Company has agreed to pay the Underwriter. The Company has also agreed to sell the Underwriter an option ("Underwriter's Purchase Option") to purchase 150,000 shares of Common Stock and indemnify the Underwriter against certain liabilities, including liabilities under the Securities Act of 1933, as amended ("Securities Act"). See "Underwriting." (2) Before deducting expenses payable by the Company, including the nonaccountable expense allowance in the amount of $243,750 ($280,313 if the Underwriter's over-allotment option is exercised in full), estimated at $800,000. (3) The Company has granted the Underwriter an option, exercisable within 45 days from the date of this Prospectus, to purchase up to 225,000 additional shares of Common Stock on the same terms set forth above, solely for the purpose of covering over-allotments, if any. If such over- allotment option is exercised in full, the total Price to Public, Underwriting Discounts and Commissions and Proceeds to Company will be $11,212,500, $897,000 and $10,315,500, respectively. See "Underwriting." The shares of Common Stock are being offered by the Underwriter, subject to prior sale, when, as and if delivered to and accepted by the Underwriter and subject to the approval of certain legal matters by counsel and certain other conditions. The Underwriter reserves the right to withdraw, cancel or modify this Offering and to reject any order in whole or in part. It is expected that delivery of certificates representing the shares of Common Stock will be made against payment therefor at the offices of the Underwriter in New York City, on or about October 22, 1996. GKNSecurities OCTOBER 17, 1996 [PHOTOS] IN CONNECTION WITH THIS OFFERING, THE UNDERWRITER MAY OVER-ALLOT OR EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. This prospectus contains references to trademarks of entities other than the Company, which have reserved all rights with respects to their respective trademarks. PROSPECTUS SUMMARY The following summary is qualified in its entirety by reference to, and should be read in conjunction with, the more detailed information and financial statements (including the notes thereto) appearing elsewhere in this Prospectus. Unless otherwise indicated, "Company" shall include the two operating subsidiaries of the Company, SC Corporation, doing business under the name SC Direct ("SC Direct"), and SC Publishing, Inc. ("SC Publishing"), a wholly-owned subsidiary of SC Direct. Each prospective investor is urged to read this Prospectus in its entirety. THE COMPANY The Company is a direct marketer targeting niche consumer product categories. SC Direct, its principal operating subsidiary, is the leading U.S. retailer of women's wigs and hairpieces. SC Publishing, a subsidiary of SC Direct, sells continuing education courses to nurses, real estate professionals and Certified Public Accountants ("CPAs"). SC Direct sells wigs and hairpieces primarily to women over the age of 50, using three distinct catalogs: Paula Young (R), Christine Jordan (TM) and Especially Yours (TM). In 1995, SC Direct mailed 20.9 million catalogs, generating net sales of $37.3 million. SC Direct has developed a proprietary data base consisting of approximately 5.6 million persons, including more than 875,000 active customers and more than one million persons who have requested catalogs in the past year but who have not made a purchase. Due to the fact that wig wearers are difficult to identify, the Company believes that its wig database is unique and would be very expensive to replicate. The Company believes that this poses a substantial barrier to entry for any potential competitor. SC Direct's target market, women over age 50, is projected by the U.S. Census Bureau to grow from 38.7 million women, or 38% of the total female population in 1995, to 51.5 million women, or 45% of the total female population in 2010. This growth is driven primarily by aging "baby-boomers." The Company believes that only approximately five million, or 25%, of the 20 million American women with thinning hair currently wear wigs, and that, accordingly, there is substantial opportunity for future growth of SC Direct's business. SC Direct's strategy for its core business is to exploit new distribution opportunities for wigs and hairpieces and to sell additional products to its customers. For example, in the last three years, SC Direct has introduced its upscale Christine Jordan catalog and its Especially Yours catalog for African- American customers, expanded into international markets and begun a test program selling to hair salons. In 1995, SC Direct launched its Paula's Hatbox (TM) catalog through which it sells a variety of fashion hats to women. The Company believes that the market for fashion hats has niche characteristics similar to those of the wig market. In addition, SC Direct intends to enter another new market by testing men's wigs in the Paula Young catalog in early 1997. The Company utilizes primarily a two-step marketing program. Step one involves obtaining prospective customers through a targeted advertising program. Step two, which commences when a prospective customer responds favorably to an advertisement placed by the Company, involves sending such prospective customer a series of catalogs designed to elicit an initial sale. Through this program, the Company has been able to convert into customers 15% to 20% of those persons who request catalogs. Because this program involves targeted mailings only to persons who have shown an interest in its products, the Company also has been able to reduce its exposure to increases in paper, postage and other catalog production costs. 3 SC Publishing offers nurses, real estate agents and CPAs home study continuing education through its Western Schools(R) catalogs. SC Publishing's strategy is to build its business by offering additional products and programs to its core customers and by expanding into new and related professional fields. In 1995, SC Publishing mailed 8.3 million catalogs generating net sales of $5.3 million. The Company intends to build its existing niche markets and enter new niche markets both by internal expansion and through acquisitions. Niche markets are characterized by smaller market size, unique or hard to find products, or hard to locate customers. The Company plans to implement its two-step marketing program in new and acquired businesses where appropriate. The catalog industry is very fragmented, with more than 8,000 catalogs currently being circulated. Many catalog retailers, especially the smaller ones, are finding it difficult to grow due to a combination of capital constraints, higher costs and an inability to achieve sufficient operating economies of scale. This situation was exacerbated by substantial increases in paper and postage costs in 1995. The Company believes that this environment will create many acquisition opportunities, allowing it to select acquisition candidates that provide either strategic growth to its existing businesses or an opportunity to enter additional niche markets. As of the date of this Prospectus, the Company has no agreement or understanding, nor is it engaged in any negotiations, with respect to any acquisition. The Company was incorporated in Delaware on November 30, 1994, as a holding company for SC Direct and SC Publishing, which emerged from bankruptcy on November 23, 1994. See "Reorganization." The principal executive offices of the Company are located at 21 Bristol Drive, South Easton, Massachusetts 02375 and its telephone number is (508) 238-0199. 4 THE OFFERING Common Stock Offered........................................ 1,500,000 shares Common Stock Outstanding Prior to this Offering............. 3,201,666 shares(1) Common Stock to be Outstanding After this Offering.......... 4,701,666 shares Nasdaq National Market Symbol............................... CTLG - -------- (1) Gives effect to a 325.51 for 1 stock split effected on October 11, 1996. USE OF PROCEEDS The Company intends to apply the net proceeds of this Offering to repay $5.9 million of the Company's Senior Indebtedness (as hereinafter defined), including: (i) $1.5 million to pay down the outstanding amount under the revolving credit portion of the Senior Indebtedness; (ii) $1.8 million of the Senior Indebtedness which is due within one year of the date hereof; and (iii) $2.6 million of the Senior Indebtedness which is due more than one year following the date hereof. The remaining $2.3 million will be used for working capital and general corporate purposes. See "Use of Proceeds." RISK FACTORS The securities offered hereby involve a high degree of risk, including, without limitation: substantial indebtedness; pledge of assets; substantial portion of proceeds used to pay debt; broad discretion in application of remaining proceeds; possible inability to refinance senior indebtedness; working capital deficit; negative net worth; recent decrease in net sales and net income; possible need for additional capital; effectiveness of catalogs and advertising; postal rates, paper prices and media costs; limited sources of fiber and limited number of wig manufacturers. See "Risk Factors." 5 SUMMARY FINANCIAL AND OPERATING DATA The summary financial data presented below, except for the summary operating data, as of and for the fiscal years ended January 1, 1994, December 31, 1994 and December 30, 1995 is derived from the audited financial statements of the Company included herein. The summary financial data for fiscal years ended December 28, 1991 and January 2, 1993 and the summary financial data for the six months ended July 1, 1995 and June 29, 1996, except for the summary operating data, are derived from the unaudited financial statements of the Company. In the opinion of management, the summary financial data presented below as of and for the six months ended July 1, 1995 and June 29, 1996 include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial position and results of operations for these periods. The six month results are not necessarily indicative of the results to be expected for the full year. This information should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the financial statements of the Company, including the notes thereto, appearing elsewhere herein. PRO FORMA HISTORICAL AS ADJUSTED(1) ------------------------------------------------------------------- ------------------------- FISCAL YEAR ENDED SIX MONTHS ENDED FISCAL YEAR SIX MONTHS ------------------------------------------------ ----------------- ENDED ENDED DEC. 28, JAN. 2, JAN. 1, DEC. 31, DEC. 30, JULY 1, JUNE 29, DEC. 30, JUNE 29, 1991 1993 1994 1994 1995 1995 1996 1995 1996 -------- -------- -------- -------- -------- ------- -------- -------------- ---------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND AVERAGE ORDER SIZE) STATEMENT OF OPERATIONS DATA: Net sales(2)............ $ 46,552 $ 47,120 $ 33,801 $38,179 $42,568 $22,419 $18,754 $42,568 $18,754 Interest expense, net... 3,242 3,080 431 661 1,918 958 909 1,343 623 Income (loss) before cumulative effect of change in accounting principle and extraordinary item..... (5,897) (2,136) 992 710 522 554 149 872 322 Net income (loss)(3).... $ (5,897) $ (2,136) $ 9,977 $12,789 $ 522 $ 554 $ 149 $ 872 $ 322 EARNINGS (LOSS) PER COMMON SHARE(4): Income (loss) before cumulative effect of change in accounting principle and extraordinary item..... $ (1.96) $ (0.71) $ 0.33 $ 0.23 $ 0.08 $ 0.14 $ 0.00 $ 0.17 $ 0.06 Net income (loss)....... $ (1.96) $ (0.71) $ 3.31 $ 4.23 $ 0.08 $ 0.14 $ 0.00 $ 0.17 $ 0.06 SUMMARY OPERATING DATA: Total catalog circulation(5)......... 17,122 17,562 18,807 22,623 29,245 15,245 12,891 Active customer file.... 762 890 941 1,094 1,096 1,254 1,222 Average order size...... $ 56.17 $ 57.98 $ 60.82 $ 60.27 $ 61.05 $ 60.05 $ 62.85 PRO FORMA HISTORICAL AS ADJUSTED(6) ------------------------------------------------------------------- -------------- FISCAL YEAR ENDED SIX MONTHS ENDED SIX MONTHS ------------------------------------------------ ----------------- ENDED DEC. 28, JAN. 2, JAN. 1, DEC. 31, DEC. 30, JULY 1, JUNE 29, JUNE 29, 1991 1993 1994 1994 1995 1995 1996 1996 -------- -------- -------- -------- -------- ------- -------- -------------- (IN THOUSANDS) BALANCE SHEET DATA: Working capital......... $ (3,480) $ (30) $ 124 $ 2,114 $ 649 $ 2,253 $ (185) $ 5,633 Total assets............ 10,756 6,150 19,142 17,364 18,170 18,755 17,777 20,547 Long-term debt(7)....... 28,461 31,621 30,125 15,180 12,876 14,792 11,813 9,343 Preferred stock......... -- -- -- 2,249 2,249 2,249 2,249 -- Stockholders' equity (deficit).............. $(28,222) $(30,358) $(20,381) $(4,654) $(4,416) $(4,246) $(4,413) $ 4,388 6 - -------- (1) Pro forma as adjusted operations data and earnings per share information gives effect to: (i) the sale of 1,109,798 shares by the Company in this Offering at an initial offering price of $6.50 per share less the Underwriter's discount and other offering expenses; (ii) the application of the net proceeds therefrom to repay $5.9 million of Senior Indebtedness; and (iii) the Preferred Conversion (as hereinafter defined) (375,000 shares). These transactions, along with the incremental effect of issuing an additional 75,000 options (13,500 shares) to Steven L. Bock, the Company's Chairman and Chief Executive Officer, in connection with this Offering and the weighted average shares outstanding as of June 29, 1996 of 3,577,986, which includes the dilutive effect of the issuance of the Warrants (as hereinafter defined) (265,335 shares) and 582,999 options to Mr. Bock and Stephen M. O'Hara, the Company's President, calculated under the treasury stock method described in Accounting Principles Board Opinion No. 15, support the share figure of 4,990,432 used to calculate pro forma as adjusted operations data and earnings per share information. (2) Net sales include for fiscal 1991 and 1992 the sales of certain subsidiaries that were sold as of the end of 1992. For comparative purposes, excluding the sold subsidiaries, the Company's net sales would be $30,817,000 in fiscal 1991 and $32,430,000 in fiscal 1992. (3) Net income reflects, for the fiscal year ended January 1, 1994, a gain of $8,985,122 from the cumulative effect of change in accounting for income taxes and for the fiscal year ended December 31, 1994, a gain from extraordinary item of $12,078,489, net of income taxes resulting from the forgiveness of debt upon the Company's emergence from bankruptcy. See the financial statements and the notes thereto. (4) Earnings per share for each fiscal year of the Company is computed by dividing net income after preferred dividends for such fiscal year by the weighted average number of shares of common stock and common stock equivalents outstanding during such fiscal year. See the financial statements and the notes thereto. (5) Reflects number of customers who are being mailed catalogs at the end of each period. (6) The pro forma as adjusted balance sheet information gives effect to the issuance of the Junior Subordinated Indebtedness (as hereinafter defined), the issuance of the Warrants, the irrevocable waiver of accrued dividends on the 13% Preferred Stock, the Preferred Conversion, the grant of options to purchase 75,000 shares of Common Stock at an exercise price of $5.33 per share to Steven L. Bock, the Company's Chairman and Chief Executive Officer, and the sale by the Company of 1,500,000 shares of Common Stock offered hereby at an initial public offering price of $6.50 per share and the application of the net proceeds therefrom as described in "Use of Proceeds." See the financial statements and the notes thereto. (7) Long term debt reflects, for fiscal years ended January 2, 1993 and January 1, 1994, amounts subject to settlement under reorganization proceedings. See "Reorganization." Unless otherwise indicated, the information in this Prospectus does not give effect to: (i) 500,000 shares of Common Stock of the Company reserved for issuance under the Company's 1996 Stock Option Plan ("Plan"), of which options to purchase 252,150 shares of Common Stock have been granted; (ii) 225,000 shares which may be issued upon exercise of the Underwriter's over-allotment option; (iii) 150,000 shares reserved for issuance pursuant to the Underwriter's Purchase Option; (iv) 657,999 shares reserved for issuance upon exercise of other outstanding options issued to Steven L. Bock and Stephen M. O'Hara, the Company's Chief Executive Officer and President, respectively ("Officers' Options"); and (v) 265,335 shares reserved for issuance upon exercise of certain outstanding warrants issued to a director and others ("Warrants"). Unless otherwise indicated, the number of shares of Common Stock and all per share information gives effect to: (x) the 325.51 for 1 stock split effected on October 11, 1996 and (y) the conversion, on a pro rata basis, of 22,491 shares ($2,249,100 face amount) of 13% preferred stock ("13% Preferred Stock") into 375,000 (post-split) shares of Common Stock on October 3, 1996 ("Preferred Conversion"). 7 REORGANIZATION The Company was incorporated on November 30, 1994 for the purpose of becoming the parent company of SC Corporation. SC Corporation was incorporated in February 1989, and in March 1989 it acquired four companies engaged in the catalog business: Wigs by Paula, Inc. ("Wigs"), the predecessor of SC Direct; Western Schools Inc., the predecessor of SC Publishing; After the Stork, Inc. ("Stork"), a children's apparel company; and Brotman's Inc. ("Brotman"), a company selling fabrics to people who sew at home. SC Corporation incurred substantial indebtedness in order to consummate these acquisitions, the terms of which indebtedness could not be supported by the operating cash flows of the acquired businesses. Accordingly, SC Corporation and each of its four subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code ("Bankruptcy") in the United States Bankruptcy Court for the District of Connecticut ("Bankruptcy Court") on December 28, 1992. From that date until November 23, 1994, SC Corporation operated its business as debtor-in-possession, subject to the jurisdiction of the Bankruptcy Court. In January 1993, the Bankruptcy Court and SC Corporation agreed to lift the stay and permit Signal Capital Corporation, SC Corporation's senior secured creditor ("Signal"), to sell Stork and Brotman. Stork was sold for $950,000 to a group of purchasers which included Viking Holdings Limited ("Viking") and Steven Bock, the Company's chairman and chief executive officer. Brotman was sold by Signal to a liquidator. SC Corporation's Disclosure Statement with respect to the First Amended and Restated Joint Plan of Reorganization of SC Corporation, Wigs and SC Publishing ("Plan of Reorganization") was approved by the Bankruptcy Court on September 21, 1994. The Plan of Reorganization was subsequently confirmed by the Bankruptcy Court on October 26, 1994, and the reorganization of SC Corporation was consummated on November 23, 1994. The Plan of Reorganization provided for the payment of $15,508,726 in cash, $1,673,453 in Subordinated Indebtedness (as hereinafter defined) notes, 10,227 shares of preferred stock valued at $1,022,700 and 295,121 shares of common stock valued at $295,121 in settlement of $24,102,851 of secured claims, and $3,345,066 in cash, $354,247 in subordinated notes, 2,164 shares of preferred stock valued at $216,400 and 179,353 shares of common stock valued at $179,353 in settlement of $11,665,353 of unsecured claims. The gain on such discharge of pre-petition claims has been recorded as an extraordinary item, net of income taxes of $1,094,649. The Company funded the Plan of Reorganization by selling additional shares of common stock and 13% Preferred Stock, entering into a new senior credit facility, and issuing Subordinated Indebtedness. Subsequent to the consummation of the reorganization, certain stockholders of the Company purchased the subordinated notes and 13% Preferred Stock from the holder of the secured claims at their face values and the common stock from the holders of the secured and unsecured claims at its fair market value. Pursuant to the Plan of Reorganization, the Company emerged from the Bankruptcy in November 1994, subject to one outstanding income and sales tax claim asserted by the Commonwealth of Massachusetts. Massachusetts has claimed a payment due of $61,000 and the Company has fully accrued this amount. 8 RISK FACTORS The securities offered hereby are speculative in nature and involve a high degree of risk. Accordingly, in analyzing an investment in these securities, prospective investors should carefully consider, along with the other matters referred to herein, the following risk factors. SUBSTANTIAL INDEBTEDNESS; PLEDGE OF ASSETS. The Company's Senior Indebtedness consists of a $16.0 million credit facility ($14.0 million term loan and $2.0 million revolving credit line), of which an aggregate of $11.9 million was outstanding on June 29, 1996. In addition, as of June 29, 1996, $4.4 million of principal and accrued interest was outstanding of its Subordinated Indebtedness and, as of August 15, 1996, $495,000 of principal and interest was outstanding of its junior subordinated indebtedness ("Junior Subordinated Indebtedness"). Substantially all of the Company's assets are pledged to secure the Senior Indebtedness, which, among other things, prohibits mergers, sales of assets, payment of dividends and creation of liens, and restricts borrowings and capital expenditures. In the event of a default, Banque Nationale de Paris ("BNP"), its senior lender, could foreclose on its security interest in the Company's assets. Such action would have a material adverse effect on the Company's business. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Liquidity and Capital Resources" and the financial statements and notes thereto. SUBSTANTIAL PORTION OF PROCEEDS USED TO PAY DEBT; BROAD DISCRETION IN APPLICATION OF REMAINING PROCEEDS. $5.9 million, or 72.2%, of the net proceeds from this Offering will be used to repay part of the Senior Indebtedness. Furthermore, the Company will have broad discretion as to the application of the remaining $2.3 million of proceeds allocated to working capital and general corporate purposes. See "Use of Proceeds." POSSIBLE INABILITY TO REFINANCE SENIOR INDEBTEDNESS. Following the application of the proceeds of this Offering to repay a portion of the Senior Indebtedness, $5.4 million of the Senior Indebtedness will remain outstanding. As part of its credit agreement with BNP, the Company is obligated to pay an additional fee of $625,000, increasing periodically to a maximum of $1.0 million on November 22, 1998, upon any future default, prepayment, change in control, or with the final loan payment ("Additional Fee"). BNP has agreed to waive the Additional Fee if the Senior Indebtedness is repaid in full on or before March 31, 1997. The Company intends to refinance the Senior Indebtedness and the Subordinated Indebtedness prior to March 31, 1997. Failure to refinance the Senior Indebtedness by March 31, 1997 will obligate the Company to pay the Additional Fee to BNP, which will have a negative impact on the Company's liquidity and earnings. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." WORKING CAPITAL DEFICIT; NEGATIVE NET WORTH; RECENT DECREASE IN NET SALES AND NET INCOME; POSSIBLE NEED FOR ADDITIONAL CAPITAL. The Company has had in the past and continues to have a working capital deficit and a negative net worth. As of June 29, 1996, the Company had a working capital deficit of $185,000 and a negative net worth of $4.4 million. Results of operations for the six months ended June 29, 1996 show a decline in net sales and net income versus the prior year. Net sales decreased $3.6 million, or 16.1%, from $22.4 million for the six months ended July 1, 1995 to $18.8 million for the six months ended June 29, 1996. Net income declined by $405,000, or 73.1%, from $555,000 for the six months ended July 1, 1995 to $149,000 for the six months ended June 29, 1996. In addition, total catalog circulation declined by 2,353,000 catalogs, or 15.4%, from 15,245,000 catalogs circulated in the six months ended July 1, 1995 to 12,891,000 catalogs circulated in the six months ended June 29, 1996. The Company expects that net sales will continue to decline for at least the next quarter. There can be no assurance that the Company's future results will improve or that the decline in net sales and net income will not be reflective of the future results of the Company. The Company anticipates, based on current plans and assumptions relating to its operations, that the proceeds of this Offering, together with existing resources and income generated from operations, should be sufficient to satisfy the Company's anticipated cash requirements for at least 12 months after completion of this Offering. If, however, additional financing becomes necessary, the Company may seek additional equity financing, which could have a dilutive effect on stockholders. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." 9 EFFECTIVENESS OF CATALOGS AND ADVERTISING. The Company targets potential new customers through its advertising programs and solicits orders from existing customers through catalog marketing campaigns. Catalog marketing campaigns and advertising are working capital intensive and the success of such activities depends, to a large extent, upon the accuracy of assumptions and judgments made by the Company. The Company must continuously identify new customers with its advertising programs and stimulate new purchases from existing customers with its catalog marketing campaigns in order to be successful. There can be no assurance that such advertising and catalog mailings will result in attracting new customers at the rate required to maintain profitability or continue to generate new purchases from the Company's existing customers. The failure of such activities to identify new customers or to generate new purchases from existing customers may have a material adverse effect on the Company's business and its results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business-- Wigs--Marketing." POSTAL RATES, PAPER PRICES AND MEDIA COSTS. Postage, shipping and paper costs are significant expenses in the operation of the Company's business. The Company mails its catalogs and generally ships its products to customers through the U.S. Postal Service and, at the customer's request and expense, ships its products by overnight and second day delivery services. The Company passes on the costs of mailing its products directly to customers as separate shipping and handling charges, but does not directly pass on paper costs and the costs of mailing its catalogs. Effective January 1, 1995, postal rates for mailing the Company's catalogs increased 14.3%. The cost of paper also increased significantly in 1995. Any future increases in postal or shipping rates or paper costs will have an adverse effect on the Company's operating results if the Company is unable to pass on these increases to its customers. In addition, a rise in media costs could have a material adverse effect on the Company's ability to generate new customers. See "Business--Wigs--Marketing." LIMITED SOURCES OF FIBER. The majority of the Company's revenue is derived from the sale of wigs. Virtually all of the wigs sold by the Company are made from special synthetic fiber manufactured by only two Japanese companies, Kaneka Corporation and Toyo Chemical Corporation. The wig manufacturers from whom the Company purchases its inventory purchase the fiber from these two fiber manufacturers. Should there be a permanent or long-term disruption in the supply of fiber, the Company believes that the time required to obtain an alternate source and the attendant delay in new production, as well as a possibly significant increase in the price of fiber, may have a material adverse effect on the Company's wig and hairpiece sales and profit margin. See "Business--Wigs--Products." LIMITED NUMBER OF WIG MANUFACTURERS. The wigs sold by the Company are produced by a limited number of manufacturers. Each of the Company's five largest manufacturers represented between 8% and 25% of the Company's overall wig purchases in the first half of 1996. The loss of one or more of these manufacturers could materially disrupt the Company's wig operations. Although the Company believes that in such an event it could purchase its wig requirements from the remaining manufacturers and from additional manufacturers, there can be no assurance that such sources of supply could meet the Company's wig requirements without considerable disruption to the Company's purchasing cycles, inventory levels and profit margins. The Company does not currently have, and does not anticipate entering into in the foreseeable future, long-term supply contracts with its manufacturers. See "Business--Wigs--Products" and "--Operations--Purchasing." RISK OF PHYSICAL DISASTER. Substantially all of the Company's telemarketing, customer service and management information systems functions are housed in the Company's main facility in South Easton, Massachusetts. Although the Company has a disaster recovery program and creates a daily back-up tape of customer list and computer information and sends such tapes on a weekly basis for off-site storage, a significant disruption or loss affecting the telephone or computer systems, or any significant damage to the Company's headquarters, could have a material adverse effect on the Company's business. Although the Company maintains $10 million of business interruption insurance, there can be no assurance that a physical disruption to the Company's business or operations would be adequately covered by such insurance. See "Business-- Operations." RISK OF A CURE FOR HAIR LOSS; CANCER TREATMENT IMPROVEMENT. Millions of American women suffer varying degrees of hair loss, including those suffering hair loss as a side effect of cancer treatments. These 10 women comprise a significant percentage of the Company's customer base for its wigs and hairpieces. Ongoing research is conducted by numerous groups, both public and private, seeking remedies for hair loss. One drug, Minoxidil (primarily marketed under the name Rogaine(R)), is now available over-the- counter and is sold to men and women as a measure against hair loss. There can be no assurance that a new drug will not be developed that could prevent hair loss among women. Such an event could have a material adverse effect on the Company's core wig business. In addition, the development of any new cancer therapies that would eliminate hair loss as a side effect of treatment could have a material adverse effect on the Company's business. See "Business-- Wigs--Industry and Market." DEPENDENCE UPON FOREIGN SUPPLIERS; EXCHANGE RATES; CURRENCY FLUCTUATIONS. All of the wigs purchased by the Company, including those purchased from domestic importers, are manufactured in Asia. The Company expects that most of its wig merchandise will continue to be manufactured in Asia in the future. Accordingly, the Company's operations are subject to the customary risks of doing business abroad, including fluctuations in the value of currencies, export duties, quotas, work stoppages and, in certain parts of the world, political instability and possible governmental intervention. Since the Company pays for its wigs in U.S. dollars, the cost of wigs may be adversely affected by an increase in the relative value of the relevant foreign currencies against the U.S. dollar. Although to date such risks have not had a significant effect on the Company's business operations, no assurance can be given that such risks will not have a material adverse effect on the Company's business operations in the future. See "Business--Wigs-- Products." RELIANCE ON KEY PERSONNEL. The Company's performance is substantially dependent on the performance of its executive officers and key employees. The loss of the services of any its key employees, particularly Steven L. Bock, its Chairman and Chief Executive Officer, or Stephen M. O'Hara, its President, could have a material adverse effect on the Company's business, financial condition or operating results. The Company has employment agreements with Messrs. Bock and O'Hara expiring December 31, 1999. The Company currently maintains an $8.5 million key person life insurance policy on Mr. Bock and a $5.5 million key person life insurance policy on Mr. O'Hara, although those amounts may be reduced. See "Management." PRIOR BANKRUPTCY. SC Corporation was formed in 1989 to effect a leveraged buy-out of four catalog companies, including the Company's present operating subsidiaries. Mr. Bock was a principal in the original investment group that formed SC Corporation in 1989. On December 28, 1992, as a result of its inability to service then-existing debt requirements, SC Corporation and each of its four subsidiaries filed voluntary petitions for bankruptcy under Chapter 11 of the United States Bankruptcy Code. From that date until November 23, 1994, SC Corporation operated its business as debtor-in-possession subject to the jurisdiction of the Bankruptcy Court. Pursuant to the Plan of Reorganization, the Company emerged from the Bankruptcy in November 1994, subject to one outstanding income and sales tax claim asserted by the Commonwealth of Massachusetts. Massachusetts has claimed a payment due of $61,000 and the Company has fully accrued this amount. Mr. Bock, who currently serves as chief executive officer and director of the Company, was, prior to and during the Bankruptcy, an executive officer and director of SC Corporation or its predecessors. Mr. O'Hara, who currently serves as president of the Company, was, prior to and during the Bankruptcy, president of Wigs. See "Reorganization." COMPETITION. The Company encounters competition in all areas of its business. The Company competes directly with other direct mail catalog retailers and numerous other retail sources of products which are the same as, or similar to, those products sold by the Company through its catalogs. Some of the Company's competitors have greater financial and marketing resources than the Company. Potential competition may emerge via new distributions channels such as the Internet and interactive television. See "Business-- Competition." POSSIBLE TERMINATION OF LEASES. The Company leases two buildings in South Easton, Massachusetts. Under the terms of the leases, the landlords and the Company have the right to terminate the leases upon four month's notice. The Company believes that, in the event that either or both landlords give the Company notice, the Company could move to a new facility within four months. Nonetheless, there can be no assurance that the Company will find an appropriate space within four months or that the process of moving and restarting operations in a new site would not have a material adverse effect on the Company's operations. See "Business--Facilities." 11 UNCERTAINTY AND EXPENSE OF INTELLECTUAL PROPERTY LITIGATION. The Company currently has several registered trademarks and may seek additional legal protection for its products and trade names. The Company has invested substantial resources in developing several distinctive catalog trademarks as well as branded products and product lines. There can be no assurance that the steps taken by the Company to protect its rights will be sufficient to deter misappropriation. Failure to protect these intellectual property assets could have a material adverse effect on the Company's business operations. Moreover, although the Company does not currently know of any pending or threatened action alleging the Company's infringement of intellectual property rights that could have a material adverse effect on the Company's business, there can be no assurance that any such action will not be commenced against the Company in the future or, if such an action is commenced, that the Company would ultimately prevail. See "Legal Proceedings." CONTINUED CONTROL BY CURRENT MANAGEMENT. Upon completion of this Offering, the Company's directors and executive officers and their affiliates will control approximately 69.3% of the outstanding shares of Common Stock. As a result, current management will be able to elect the entire Board of Directors of the Company, thereby enabling them to control all major decisions of the Company. Furthermore, such concentration of ownership may have the effect of preventing a change in control of the Company. See "Principal Stockholders" and "Description of Securities." MANAGEMENT OF GROWTH. The Company has experienced significant growth in recent years, and this growth has placed significant demands on the Company's managerial, operational and financial resources. The Company is dependent on its ability to retain and motivate high quality personnel, especially its management, marketing and merchandising executives and other key employees, and the inability of the Company to do so would have a material adverse effect on the Company's business, financial condition and operating results. In addition, the Company's operations are dependent upon the accuracy, capability and proper utilization of its management information systems, including its computers and telephone systems, which the Company will need to expand and enhance on a regular basis to support its planned growth and to remain competitive. There can be no assurance that if the Company continues to grow, management will be effective in attracting and retaining additional qualified personnel, expanding the Company's physical facilities, integrating acquired businesses or otherwise managing growth. If the Company is unable to manage growth effectively, the Company's business, financial condition and operating results could be materially adversely affected. See "Business" and "Management." ABSENCE OF PRIOR PUBLIC MARKET. Prior to this Offering, there has been no public market for the Common Stock of the Company and there can be no assurance that an active trading market for the Common Stock will develop or be sustained after this Offering. The initial public offering price has been determined solely by negotiation between the Company and the Underwriter based on a number of factors and may not be indicative of the market price for the Common Stock after this Offering. The trading price of the Company's Common Stock is expected to be subject to significant fluctuations in response to variations in quarterly operating results, changes in analysts' earnings estimates, general conditions in the wig industry and other factors. In addition, the stock market is subject to price and volume fluctuations that affect the market prices for companies and that are often unrelated to operating performance. See "Underwriting." LIMITATION ON USE OF NOLS. The Company currently has recorded a deferred tax asset reflecting the benefit of approximately $18 million of net operating loss carryforwards ("NOLs") available for federal and state income tax purposes, which expire from 2005 through 2010. The Company believes that this Offering will result in an "ownership change" under Section 382 of the Internal Revenue Code of 1986 ("Code") and, as a result, the Company's ability to use its "pre-change" NOLs will be limited to between $1.5 million and $2.0 million in each fiscal year following this Offering. Realization of the NOLs is dependent on generating sufficient taxable income prior to expiration of the loss carryforwards. There can be no assurance that the Company will be able to use the NOLs. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." STATE SALES TAX COLLECTION. In 1994, the United States Supreme Court reaffirmed an earlier decision that allowed direct marketers to make sales into states where they do not have a physical presence without collecting 12 sales taxes but noted that Congress has the power to change this law. The imposition of an obligation to collect sales taxes may have a negative effect on the Company's response rates and may require the Company to incur administrative costs in collecting and remitting the sales taxes. The Company believes that Massachusetts is the only jurisdiction where it is currently required to collect sales taxes. See "Business--Government Regulations." SHARES ELIGIBLE FOR FUTURE SALE. Sales of the Company's Common Stock in the public market after this Offering could adversely affect the market price of the Common Stock. See "Management--Stock Option Plan", "Description of Securities" and "Shares Eligible for Future Sale." ANTITAKEOVER MATTERS; POTENTIAL ADVERSE EFFECT OF FUTURE ISSUANCES OF AUTHORIZED PREFERRED STOCK. The Company's Certificate of Incorporation and By- laws contain certain provisions that may delay, defer or prevent a takeover of the Company. The Company's Board of Directors has the authority to issue up to 1,000,000 shares of preferred stock, par value $.01 per share ("Preferred Stock"), and to determine the price, rights, preferences and restrictions, including voting rights, of those shares, without any further vote or action by the stockholders. Accordingly, the Board of Directors is empowered, without stockholder approval, to issue Preferred Stock, for any reason and at any time, with such rates of dividends, redemption provisions, liquidation preferences, voting rights, conversion privileges and other characteristics as the Board of Directors may deem necessary. The rights of holders of Common Stock will be subject to, and may be adversely affected by, the rights of holders of any Preferred Stock that may be issued in the future. The Company's By-laws include provisions establishing advance notice procedures with respect to stockholder proposals and director nominations and permit special stockholder meetings to be called only by the Board of Directors or the Chief Executive Officer. In addition, the Company is subject to certain anti- takeover provisions of the Delaware General Corporation Law ("DGCL"). Such provisions could adversely affect the holders of the Common Stock and could discourage, delay or prevent a takeover of the Company. See "Description of Securities." IMMEDIATE AND SUBSTANTIAL DILUTION. Purchasers of the Common Stock offered hereby will incur immediate and substantial dilution of $5.57 or 85.7%, representing the difference between the net tangible book value of the Common Stock immediately after this Offering and the initial public offering price of the Common Stock of $6.50. See "Dilution." EFFECT OF OUTSTANDING OPTIONS AND WARRANTS. Immediately after this Offering, not including the Underwriter's Purchase Option, there will be outstanding options and warrants to purchase, in the aggregate, 1,175,484 shares of Common Stock at per share exercise prices ranging from $0.31 to the initial public offering price. These options and warrants consist of: (i) options to purchase 252,150 shares of common stock at the initial public offering price granted under the Plan, 10,000 of which are currently exercisable; (ii) Officers' Options to purchase 657,999 shares of Common Stock, consisting of options to purchase 582,999 shares at $0.31 per share, of which options to purchase 528,444 shares are currently exercisable, and options to purchase 75,000 shares at $5.33 per share, none of which are currently exercisable; and (iii) Warrants to purchase 265,335 shares at $1.88, all of which are currently exercisable. The exercise of the foregoing options and warrants and the Underwriter's Purchase Option will dilute the percentage ownership of the Company's stockholders and any sales in the public market of shares of Common Stock underlying such securities may adversely affect the prevailing market price for the Common Stock. Moreover, the terms upon which the Company will be able to obtain additional equity capital may be adversely affected since the holders of the outstanding securities will, to the extent they are able, likely exercise them at a time when the Company could, in all likelihood, obtain any needed capital on terms more favorable to the Company than those provided in the options and the warrants. See "Dilution." NO DIVIDENDS. The Company has never paid cash dividends on the Common Stock. The Company intends to retain any future earnings to finance its growth. Accordingly, any potential investor who anticipates the need for current dividends from an investment in the Common Stock should not purchase any of the shares of Common Stock offered hereby. The Company's Senior Indebtedness contains, and the Company anticipates that any future credit facility or other indebtedness that the Company may enter into or incur would contain, a prohibition against the payment of cash dividends and certain restrictions on the payment of non-cash dividends. See "Dividend Policy." 13 USE OF PROCEEDS The net proceeds to the Company from the sale of Common Stock offered hereby, assuming an initial public offering price of $6.50 per share, are estimated to be $8,170,000, or $9,478,938 if the Underwriter's over-allotment option is exercised in full, after deducting the estimated underwriting discounts and offering expenses payable by the Company. Of this amount, $5.9 million, or 72.2% of the net proceeds, will be used to repay a portion of the Senior Indebtedness, including (i) $1.5 million to pay down the outstanding amount under the revolving credit portion of the Senior Indebtedness; (ii) $1.8 million of the Senior Indebtedness which is due within one year of the date hereof; and (iii) $2.6 million of the Senior Indebtedness which is due more than one year following the date hereof. The Company's Senior Indebtedness consists of a $14.0 million term loan which bears interest at 3.5% above certain LIBOR rates and matures on May 22, 1999; and a $2.0 million revolving credit facility, which bears interest at 2% over the prime rate and matures on May 22, 1999. An aggregate of $11.9 million was outstanding under the Senior Indebtedness on June 29, 1996. The remainder of the net proceeds of this Offering, estimated to be approximately $2.3 million, or 27.8% of the net proceeds ($3.6 million, or 37.8% of the net proceeds, if the Underwriter's over-allotment option is exercised in full), will be used for general corporate purposes, including capital expenditures and working capital. The Company plans to use its available working capital, including cash flow from operations and net proceeds of this Offering to expand its business by, among other things: (i) increasing advertising levels in its wig and hat business; (ii) testing new marketing programs; (iii) producing and mailing additional catalogs; and (iv) increasing direct purchasing of wigs and hairpieces. Depending on the Company's business needs and cash flow, additional amounts of the Company's remaining Senior Indebtedness may be repaid from the net proceeds of this Offering allocated to working capital. In addition, if a suitable opportunity arises, the Company may also use a portion of the net proceeds of this Offering as part of the financing for an acquisition. As of the date of this Prospectus, the Company has no agreement or understanding, nor is it engaged in any negotiations, with respect to any acquisition. Net proceeds not immediately required for the purposes described above will be invested in United States government securities, short-term certificates of deposit, money market funds or other short-term interest-bearing government obligations. The Company anticipates, based on current plans and assumptions relating to its operations, that the proceeds of this Offering, together with existing resources and income generated from operations, should be sufficient to satisfy the Company's anticipated cash requirements for at least 12 months after completion of this Offering. After that time, the Company believes that income from operations should satisfy the Company's working capital needs; however, there can be no assurance that this will be the case. The allocation of the net proceeds of this Offering represents the Company's best estimate based upon its current plans and certain assumptions regarding industry and general economic conditions and the Company's future revenues and expenditures. If any of these factors change, the Company may find it necessary or advisable to reallocate some of the proceeds within the above described categories or may be required to seek additional financing. There can be no assurance that additional financing will be available to the Company on acceptable terms, or at all. Any failure to obtain additional financing, if required, could have a material adverse effect on the Company. 14 CAPITALIZATION The following table sets forth the actual capitalization of the Company as of June 29, 1996. The pro forma information gives effect to the issuance of the Junior Subordinated Indebtedness, the issuance of the Warrants, the irrevocable waiver of accrued dividends on the 13% Preferred Stock in August 1996, the Preferred Conversion, and the grant of options to purchase 75,000 shares of Common Stock at an exercise price of $5.33 per share to Steven L. Bock, the Company's chairman and chief executive officer. The pro forma as adjusted information gives effect to all of the above, and, in addition, the sale by the Company of 1,500,000 shares of Common Stock offered hereby at an initial public offering price of $6.50 per share and the application of the estimated net proceeds therefrom as described in "Use of Proceeds." This table should be read in conjunction with the financial statements of the Company including the notes thereto, appearing elsewhere in this Prospectus. AS OF JUNE 29, 1996 ------------------------------- PRO PRO FORMA ACTUAL FORMA AS ADJUSTED -------- -------- ----------- (IN THOUSANDS) Short-term debt: Current portion of long-term debt............ $ 2,950 $ 2,950 $ 1,352 Revolving portion of line of credit.......... 1,450 1,450 -- Long-term debt: Non-current portion of long-term debt........ 7,450 7,450 4,598 Subordinated notes........................... 4,363 4,744 4,744 Accrued dividends............................ 511 -- -- Stockholders' equity: Preferred Stock, $1.00 par value; 1,000,000 shares authorized, 22,491 shares issued and outstanding................................. 2,249 -- -- Common Stock, $.01 par value; 10,000,000 shares authorized, 2,826,666 shares issued and outstanding at June 29, 1996, 3,201,666 outstanding on a pro forma basis and 4,701,666 outstanding as adjusted........... 28 32 47 Additional paid-in capital................... 4,496 7,460 15,615 Note from stockholder........................ (140) (140) (140) Deferred compensation........................ -- (88) (88) Accumulated deficit.......................... (11,046) (11,046) (11,046) -------- -------- -------- Total stockholders' equity................. (4,413) (3,782) 4,388 -------- -------- -------- Total capitalization....................... $ 12,311 $ 12,812 $ 15,082 ======== ======== ======== DIVIDEND POLICY The Company has never declared or paid cash or other dividends on the Common Stock and it is currently the intention of the Company not to declare or pay cash dividends on the shares of Common Stock. The payment of cash dividends in the future will depend on the Company's earnings, financial condition, capital needs and other factors deemed relevant by the Board, including statutory restrictions on the availability of capital for the payment of dividends, the rights of holders of any series of preferred stock that may hereafter be issued and the limitations, if any, on the payment of dividends under any then-existing credit facility or other indebtedness. The Company's Senior Indebtedness contains, and the Company anticipates that any future credit facility or other indebtedness that the Company may enter into or incur would contain, a prohibition against the payment of cash dividends and restrictions on the payment of non-cash dividends. It is the current intention of the Board to retain earnings, if any, to finance the operations and expansion of the Company's business. 15 DILUTION The difference between the initial public offering price per share of Common Stock and the pro forma as adjusted net tangible book value per share of Common Stock after this Offering constitutes the dilution per share of Common Stock to investors in this Offering. Net tangible book value per share is determined by dividing the net tangible book value (total tangible assets less total liabilities) by the number of outstanding shares of Common Stock. At June 29, 1996, the Company had a negative pro forma net tangible book value of $3,816,169, or approximately negative $1.19 per share of Common Stock. After giving effect to the sale of Common Stock offered hereby (less underwriting discounts and estimated expenses of this Offering), the net tangible book value of the Company would be $4,353,831, or approximately $.93 per share. This represents an immediate increase in net tangible book value of $2.12 per share to the existing stockholders, and an immediate dilution of approximately $5.57 per share to investors in this Offering (or approximately 85.7% of the initial public offering price). The following table illustrates the per share dilution without giving effect to results of operations of the Company subsequent to June 29, 1996. Initial public offering price................................. $6.50 Pro forma net tangible book value per share before Offering. $(1.19) Increase in net tangible book value per share attributable to new investors........................................... 2.12 Net tangible book value per share after Offering.............. .93 ----- Dilution to new investors..................................... $5.57 ===== The following table summarizes the number and percentage of shares of Common Stock purchased from the Company, the amount and percentage of consideration paid and the average price per share paid by the existing stockholders and by new investors pursuant to this Offering: SHARES PURCHASED TOTAL CONSIDERATION AVERAGE ----------------- ------------------- PRICE PER NUMBER PERCENT AMOUNT PERCENT SHARE --------- ------- ----------- ------- --------- Existing stockholders........... 3,201,666 68.1% $ 7,529,000 43.6% $2.35 New investors................... 1,500,000 31.9 9,750,000 56.4 $6.50 --------- ----- ----------- ----- Total......................... 4,701,666 100.0% $17,279,000 100.0% ========= ===== =========== ===== 16 SELECTED FINANCIAL AND OPERATING DATA The selected financial data presented below, except for the selected operating data, as of and for the fiscal years ended January 1, 1994, December 31, 1994 and December 30, 1995 is derived from the audited financial statements of the Company included herein. The selected financial data for fiscal years ended December 28, 1991 and January 2, 1993 and the selected financial data for the six months ended July 1, 1995 and June 29, 1996, except for the selected operating data, are derived from the unaudited financial statements of the Company. In the opinion of management, the selected financial data presented below as of and for the six months ended July 1, 1995 and June 29, 1996 include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial position and results of operations for these periods. The six month results are not necessarily indicative of the results to be expected for the full year. This information should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the financial statements of the Company, including the notes thereto, appearing elsewhere herein. PRO FORMA HISTORICAL AS ADJUSTED(1) ------------------------------------------------------------------- ------------------------- FISCAL YEAR ENDED SIX MONTHS ENDED YEAR SIX MONTHS ------------------------------------------------ ----------------- ENDED ENDED DEC. 28, JAN. 2, JAN. 1, DEC. 31, DEC. 30, JULY 1, JUNE 29, DEC. 30, JUNE 29, 1991 1993 1994 1994 1995 1995 1996 1995 1996 -------- -------- -------- -------- -------- ------- -------- -------------- ---------- (IN THOUSANDS, EXCEPT PER-SHARE AMOUNTS AND AVERAGE ORDER SIZE) STATEMENT OF OPERATIONS DATA: Net sales(2)........... $ 46,552 $ 47,120 $ 33,801 $38,179 $42,568 $22,419 $18,754 $42,568 $18,754 Cost of sales(2)....... 21,699 21,544 13,868 15,648 16,423 8,859 7,003 16,423 7,003 -------- -------- -------- ------- ------- ------- ------- ------- ------- Gross profit(2)........ 24,853 25,576 19,933 22,531 26,145 13,560 11,751 26,145 11,751 Selling, general and administrative(2)..... 27,487 24,452 16,768 17,772 22,835 11,156 10,591 22,835 10,591 Restructuring charges.. -- -- -- -- 513 513 -- 513 -- -------- -------- -------- ------- ------- ------- ------- ------- ------- Income (loss) from operations............ (2,634) 1,124 3,165 4,759 2,797 1,891 1,160 2,797 1,160 Interest expense, net.. 3,242 3,080 431 661 1,918 958 909 1,343 623 Reorganization items... -- -- 1,038 2,890 -- -- -- -- -- -------- -------- -------- ------- ------- ------- ------- ------- ------- Income (loss) before income taxes, cumulative effect of change in accounting principle and extraordinary item.... (5,876) (1,956) 1,696 1,208 879 933 251 1,454 537 Income taxes........... 21 180 704 498 357 379 102 582 215 -------- -------- -------- ------- ------- ------- ------- ------- ------- Income (loss) before cumulative effect of change in accounting principle and extraordinary item.... $ (5,897) $ (2,136) $ 992 $ 710 $ 522 $ 554 $ 149 $ 872 $ 322 ======== ======== ======== ======= ======= ======= ======= ======= ======= Net income (loss)(3)... $ (5,897) $ (2,136) $ 9,977 $12,789 $ 522 $ 554 $ 149 $ 872 $ 322 -------- -------- -------- ------- ------- ------- ------- ------- ------- Preferred stock dividends............. -- -- -- 31 292 146 146 -- -- -------- -------- -------- ------- ------- ------- ------- ------- ------- Net income available to common stockholders... $ (5,897) $ (2,136) $ 9,977 $12,758 $ 230 $ 408 $ 3 $ 872 $ 322 ======== ======== ======== ======= ======= ======= ======= ======= ======= EARNINGS (LOSS) PER COMMON SHARE:(4) Income (loss) before cumulative effect of change in accounting principle and extraordinary item.... $ (1.96) $ (0.71) $ 0.33 $ 0.23 $ 0.08 $ 0.14 $ 0.00 $ 0.17 $ 0.06 Net Income (loss)...... $ (1.96) $ (0.71) $ 3.31 $ 4.23 $ 0.08 $ 0.14 $ 0.00 $ 0.17 $ 0.06 OTHER FINANCIAL AND OPERATING DATA: Total catalog circulation(5)........ 17,122 17,562 18,807 22,623 29,245 15,245 12,891 Active customer file... 762 890 941 1,094 1,096 1,254 1,222 Average order size..... $ 56.17 $ 57.98 $ 60.82 $ 60.27 $ 61.05 $ 60.05 $ 62.85 PRO FORMA HISTORICAL AS ADJUSTED(6) ------------------------------------------------------------------- -------------- FISCAL YEAR ENDED SIX MONTHS ENDED SIX MONTHS ------------------------------------------------ ----------------- ENDED DEC. 28, JAN. 2, JAN. 1, DEC. 31, DEC. 30, JULY 1, JUNE 29, JUNE 29, 1991 1993 1994 1994 1995 1995 1996 1996 -------- -------- -------- -------- -------- ------- -------- -------------- (IN THOUSANDS) BALANCE SHEET DATA: Working capital........ $ (3,480) $ (30) $ 124 $ 2,114 $ 649 $ 2,253 $ (185) $ 5,633 Total assets........... 10,756 6,150 19,142 17,364 18,170 18,755 17,777 20,547 Long-term debt(7)...... 28,461 31,621 30,125 15,180 12,876 14,792 11,813 9,343 Preferred stock........ -- -- -- 2,249 2,249 2,249 2,249 -- Stockholders' equity (deficit)............. $(28,222) $(30,358) $(20,381) $(4,654) $(4,416) $(4,246) $(4,413) $ 4,388 17 - -------- (1) Pro forma as adjusted operations data and earnings per share information gives effect to: (i) the sale of 1,109,798 shares by the Company in this Offering at an initial offering price of $6.50 per share less the Underwriter's discount and other offering expenses; (ii) the application of the net proceeds therefrom to repay $5.9 million of Senior Indebtedness; and (iii) the Preferred Conversion (375,000 shares). These transactions, along with the incremental effect of issuing an additional 75,000 options (13,500 shares) to Steven L. Bock, the Company's Chairman and Chief Executive Officer, in connection with this Offering and the weighted average shares outstanding as of June 29, 1996 of 3,577,986, which includes the dilutive effect of the issuance of the Warrants (265,335 shares) and 582,999 options to Mr. Bock and Stephen M. O'Hara, the Company's President, calculated under the treasury stock method described in Accounting Principles Board Opinion No. 15, support the share figure of 4,990,432 used to calculate pro forma as adjusted operations data and earnings per share information. (2) Net sales, cost of sales, gross profit and selling, general and administrative expenses include for fiscal 1991 and 1992 the results of certain subsidiaries that were sold as of the end of 1992. For comparative purposes, excluding the sold subsidiaries the Company's net sales, cost of sales, gross profit and selling, general and administrative expenses would be: $30,817,000, $13,608,000, $17,209,000 and $16,607,000, respectively, in fiscal 1991 and $32,430,000, $14,367,000 $18,063,000 and $15,885,000, respectively, in fiscal 1992. (3) Net income reflects, for the fiscal year ended January 1, 1994, a gain of $8,985,122 from the cumulative effect of change in accounting for income taxes, and for the fiscal year ended December 31, 1994, a gain from extraordinary item of $12,078,489, net of income taxes resulting from the forgiveness of debt upon the Company's emergence from the Bankruptcy. See the financial statements and the notes thereto. (4) Earnings per share for each fiscal year of the Company is computed by dividing net income after preferred dividends for such fiscal year by the weighted average number of shares of common stock and common stock equivalents outstanding during such fiscal year. See the financial statements and the notes thereto. (5) Reflects the number of customers who are being mailed catalogs at the end of each period. (6) The pro forma as adjusted balance sheet information gives effect to the issuance of the Junior Subordinated Indebtedness, the issuance of the Warrants, the irrevocable waiver of accrued dividends on the 13% Preferred Stock, the Preferred Conversion, the grant of options to purchase 75,000 shares of Common Stock at an exercise price of $5.33 per share to Steven L. Bock, the Company's chairman and chief executive officer, the sale by the Company of 1,500,000 shares of Common Stock offered hereby at an initial public offering price of $6.50 per share and the application of the net proceeds therefrom as described in "Use of Proceeds." See the financial statements and the notes thereto. (7) Long-term debt reflects, for fiscal years ended January 2, 1993 and January 1, 1994, amounts subject to settlement under reorganization proceeding. See "Reorganization." 18 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Unless otherwise indicated, "1995" means the Company's fiscal year ended December 30, 1995, "1994" means the Company's fiscal year ended December 31, 1994, "1993" means the Company's fiscal year ended January 1, 1994 and "1992" means the Company's fiscal year ended January 2, 1993. The discussion and analysis below should be read in conjunction with the Financial Statements of the Company and the notes to the financial statements included elsewhere in this Prospectus. In addition to historical information, the following Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ significantly from those anticipated in these forward-looking statements as a result of certain factors, including those discussed in "Risk Factors" and elsewhere in this Prospectus. OVERVIEW The Company is a direct marketer targeting niche consumer product categories. SC Direct, its principal operating subsidiary, is the leading U.S. retailer of women's wigs and hairpieces. SC Publishing, a subsidiary of SC Direct, sells continuing education courses to nurses, real estate professionals and CPAs. In 1995, SC Direct's sales of women's wigs, hairpieces, accessories and hats represented 87.6% of the Company's net sales. Since 1992, SC Direct's sales have grown through: (i) the expansion of its core Paula Young wig business; (ii) the introduction in 1993 of the upscale Christine Jordan wig catalog; (iii) the introduction in 1994 of the Especially Yours catalog, serving African-American women; and (iv) the introduction in 1995 of the Paula's Hatbox catalog. In addition, in 1995 the Company began selling directly to consumers in Canada. The balance of the Company's sales come from SC Publishing's catalogs, which sell continuing education courses to nurses, real estate agents and CPAs. In July 1995, the Company moved SC Publishing from San Diego, California to the Company's South Easton, Massachusetts facilities. The Company encountered difficulties in integrating SC Publishing into its operations in South Easton, resulting in disruptions to SC Publishing's operations and a reduction in its 1995 operating profitability. As a direct marketer, an important goal of the Company is to expand the size and prevent the "aging" of, and maximize sales to, its customer file. To acquire new customers and prevent the "aging" of its customer file, the Company must continually expend working capital to maintain its advertising program and convert the recipients of its catalogs into customers. In addition, to retain and sell more to existing customers, the Company must expend working capital for additional catalog mailings to these customers. Reductions in advertising lead to declines in new customer prospects and, therefore, new customers. In addition, the Company experiences a time lag between advertising expenditures to gain new customer prospects and the receipt of revenues generated by new customers. As is typical in the catalog industry, the Company's business is affected by increases in paper, postage, print and other catalog production costs. During a period of rising postage and paper costs, such as 1995, the catalog industry faces pressure on operating profits. The Company believes that its niche focus allows it to target its mailings, thereby reducing its exposure to increases in paper, postage and other catalog production costs. RESULTS OF OPERATIONS SIX MONTHS ENDED JUNE 29, 1996 COMPARED TO SIX MONTHS ENDED JULY 1, 1995 Net sales decreased $3.6 million, or 16.1%, from $22.4 million for the six months ended July 1, 1995 to $18.8 million for the six months ended June 29, 1996. This decrease resulted from the Company's decision to conserve working capital by limiting its advertising expenditures during the second half of 1995 and the first half of 1996 which reduced the number of catalogs mailed to prospective new customers. Gross sales of wigs and hairpieces to new customers declined $2.8 million, or 57.1%, from $4.9 million in 1995 to $2.1 million in 1996. Gross sales to new customers represented 9.2% of gross sales in the first half of 1996 and 18.4% of gross sales in the first half of 1995. Gross sales of wigs and hairpieces to existing customers declined $600,000, or 19 3.6%, from $16.8 million in 1995 to $16.2 million in 1996. In addition, gross sales of continuing education courses declined approximately $600,000, or 19.4%, from $3.1 million in the six months ended July 1, 1995 to $2.5 million in the six months ended June 29, 1996 due to a decision to mail fewer catalogs. Gross margins from the sale of wigs and hairpieces increased from 58.2% in the six months ended July 1, 1995 to 60.8% in the six months ended June 29, 1996 primarily due to lower product costs resulting from the continued expansion of direct purchasing from overseas manufacturers. In the six months ended June 29, 1996, the Company purchased 55.1% of its wigs directly from manufacturers compared to 30.7% in the six months ended July 1, 1995. Gross margin for continuing education courses increased slightly from 75.0% in the six months ended July 1, 1995 to 75.4% in the six months ended June 29, 1996. Selling, general and administrative ("SG&A") expenses declined $600,000, or 5.4%, from $11.2 million in the six months ended July 1, 1995 to $10.6 million in the six months ended June 29, 1996. In the six months ended June 29, 1996, the Company mailed fewer catalogs because of increases in paper prices and postage rates, decreased advertising expenditures to conserve working capital and employed additional senior managers. Total catalogs mailed decreased by 2.3 million, or 15.1%, from 15.2 million in 1995 to 12.9 million in 1996. Total postage costs decreased $600,000, or 19.4%, from $3.1 million in the first six months of 1995 to $2.5 million in the first six months of 1996. Despite the reduction in the number of catalogs mailed, total catalog production costs increased by $100,000, or 3.6%, from $2.8 million in 1995 to $2.9 million in 1996, because of the increased paper prices. Advertising expenditures decreased by $400,000, and general office overhead increased by $300,000. Deferred catalog costs increased $400,000, or 19.1%, from $2.1 million in the six months ended July 1, 1995 to $2.5 million in the six months ended June 29, 1996. This increase was caused by an increase in the amount of production costs being amortized, offset by a reduction in catalogs mailed and a reduction in the prepayment of costs for catalogs not yet mailed. Net interest expense declined $49,000, or 5.1%, from $958,000 in the six months ended July 1, 1995 to $909,000 in the six months ended June 29, 1996, reflecting lower interest rates and lower principal amounts outstanding on the Senior Indebtedness. 1995 COMPARED TO 1994 Net sales increased $4.4 million, or 11.5%, from $38.2 million in 1994 to $42.6 million in 1995. This increase is attributable to (i) an increase in gross sales of wigs and hairpieces of $1.9 million, or 5.8%, from $32.6 million in 1994 to $34.5 million in 1995; (ii) an increase in gross sales of wigs, hairpieces and hats through new catalogs of $1.3 million, or 162.5%, from $800,000 in 1994 to $2.1 million in 1995; (iii) $1.1 million of gross sales of wigs and hairpieces marking the commencement of direct sales by the Company into Canada; and (iv) an increase in gross sales of continuing education courses of $1.3 million, or 32.5%, from $4.0 million in 1994 to $5.3 million in 1995. In addition, a reduction in the rate of returned merchandise accounted for $800,000 of the increase in net sales. Gross sales of wigs and hairpieces to new customers declined $2.6 million, or 26.3%, from $9.9 million in 1994 to $7.3 million in 1995. Gross sales of wigs and hairpieces to new customers represented 21.3% of gross sales in 1994 and 14.5% of gross sales in 1995. This decline was caused by a decline in advertising during the last half of 1995 which resulted in the mailing of 221,000 fewer inquiry catalogs in 1995 and lower response rates to the inquiry series. Gross margin from the sale of wigs and hairpieces increased from 56.9% in 1994 to 59.6% in 1995 due to an increase in the direct purchasing of wigs from overseas manufacturers. Gross margin from the sale of continuing education courses decreased as a percentage of sales from 76.6% in 1994 to 74.1% in 1995 reflecting an increase in costs due to purchasing smaller quantities to fill back orders and an increase in author fees. Inventories increased by $900,000, or 21.4%, from $4.2 million at the end of 1994 to $5.1 million at the end of 1995. While this rate of increase was higher than the rate at which sales increased in 1995, it was caused 20 by a $968,000 shortfall from budgeted sales in the fourth quarter of 1995. Inventory levels were reduced by $1,000,000, or 19.6%, through the normal course of business in the first six months of 1996, from $5.1 million at the end of December 1995 to $4.1 million at the end of June 1996. The Company disposes of closeout inventory through a special mailing program to customers. SG&A expenses increased by $5.0 million, or 28.1%, from $17.8 million in 1994 to $22.8 million in 1995. SG&A as a percentage of sales increased from 46.6% in 1994 to 53.6% in 1995, primarily as a result of sharp increases in paper, postage and media costs. Total catalogs mailed increased by 6.6 million, or 29.2%, from 22.6 million in 1994 to 29.2 million in 1995. Due to a 14.3% postal rate increase at the beginning of 1995, total postage costs increased $1.7 million, or 39.5%, from $4.3 million in 1994 to $6.0 million in 1995. Total catalog production costs increased by $2.3 million, or 56.1%, from $4.1 million in 1994 to $6.4 million in 1995. Catalog production costs were adversely affected by continuous increases in the cost of paper during 1995 that ranged from 19% to 45% depending on paper grade. In December 1995 paper prices were 45% to 55% higher than in September 1994. Deferred catalog costs increased by $600,000 or 35.3%, from $1.7 million in 1994 to $2.3 million in 1995. An increase in prepaid costs for catalogs not yet mailed caused $400,000 of the increase. The remaining $200,000 of the increase is attributable to changes in amortization schedules that more accurately match catalog costs with associated catalog revenue streams in accordance with the adoption of 93-7, "Reporting on Advertising Costs." Media costs were affected by a 55.5% increase in the cost of free standing inserts from $3.64 per thousand inserts in 1994 to $5.66 per thousand in 1995. As a result of this rate increase and the continuing need to conserve working capital, the Company reduced its total spending on this medium from $695,000 in 1994 to $425,000 in 1995, a 38.9% reduction. Net interest expense increased from $661,000 in 1994 to $1.9 million in 1995, reflecting a full year of debt servicing costs on the Senior and Subordinated Indebtedness incurred as part of the Company's reorganization in November 1994. 1994 COMPARED TO 1993 Net sales increased $4.4 million, or 13.0%, from $33.8 million in 1993 to $38.2 million in 1994. This increase was driven by an increase in gross sales of wigs and hairpieces to existing customers of $3.6 million, or 12.4%, from $29.0 million in 1993 to $32.6 million in 1994. Gross sales of wigs and hairpieces to new customers in 1994 increased by $3.4 million, or 52.3%, from $6.5 million in 1993 to $9.9 million in 1994 due to an increase in advertising. Gross sales to new customers in 1994 were 21.3% of total gross sales in 1994 in 1994 and 16.3% of total gross sales in 1993. Gross sales of continuing education courses declined $500,000, or 11.1%, from $4.5 million in 1993 to $4.0 million in 1994. The Company's gross margin remained relatively constant at 59.0% in 1993 and 59.0% in 1994, although gross profit increased $2.6 million as a result of the increase in sales. Gross margin from the sale of wigs and hairpieces increased from 56.1% in 1993 to 56.9% in 1994 reflecting the continuation of the direct import program. Gross margin from the sale of continuing education courses declined from 77.6% in 1993 to 76.6% in 1994 as sales of continuing education courses for nurses, which have lower gross margins, increased to 53% of sales in 1994 from 50% in 1993, and sales of courses for real estate agents, which have higher gross margins, declined from 23% of sales in 1993 to 21% in 1994. In addition, the Company lowered prices in the real estate catalogs to compete with lower priced competitors. SG&A expenses increased $1.0 million, or 6.0%, from $16.8 million in 1993 to $17.8 million in 1994. SG&A as a percentage of sales declined from 49.6% in 1993 to 46.5% in 1994. Total catalogs mailed increased 21 by 3.8 million, or 20.2%, from 18.8 million in 1993 to 22.6 million in 1994. Total postage costs increased $500,000, or 13.2%, from $3.8 million in 1993 to $4.3 million in 1994. Total catalog production costs increased by $300,000, or 7.9%, from $3.8 million in 1993 to $4.1 million in 1994. Deferred catalog costs increased by $200,000, or 13.0%, from $1.5 million in 1993 to $1.7 million in 1994. This increase was caused by an increase in the number of catalogs being amortized and an increase in photography costs and costs associated with the start-up of the Company's hat catalog. Media costs were affected by a 35.7% decrease in the costs of free standing inserts from $5.66 per thousand in 1993 to $3.64 per thousand in 1994. Although the Company benefitted from this decrease in media rates, on a cost per thousand basis, a need to conserve working capital caused the Company to decrease its total spending on this medium from $1,003,000 in 1993 to $695,000 in 1994, a 30.7% decrease. Net interest expense increased $230,000, or 53.4%, from $431,000 in 1993 to $661,000 in 1994 as a result of the interest expense incurred during the last six weeks of 1994 on the Senior Indebtedness and Subordinated Indebtedness incurred to finance the Company's Plan of Reorganization. Reorganization expense increased from $1.0 million in 1993 to $2.9 million in 1994, reflecting the use of additional legal, accounting and other professional services needed to emerge from the Bankruptcy and an additional compensation expense of $533,000. An extraordinary gain of $12.1 million was recognized in 1994, reflecting the forgiveness of debt upon the execution of the Plan of Reorganization on November 23, 1994. 1993 COMPARED TO 1992 Net sales in 1992 included $14.7 million of sales from two subsidiaries that were sold as of the end of 1992. Excluding those sales, net sales for 1992 were $32.4 million. Net sales in 1993 increased $1.4 million, or 4.3%, from $32.4 million in 1992 to $33.8 million in 1993. Gross sales of wigs and hairpieces increased $2.7 million, or 10.3%, from $26.3 million in 1992 to $29.0 million in 1993. Gross sales of wigs and hairpieces to new customers decreased $400,000, or 5.8%, from $6.9 million in 1992 to $6.5 million in 1993. Gross sales of continuing education courses increased $200,000, or 4.7%, from $4.3 million in 1992 to $4.5 million in 1993. Gross margin increased from 55.7% in 1992 to 59.0% in 1993 as a result of the start of SC Direct's direct purchasing program, together with a significant shift to lower cost importers for a substantial portion of its wig purchases. Gross margins from the sale of continuing education courses declined slightly as lower margin sales to CPAs increased as a percentage of total sales of continuing education courses. SG&A expenses increased $900,000, or 5.7%, from $15.9 million in 1992 to $16.8 million in 1993. Included in 1992 SG&A expenses were approximately $600,000 of non-recurring expenses relating to the sale of two subsidiaries as of the end of 1992. Excluding the $600,000, SG&A expense increased $1.5 million, or 9.8%, from $15.3 million in 1992 to $16.8 million in 1993. Advertising expenditures increased by $1.1 million from $2.4 million in 1992 to $3.5 million in 1993. Total catalogs mailed increased by 1.2 million, or 6.8%, from 17.6 million in 1992 to 18.8 million in 1993. Total postage costs increased by $100,000, or 2.7%, from $3.7 million in 1992 to $3.8 million in 1993. Total catalog production costs increased by $300,000, or 8.6%, from $3.5 million in 1992 to $3.8 million in 1993. Deferred catalog costs remained constant at $1.5 million at the end of fiscal 1993 and fiscal 1992. Net interest expense decreased by $2.7 million, or 87.1%, from $3.1 million in 1992 to $431,000 in 1993 as a result of no interest being accrued on $26.3 million of pre-bankruptcy debt during 1993. LIQUIDITY AND CAPITAL RESOURCES The Company expends significant amounts of working capital for advertising, inventory and catalog production costs in advance of the revenues generated by these items. The Company has met its working capital needs primarily through funds generated from operations and short-term bank financing. Because of the need to amortize the Senior Indebtedness, there have been limited funds available to expand the business. Cash flow provided by operating activities fluctuated during the past three fiscal years as business conditions changed. In 1993 the Company generated $615,000 from operating activities, in 1994 the Company used $1.2 22 million in operating activities and in 1995 the Company generated $1 million from operating activities. In 1993 and 1994, while the Company was in bankruptcy, cash was used to provide working capital for inventory, advertising and catalog expenses. In addition, the Company accrued bankruptcy related expenses during 1993 and 1994 which were paid at the end of 1994 along with pre-petition obligations. In 1995 the Company increased its accounts payable to normal levels. In the first six months of 1996 cash flow from operating activities increased by $1.2 million from the first six months of 1995 primarily as a result of a $983,000 reduction in inventory. The Company's Senior Indebtedness consists of a $16.0 million credit facility ($14.0 million term loan and $2.0 million revolving credit line), of which an aggregate of $11.9 million was outstanding on June 29, 1996. The term loan portion of the Senior Indebtedness is payable in installments, with the final installment due on May 22, 1999, and bears interest at 3.5% above certain LIBOR rates or, at the Company's option, at 2% over the prime rate. The revolving portion is due on the maturity of the term loan and bears interest at 2% over the prime rate. $5.9 million of the proceeds of this Offering are being used to repay the Senior Indebtedness, including (i) $1.5 million to pay down the outstanding amount under the revolving credit portion of the Senior Indebtedness; (ii) $1.8 million of the Senior Indebtedness which is due within one year of the date hereof; and (iii) $2.6 million of the Senior Indebtedness which is due more than one year following the date hereof. The Company will be able to reborrow under the revolving credit line following this Offering. In addition to principal and interest due under the Senior Indebtedness, the Company is obligated to pay the Additional Fee to BNP in the event of any future default, prepayment or change in control, or upon the final principal payment in May 1999. The Additional Fee is currently $625,000 and will rise to $1.0 million over the term of the Senior Indebtedness. On August 14, 1996, the Company entered into a Second Amendment, Waiver and Consent ("Second Amendment") with BNP. Pursuant to the Second Amendment, BNP consented to this Offering and the use of proceeds of this Offering, agreed to amend certain financial covenants and agreed to waive the Additional Fee provided that BNP's Senior Indebtedness is repaid in full on or prior to March 31, 1997. See "Use of Proceeds" and Note 5 to the financial statements. Pursuant to the Plan of Reorganization, certain of the Company's current stockholders purchased $3.6 million of subordinated indebtedness earning 11.5% interest per annum, payable semi-annually on June 1 and December 1 ("Subordinated Indebtedness"). The Company may, at its option through November 22, 1999, and, under certain conditions, through November 22, 2002, pay interest on the Subordinated Indebtedness with additional notes containing identical terms and conditions as the Subordinated Indebtedness. The principal of the Subordinated Indebtedness is due December 1, 2002, subject to a subordination agreement with BNP. As of June 29, 1996, approximately $4.4 million, including accrued interest, was outstanding under the Senior Indebtedness. The Company has high amortization payments under the Senior Indebtedness. The Company had little cash on hand at the end of any year, except 1993 when it was in bankruptcy. Cash generated from operations plus $1.5 million of borrowings under the revolving credit line have been used for working capital and to pay principal and interest on the Senior Indebtedness. The term loan portion of the Senior Indebtedness has been reduced from the original $14.0 million outstanding when the loan was obtained in November 1994 to $10.4 million at the end of June 1996. Capital expenditures average under $400,000 per year. Due to its working capital constraints, on June 1, 1996 the Company entered into an agreement with a director, Martin Franklin, and two associates of Mr. Franklin, pursuant to which Mr. Franklin and such associates loaned $495,000 to the Company. This loan was made on August 9, 1996, bears interest at 11.5%, and is due August 9, 1999, provided that this loan will not be repaid prior to the repayment of the Subordinated Indebtedness. In addition, in connection with such loan, Mr. Franklin and his associates purchased for $5,000 a warrant to acquire an aggregate of 265,335 shares of the Company's Common Stock at an aggregate exercise price of $500,000. See "Certain Transactions" and Note 13 to the financial statements. The Company anticipates that following this Offering and the application of the proceeds to repay a portion of the Senior Indebtedness, there will be approximately $5.4 million of Senior Indebtedness outstanding. The Company plans to refinance the remaining Senior Indebtedness and the Subordinated Indebtedness after this 23 Offering. The Company believes that partial repayment of the Senior Indebtedness will lower its debt servicing cost, and that this, together with the remaining net proceeds of this Offering, will enable the Company to expand its business. Should the Company be unable to secure a lender to refinance both the Senior and Subordinated Indebtedness, the Company will attempt to refinance only the Senior Indebtedness. The Company anticipates, based on current plans and assumptions relating to its operations, that the proceeds of this Offering, together with existing resources and cash generated from operations, should be sufficient to satisfy the Company's anticipated cash requirements for at least 12 months after completion of this Offering. After that time, the Company believes that income from operations should satisfy the Company's working capital needs; however, there can be no assurance that this will be the case. The Company currently has recorded a deferred tax asset reflecting the benefit of approximately $18 million of NOLs available for federal and state income tax purposes, which expire from 2005 through 2010. The Company believes that this Offering will result in an "ownership change" under Section 382 of the Code and, as a result, the Company's ability to use its "pre-change" NOLs will be limited to between $1.5 million and $2.0 million in each fiscal year following this Offering. Realization of the NOLs is dependent on generating sufficient taxable income prior to expiration of the loss carryforwards. There can be no assurance that the Company will be able to use the NOLs. The Company believes that it is more likely than not that the deferred tax asset will be realized. This belief is based on the Company's ability to generate income before taxes of $878,837, $1,208,278, and $1,696,288 for the years ended December 30, 1995, December 31, 1994 and January 1, 1994, respectively. During this period, the deferred tax asset has been reduced by $2,205,766, or approximately 24%, from $8,985,122 at January 1993 to $6,779,356 at December 30, 1995. Prior to 1993, the Company recorded significant operating losses. These losses were primarily due to poor operating performances of two of the Company's four subsidiaries during that period and the significant debt service during that period. The Company disposed of the two poor performing subsidiaries in January 1993 and reduced its debt service as part of the Plan of Reorganization. Aggregate net losses for the two subsidiaries for 1992 and 1991, respectively, including a loss of $671,396 on disposal in 1992, were $1,766,473 and $4,208,847. The Company's remaining two subsidiaries have a history of operating profits. Although these profits decreased in 1995, the decrease in profitability was experienced throughout the direct mail catalog industry due to the increase in both paper and postage rates in that year. The Company has enacted certain policies in order to reduce operating expenses and increase profitability in response to the increase in paper and postage expenses and believes that it will be able to attain its past levels of profitability in the near future. The Company does not expect any significant differences between book and tax income and therefore the Company believes that its book income closely approximates its actual taxable income against which the NOLs can be applied. SEASONALITY AND INFLATION The Company's sales have been generally non-seasonal. The need-based profile of the Company's wig and continuing education customers serves to minimize seasonality, as opposed to the traditional seasonality of want-based consumption. The impact of inflation on the Company's operations has not been significant to date. However, there can be no assurance that a high rate of inflation in the future would not have an adverse effect on the Company's operating results. 24 BUSINESS GENERAL The Company is a direct marketer targeting niche consumer product categories. SC Direct, its principal operating subsidiary, is the leading U.S. retailer of women's wigs and hairpieces. SC Publishing, a subsidiary of SC Direct, sells continuing education courses to nurses, real estate professionals and CPAs. SC Direct sells wigs and hairpieces primarily to women over the age of 50, using three distinct catalogs: Paula Young, Christine Jordan and Especially Yours. In 1995, SC Direct mailed 20.9 million catalogs, generating net sales of $37.3 million. SC Direct has developed a proprietary data base consisting of approximately 5.6 million persons, including more than 875,000 active customers and more than one million persons who have requested catalogs in the past year but who have not made a purchase. Due to the fact that wig wearers are difficult to find, the Company believes that its wig database is unique and would be very expensive to replicate. The Company believes that this poses a substantial barrier to entry for any potential competitor. SC Direct's target market, women over age 50, is projected by the U.S. Census Bureau to grow from 38.7 million women, or 38% of the total female population in 1995, to 51.5 million women, or 45% of the total female population in 2010. This growth is driven primarily by aging "baby-boomers." The Company believes that only approximately five million, or 25%, of the 20 million American women with thinning hair currently wear wigs, and that, accordingly, there is substantial opportunity for future growth of SC Direct's business. SC Direct's strategy for its core business is to exploit new distribution opportunities for wigs and hairpieces and to sell additional products to its customers. For example, in the last three years, SC Direct has introduced its upscale Christine Jordan catalog and its Especially Yours catalog for African- American customers, expanded into international markets and begun a test program selling to hair salons. In 1995, SC Direct launched its Paula's Hatbox catalog, through which it sells a variety of fashion hats to women. The Company believes that the market for fashion hats has niche characteristics similar to those of the wig market. In addition, SC Direct intends to begin test marketing men's wigs in the Paula Young catalog in early 1997. SC Publishing offers nurses, real estate agents and CPAs home study continuing education through the Western Schools catalogs. SC Publishing's strategy is to build its business by offering additional products and programs to its core customers and by expanding into new and related professional fields. In 1995, SC Publishing mailed 8.3 million catalogs, generating net sales of $5.3 million. The Company intends to build its business in existing niche markets and enter new niche markets both by internal expansion and through acquisitions. Niche markets are characterized by smaller market size, unique or hard to find products, or hard to locate customers. In executing its plans, the Company will seek to do the following: . REFINE MARKETING PROGRAMS. The Company continually seeks to refine its marketing programs, including the two-step marketing program which it utilizes to identify hard to locate customers in niche markets. The Company constantly seeks to develop new and improved marketing techniques to increase catalog requests, convert catalog requests into orders and increase sales to existing customers. . OFFER BROAD PRODUCT SELECTION AT ATTRACTIVE PRICING. The Company believes that it differentiates itself from both traditional store-front retailers and other direct marketers by offering a broad and deep selection of the products it offers. By virtue of its large order volume and direct purchasing from wig manufacturers, the Company is able to offer wigs at prices lower than most hair salons and wig shops. . MAINTAIN CLOSE SUPPLIER RELATIONSHIPS. The Company maintains close relationships with many of the leading wig manufacturers. Through these relationships, the Company is able to obtain better control over purchasing, styles, quality and cost. 25 . CONTINUE TO PROVIDE SUPERIOR CUSTOMER SERVICE. By emphasizing the training of marketing representatives, the Company seeks to maintain high levels of customer satisfaction. The Company seeks to provide prompt, courteous and knowledgeable service to its customers in order to build customer loyalty and demonstrate to the customer the convenience of catalog shopping. . ACHIEVE ECONOMIES OF SCALE AND EFFICIENCIES. The Company believes that, if it is able to achieve its growth objectives, it will be able to reduce its fixed and other costs as a percentage of sales. . DEVELOP NEW PRODUCTS AND ENTER NEW MARKETS. The Company intends to add new product lines through new or expanded catalogs. To that end, the Company carefully monitors the wig, hat and continuing education markets to identify unfulfilled consumer demand. By developing and offering new products to meet that demand, the Company creates additional sales opportunities and reinforces customer loyalty to the Company's catalogs. The Company is seeking to add complementary products to its existing product lines that would appeal to its current customer base. The Company is also looking for new markets to enter, either through internal development or acquisitions. WIGS INDUSTRY AND MARKET Based on U.S. Census Bureau import data, approximately five million wigs are sold annually in the United States. The wig market is comprised of fashion wig wearers and need-based wig wearers. Need-based wig wearers purchase wigs as an everyday necessity due to a physical problem such as naturally thinning hair or total hair loss, as well as temporary hair loss due to medical procedures and conditions (i.e., cancer treatments). Many everyday wig wearers prefer to replace their wigs every three to four months, and have a wig "wardrobe," consisting of several wigs of different styles and colors. In the 1960s, wigs and related products were broadly viewed as a fashion accessory, but as styles changed the fashion-driven demand for wigs decreased. Due to this trend, during the 1970s and 1980s the number of specialty wig boutiques declined and department stores reduced their selling space and inventories of wigs. The Company recognized that a base of dedicated, need- based wig customers existed which was no longer being adequately serviced by the remaining retail alternatives. Therefore, the Company launched its catalog business to service this market. The retail wig market is serviced by direct mail catalogers and retail markets, including beauty salons, department stores and wig shops. The Company estimates that catalog retailers represent 40% of the current market and offer the benefits of privacy, convenience, lower prices and broad product selection. Retail stores provide customers with more personalized service and allow customers to try on the product, however, they charge higher prices and offer less convenience, privacy and selection than catalog retailers. The Company believes it has advantages over its two principal mail order competitors, General Wig Company (a subsidiary of Revlon, Inc.), which markets wigs through the Beauty Trends catalog, and Vincent James Company, which markets wigs through the TWC Catalog. The Company believes that these advantages include economies of scale, the size of its customer list, and the extent of its advertising program. The Company estimates that all other wig catalog retailers represent less than 5% of the market. The African-American wig market, unlike the Caucasian market, has yet to undergo the transition to direct marketing from retail outlets. Currently, only about 5% of African-American wigs are sold through catalogs, with the balance sold in beauty salons, department stores and wig shops. As a result, there are no significant catalog competitors. The Company is aware of only three other mail order catalogs targeting the African-American market--Black is Beautiful, Naomi Simms and Gold Medal. Millions of American women suffer varying degrees of hair loss. These women comprise a significant percentage of the Company's customer base for its wigs and hairpieces. Ongoing research is conducted by 26 numerous groups, both public and private, seeking remedies for hair loss. One drug, Minoxidil (primarily marketed under the name Rogaine(R)) is available over-the-counter and is sold to men and women as a measure against hair loss. There can be no assurance that a new drug will not be developed that could prevent hair loss among women. Such an event could have a material adverse effect on the Company's core wig business. In addition, any new cancer therapies that would eliminate hair loss as a side effect of treatment could have a material adverse effect on the Company's business. PRODUCTS The Company sells a full range of wigs and hairpieces in five separate product lines. Hairpieces include wiglets and add-ons or extensions. Wiglets are small wigs generally worn on the top of the head to add style or cover thinning hair on the top or crown area. Add-ons or extensions are usually added for style reasons, generally to the back of the head. The Company offers about 45 different wig styles per catalog in more than 25 colors, including browns, blondes, grays and reds. Most wigs are available in one or two sizes, except for wigs in the Christine Jordan line which offers all styles in five sizes. All of the Company's wigs, as well as the majority of all wigs sold in the U.S., are manufactured in small, privately-owned factories in Korea, Indonesia and China that manufacture to the specifications and designs of their customers. The Company believes that there is adequate supply to meet the demand, and the Company is not solely dependent on any one manufacturer for its wig supply. All wigs and hairpieces sold by the Company are made of synthetic fibers. The wig market is dominated by synthetic fiber wigs. Synthetic fiber has several advantages over human hair, including lower cost, permanent styling, truer colors and cleanliness. The Company expects that most of its wig merchandise will continue to be manufactured in Asia in the future. Accordingly, the Company's operations are subject to the customary risks of doing business abroad, including fluctuations in the value of currencies, export duties, quotas, work stoppages and, in certain parts of the world, political instability and possible governmental intervention. Since the Company pays for its wigs in U.S. dollars, the cost of wigs may be adversely affected by an increase in the relative value of the relevant foreign currencies against the U.S. dollar. Although to date such risks have not had a significant effect on the Company's business operations, no assurance can be given that such risks will not have a material adverse effect on the Company's business operations in the future. Wigs are manufactured using a special modacrylic fiber, the market for which is dominated by two Japanese firms, Kaneka Corporation and Toyo Chemical Corporation. Modacrylic fiber is not a proprietary material, and other manufacturers in the past have produced this material. Although the Company believes that in the event of a disruption in the supply of fiber, alternative sources could be found, such a transition to new fiber suppliers could interrupt or delay wig production schedules, potentially causing a material adverse effect on the Company's business. The manufacture of a wig begins with the blending of the fibers for color and the cutting of the fiber to proper length. The fibers are then sewn to a cotton or lace wefting, after which the predetermined curl pattern is baked in. The wefting is then sewn together into the final pattern and styled. During the first half of 1996, the Company purchased approximately 55% of its wigs and hairpieces directly from foreign manufacturers and the balance from four U.S. importers. Each of the Company's five largest manufacturers represented between 8% and 25% of its overall wig purchases in the first half of 1996. The Company is increasing the percentage of wigs purchased directly from manufacturers because direct purchasing permits better control over price, quality and style. By 1998, the Company plans to purchase 80% to 90% of its wigs directly from the manufacturers. The Company also sells wig accessories, including brushes and stylers, styrofoam head forms and stands, rainhoods, wig liners, shampoos and styling products, generally at prices below $10. MARKETING The Company markets its products through catalogs, generally by way of a two-step marketing program. Step one involves obtaining prospective customers by soliciting customer interest through targeted advertising. 27 The Company uses a variety of advertising media, including magazines, newspaper tabloids, co-op mailers, package insert programs and television. The Company places advertising based on demographics, cost and historical experience. Historical experience is measured by cost per inquiry, cost per customer and lifetime value of a customer and, based on this information, the Company determines which media are effective and where future marketing dollars should be spent. Step two, which commences when a prospective customer responds favorably to an advertisement placed by the Company, involves sending the prospective customer a series of catalogs designed to elicit an initial sale. By pre- qualifying prospects in this manner, SC Direct has been able to convert 15% to 20% of inquirers into customers within one year of catalog request. If a sale is made, the customer is put on an active list and additional catalogs designed to create a repeat buyer are mailed. Inactive inquiries and customers are periodically sent a program of targeted mailings designed to reactivate customer interest. The Company believes that in niche markets its two-step marketing program has several advantages over the more traditional one-step marketing approach which entails mailing unsolicited catalogs to rented names. Since catalogs are sent only to persons who have shown an interest in the Company's products, the Company experiences higher conversion rates and fewer catalogs need to be printed and mailed, which leads to savings in paper, postage and other catalog production costs. The Company continually refines its marketing programs and processes for the purpose of increasing its conversion rate and satisfying its existing customers. The Company employs a variety of research methods, including demographic analysis, customer surveys, test mailings and advertising, focus groups and outside research sources. The Company's research efforts have assisted the Company in pursuing its strategic goals by identifying new niche markets, such as hats and wigs and hairpieces for African-American women. BRANDS The Company markets through three distinct wig catalogs: Paula Young, Christine Jordan and Especially Yours. Each catalog includes detailed product descriptions and specifications, full color photographs and pricing information. Each of these catalogs is published several times a year, and often, different variations of each catalog are distributed. Each catalog focuses on its namesake brand, as well as other selections of the Company's brands. The Company markets the following brands through its catalogs: Paula Young is the Company's flagship line, is designed to have the broadest appeal and is available in all three catalogs. Paula Young wigs are value priced from $29 to $59 and have a "shake and wear" styling with quality construction. Gross sales of Paula Young brand wigs were $21.8 million in 1995, or 51% of the Company's wig sales. Celebrity Secrets(R) is geared toward a more sophisticated customer. Celebrity Secrets has more contemporary styling and unique features, such as a monofilament "partial scalp" permitting a natural looking hair part. These wigs command slightly higher prices ranging from $49 to $69 and are available in all three catalogs. Gross sales of Celebrity Secrets brand wigs were $3.8 million in 1995, or 9% of the Company's wig sales. Christine Jordan is the Company's premium brand and consists of the Company's highest quality wigs ranging in price from $69 to $99. Christine Jordan wigs have a unique fiber blend and come in their own distinctive colors. In addition, the wigs have comfort construction with a natural hairline and it is the only brand in the industry to carry five sizes in all styles. This wig line is featured in its own separate catalog as well as the Paula Young and Especially Yours catalogs. Gross sales of Christine Jordan brand wigs were $9.2 million in 1995, or 21% of the Company's wig sales. Especially Yours offers styles specially designed for African-American women and offers a variety of features, including natural hairline crimping and fiber texture, to reflect the natural hair of African-Americans. 28 Especially Yours is featured in its own separate catalog with prices ranging from $29 to $69 and is also being tested in selected Paula Young catalogs. Gross sales of Especially Yours wigs were $600,000 in 1995, or 1% of the Company's wig sales. Touch of Class features only hairpieces, including wiglets, add-ons and extensions. Touch of Class products are sold primarily in the Paula Young catalog. Gross sales of Touch of Class brand hairpieces were $3.6 million in 1995, or 8% of the Company's wig sales. In addition to its own five proprietary brands, the Company also markets Eva Gabor(R) wigs, a brand comparable in quality to Paula Young and Celebrity Secrets, but which is owned by Eva Gabor International. Eva Gabor wigs comprised 10% of the Company's 1995 wig sales. There is no licensing or marketing agreement between the Company and Eva Gabor International. NEW OPPORTUNITIES African-American Market. Although African-American women comprise approximately 13% of the U.S. female population, they purchase approximately 50% of the wigs sold. The Company estimates that sales to the African-American wig market approximate $125 million annually. African-American women wear hairpieces for fashion reasons and are more likely to begin wearing wigs and hairpieces at a younger age than Caucasian women. The Company's newest wig catalog, Especially Yours, targets this market and is already the largest African-American wig catalog. The Company plans to market actively to African- American women. International Expansion. The Company seeks to leverage its marketing and product knowledge, infrastructure and procurement ability to expand internationally. The Company estimates that the international market is at least as large as the U.S. market. In the United Kingdom and New Zealand, the Company has entered into license agreements which grant each licensee exclusive rights to use the Company's trademarks to sell wigs in the licensee's territory. The licensee uses the Company's inventory and fulfillment services, for which the Company is reimbursed, and also receives marketing advice and catalog development assistance. Pursuant to the license agreements, the licensees are required to pay royalties on their net sales, including a minimum guaranteed annual royalty, and expend a specified minimum amount of advertising expenditures each year. The U.K. licensee will conduct a test introduction of hats in late 1996 and plans to enter the Netherlands market with wigs in early 1997. The Company has targeted Europe, Japan, Scandinavia, Australia, Israel and South Africa as potential expansion areas. In 1995, the Company purchased its Canadian licensee's customer list and began to market directly to Canadian consumers. The Company's Canadian gross sales totaled $1,100,000 in 1995. There can be no assurance that the Company will be able to achieve international success with its products. Business to Business. The Company launched a pilot program in 1995 to sell wigs to beauty salons. The program permits participating salons to offer their customers a broad selection of styles while keeping a limited inventory of wigs in the store. Men's Wigs. Utilizing its two-step marketing program, the Company intends to begin test marketing men's wigs in the Paula Young catalog in early 1997. HATS In 1995, as part of its overall expansion strategy, the Company launched the Paula's Hatbox catalog. The Company believed that the fashion hat market, like the wig market, was not well served by existing retail chains of distribution, with no major competitor offering a broad selection of quality hats. The Company's research suggested that the marketing skills needed to capture this niche market were similar to those the Company used in the wig market. The women's fashion hat market is fragmented among department stores, small boutiques, resort stores and other general merchants and catalog retailers who offer a limited number of styles as a complement to their 29 principal product lines. Although the women's fashion hat market is estimated to be a $700 million market, no dominant hat retailer has emerged. The Company sells a variety of hats in more than 125 styles and colors, ranging in style and price from simple baseball caps or sun visors for under $20 to designer hats for more than $200. Paula's Hatbox also includes hat pins and accessories, including costume jewelry, sunglasses, scarves, belts and handbags. The majority of the Company's hats are manufactured domestically and purchased from domestic vendors often from top designers. Currently, with the exception of hat boxes, the Company does not purchase hats and related products directly from manufacturers. As sales of hats expand, the Company expects to improve profit margins through improved sourcing. The Company is using the two step marketing approach developed in its wig business to sell hats. In addition, the Company is testing new one step marketing techniques and selling hats through its Especially Yours catalog. In 1995, Paula's Hatbox represented less than 1% of the Company's sales. Although the Company believes that the hat market presents a significant opportunity for growth, there can be no assurance that the Company's efforts to expand its hat business will be successful or profitable. CONTINUING EDUCATION SC Publishing distributes catalogs under the name of Western Schools and specializes in providing continuing education ("CE") to nurses, real estate brokers and salespersons, and CPAs. SC Publishing represents a relatively small proportion of the Company's overall revenue, with net sales in 1995 of $5.3 million, or approximately 12% of the Company's overall net sales. SC Publishing's predecessor was organized in 1978 in California to provide real estate continuing education courses. Required CE frequency and the number of required hours varies from profession to profession and from state to state depending on state laws and association regulations. The CE industry has many small providers, including local universities, but few large providers. In addition, some hospitals and CPA firms educate their own employees through in-house programs and by subsidizing outside programs. Because CE is a required product, people may not be enthusiastic buyers. Accordingly, SC Publishing competes aggressively on price, course content and selection, and customer service. Nursing represented more than half of SC Publishing's continuing education sales in 1995. Twenty-one states currently require nurses to have some form of CE. Two additional states will begin to require CE in 1997. SC Publishing is exploring the expansion of this segment through the addition of non-CE products and business-to-business opportunities in joint ventures, with hospitals, nursing homes and seminar providers. SC Publishing sells continuing education to real estate agents only in California, which is the largest U.S. market for real estate agents and brokers. Although the California real estate market has been depressed in recent years, the Company believes there are signs of improvement in this market. SC Publishing is seeking to build market share by refining its circulation plan and expanding its offerings to other related professionals such as appraisers and new home builders. SC Publishing is also assessing opportunities to begin selling in other states which require real estate agents to take CE. SC Publishing sells continuing education to CPAs, who generally are required to obtain CE every year. SC Publishing seeks to compete in this market by offering current CE topics in a convenient manner at competitive prices. SC Publishing develops its products by first identifying topics pertinent to its target audiences of nurses, real estate agents and CPAs and then contracting with qualified authors to develop a course text book and exam materials. In some cases where products may change rapidly because of changing regulations or knowledge, SC Publishing buys existing textbooks and contracts with authors and/or industry experts to convert these into 30 courses. All courses are reviewed by other industry experts before publishing. SC Publishing generally prints its own materials and hence controls its own inventory investment based on projected demand. OPERATIONS ORDER ENTRY AND CUSTOMER SERVICE The Company has structured its telemarketing operation and training for its telemarketing representatives to simplify catalog shopping by emphasizing prompt, courteous and knowledgeable service. Customers may call toll free telephone numbers 24 hours a day, seven days a week, to place orders or to request a catalog. Approximately 63% of the Company's orders are placed by telephone, with calls lasting three to four minutes. The balance of orders are received by mail. The Company has contracted with an outside telemarketing provider to handle calls in the event call volume exceeds the Company's capacity during peak business hours, as well as to answer the Company's phones during off-peak hours. Overflow situations also occur due to holidays and operational disruptions such as poor weather. Telemarketing representatives process orders directly into the Company's computer system which provides customer history, product availability, product specifications, expected ship date and order number. The telemarketing representatives use a scripted catalog sales system, are knowledgeable in key product specifications and features, and are trained to cross-sell accessories and related products. In keeping with the Company's efforts to maximize operating efficiency, representatives are trained to handle a range of products and customer service calls, allowing the Company to shift representatives among products as call volume requires. The Company signed a new three year contract with AT&T in 1995 which management believes provides the Company with long-distance rates comparable to those enjoyed by larger users. The Company uses AT&T equipment with a 500 line capacity and presently uses about 320 lines in 86 stations. The Company's telephone system permits flexibility in routing calls to maximize teleservice representative efficiency. CREDIT Virtually all of the Company's sales are transacted by check or through credit card, and, as a result, accounts receivable consist primarily of amounts due from the Company's credit card processor. Credit card payments are deposited electronically into the Company's bank account one to two days after submission of credit card transactions. Personal checks over $200 and all credit card charges are pre-authorized. During fiscal 1995, losses due to bad checks amounted to less than 1% of net product sales. In addition, purchases from SC Direct may be made by certain customers with the Paula Young credit card, which SC Direct began testing in 1990 and in 1995 offered to all wig customers who had previously paid by check. Before expanding the credit card program further, the Company is evaluating whether to continue to administer the card and finance the receivables internally or to outsource these functions. FULFILLMENT The Company's fulfillment goal is the prompt delivery of ordered merchandise. The Company's investment in computer systems has resulted in operating efficiencies in order entry and fulfillment. Orders of in-stock merchandise received before 11:00 a.m. are shipped on the same day, usually via bulk or priority mail. For an additional charge, the Company will ship by overnight or second day courier. Merchandise not in stock on the date of order is shipped for delivery on the same day it is received by the Company, or the next business day. The Company uses an integrated computer picking, packing and shipping system. The system monitors the in-stock status of each item ordered, processes the order and generates all related packing and shipping materials, taking into account the location of items within the distribution center. During fiscal 1995, the Company shipped an average of approximately 3,800 orders per day, with a peak of 5,473 orders shipped in one day. The Company currently has the capacity to ship approximately 7,800 orders per day in two shifts. 31 RETURNS The Company's return policy allows customers to return products for prompt refund or exchange. Returns for refund and exchange over the past three years averaged 16% and 14%, respectively, at SC Direct and 2% and 1%, respectively, at SC Publishing. The Company believes that these return levels are normal for mail order products of this nature. Return experience is closely monitored at the SKU level to identify trends in product offerings, product defects and quality issues in an attempt to assess future purchases, enhance customer satisfaction and reduce overall returns. Returned wigs are inspected and returned to inventory if not worn, and if worn are donated to various hospitals' chemotherapy departments and local chapters of the American Cancer Society. Undamaged and unmarked SC Publishing books are also returned to inventory. INVENTORY MANAGEMENT The Company's inventory management goal is a high initial fulfillment rate with reasonable levels of inventory investment and low overstocks. To achieve this goal, the Company seeks to schedule merchandise deliveries and inventory amounts to conform closely to sales levels. The Company typically orders merchandise in several lots, with the sizes of reorders dependent on customer demand. Initial orders for wigs and hats are placed two to four months before a catalog mailing. Initial deliveries are scheduled to occur one or two weeks before the first mailing. Initial purchase quantities are based on a variety of factors, including past experience with the same or similar products, future availability, shipping time, and, with respect to hat vendors, the Company's ability to negotiate a reorder commitment from the vendor. The Company analyzes the initial sales and returns for each item in a catalog. Using this information, the Company projects gross demand and returns for such items and, based on these projections and inventory on hand and on order, makes decisions regarding additional purchases. The Company sells overstocks and discontinued items through targeted mailings and sale pages bound into its full-price catalogs. CATALOG PRODUCTION The Company's catalogs are created in-house by the Company's graphic arts staff of designers and production artists using a computer desktop publishing system. The Company's in-house preparation of catalogs provides the Company with greater control, flexibility and creativity in catalog production and product selection, and results in significant cost savings. The Company mailed 29.2 million catalogs in fiscal 1995, compared to 22.6 million catalogs in fiscal 1994. The Company's most active customers receive a Company catalog as often as every two weeks. DATABASES The Company has developed databases consisting in aggregate of approximately 5.9 million persons, including more than 1.2 million active customers and more than one million active inquirers. The Company markets mailing lists derived from its databases to non-competing businesses to provide additional sources of income after confirming that security measures are in place to protect this proprietary data. List rental income was $200,000 in 1995. The Company has undertaken limited exchanges of lists of inactive customers with wig competitors. COMPETITION The mail order catalog business is highly competitive. The Company believes that it competes on the basis of quality, value, service, product offerings, advertising effectiveness, catalog design, convenience and efficiency. The Company's wig and hat catalogs compete with other mail order catalogs, both specialty and general, and retail stores, including department stores, specialty stores, discount stores and hair salons and wig shops. The Company's CE catalogs compete with other mail order catalogs, in-house CE, professional associations, and seminar providers. The Company believes that the Company's catalogs have a competitive advantage in providing greater selection, convenience and privacy than traditional retail outlets. Some of the Company's competitors have greater financial and marketing resources than the Company. Potential competition may emerge from new distribution channels such as the Internet and interactive television. 32 EMPLOYEES As of July 31, 1996, the Company employed a total of 278 employees, comprising 63 salaried full-time employees, 138 full-time hourly employees, and 77 part-time hourly employees. None of the Company's employees are covered by a collective bargaining agreement. The Company believes that its relations with its employees are good. FACILITIES The Company occupies a 43,000 square foot building in South Easton, Massachusetts, which is utilized as one-third warehouse and two-thirds office space. In addition, the Company also leases another 22,000 square foot facility one block away, primarily utilized as additional warehouse space. In June 1995, rent on the main facility was adjusted from $40,000 to $25,000 per month, which management estimates to be slightly above market rates. The rent on the 22,000 square foot facility is approximately at market rate. Under the terms of the current leases, each landlord and the Company have the right to terminate the respective lease upon four month's notice. In the event a landlord gives the Company notice, the Company believes that it could move to new appropriate space within four months. Nonetheless, there can be no assurance that the Company will find appropriate space within four months. The process of moving to and restarting operations in a new site could have a material adverse effect on the Company's operations. The Company is planning to expand to a larger facility to provide room for growth and eliminate the inefficiencies of operating two warehouses. Currently, the Company is investigating the lease of an appropriately sized facility within a 10 to 15 mile radius of its present location. If the Company does not locate a suitable site, it may enter into negotiations with its present landlords for long-term leases. There can be no assurance that the Company will be successful in locating a new facility or negotiating new leases. TRADEMARKS AND TRADE NAMES The Company has registered 7 trademarks and has 3 trademark applications pending with the U.S. Patent and Trademark Office and has 4 trademarks registered under California state law. In the course of normal business, the Company often utilizes new tradenames. When appropriate, the Company seeks to register these names. GOVERNMENT REGULATIONS In 1994, the United States Supreme Court reaffirmed an earlier decision that allowed direct marketers to make sales into states where they do not have a physical presence without collecting sales taxes, but noted that Congress has the power to change this law. The imposition of an obligation to collect sales taxes may have a negative effect on the Company's response rates and may require the Company to incur administrative costs in collecting and remitting the sales taxes. The Company believes that Massachusetts is the only jurisdiction where it is currently required to collect sales taxes. LEGAL PROCEEDINGS The Company is, from time to time, a party to routine litigation arising in the normal course of its business. The Company believes that none of these actions will have a material adverse effect on the financial condition or results of operations of the Company. The Company currently has several registered trademarks and may seek additional legal protection for its products and trade names. The Company has invested substantial resources in developing several distinctive catalog trademarks as well as branded products and product lines. There can be no assurance that the steps taken by the Company to protect its rights will be sufficient to deter misappropriation. Failure to protect these intellectual property assets could have a material adverse effect on the Company's business operations. Moreover, although the Company does not currently know of any lawsuit alleging the Company's infringement of intellectual property rights that could have a material adverse effect on the Company's business, there can be no assurance that any such lawsuit will not be filed against the Company in the future or, if such a lawsuit is filed, that the Company would ultimately prevail. 33 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The directors and executive officers of the Company are as follows: NAME AGE POSITION - ---- --- -------- Steven L. Bock........................ 42 Chairman of the Board and Chief Executive Officer Stephen M. O'Hara..................... 41 President and Secretary J. William Heise...................... 48 Senior Vice President and Chief Financial Officer Jerral R. Pulley...................... 62 Senior Vice President Alan S. Cooper........................ 37 Director Martin Franklin....................... 31 Director Samuel L. Katz........................ 31 Director Guy Naggar............................ 55 Director STEVEN L. BOCK has been Chairman of the Board and Chief Executive Officer of the Company (or its predecessor company) since December 1990. He has been a director of SC Direct and SC Publishing (including the years when these companies were under bankruptcy protection of the courts) since March 1989. SC Direct was formed by RSG Partners, a private investment and management firm founded by Mr. Bock and two partners in 1988. Mr. Bock was a partner in RSG Partners from 1988 to 1990. From October 1986 to October 1988, Mr. Bock was a vice president of TSG Holdings, Inc., the investment advisor to Transcontinental Services Group, a U.K. listed investment holding company, where he was responsible for initiating, financing and managing business investments. Mr. Bock is a director of Xetex Corporation, a technology development company. Part of Xetex's business is conducted through SOLI.FLO SM, a 50/50 joint venture with Fluor Daniel Inc., a publicly held engineering and construction company. Mr. Bock is a Member of SOLI.FLO's Members Committee. Mr. Bock is a member of the Young Presidents Organization. He graduated (summa cum laude) with a B.A. degree from SUNY at Albany and received his J.D. degree (cum laude) from Harvard Law School. STEPHEN M. O'HARA has been President of the Company since 1994 and was President of Wigs by Paula, Inc., a predecessor company, from November 1991 to November 1994 (including the years Wigs By Paula, Inc. was under the protection of the bankruptcy courts). From May 1990 to November 1991, Mr. O'Hara was Vice President, Marketing and Vice President, Strategy of the All American Gourmet division of Kraft General Foods. From May 1988 to May 1990, Mr. O'Hara was President of Quantum Investments, a venture capital firm targeting small consumer businesses, as well as a principal in Quantum Associates, a management consulting firm. From November 1984 to May 1988 he served in a variety of positions with CML Group ("CML"), most recently as President of CML's subsidiary Carroll Reed, Inc., a women's apparel retailer and direct marketer. Prior to CML, Mr. O'Hara served in Procter and Gamble's marketing department from 1979 to 1984. Mr. O'Hara holds A.B. and M.B.A. degrees from Harvard University. J. WILLIAM HEISE has been Chief Financial Officer of the Company since August 1996 and was Acting Chief Financial Officer from March 1996 to August 1996. From November 1994 to November 1995, Mr. Heise was Vice President/Chief Financial Officer at Sun Television and Appliances, Inc., a retailer of consumer electronics and appliances. From October 1983 to March 1994, Mr. Heise served in a variety of positions with Victoria's Secret Catalogue, Inc., including Executive Vice President/Chief Financial Officer from 1989 to 1992 and Executive Vice President/Operations from 1992 to 1994. Mr. Heise holds a B.A. degree from Ohio University. JERRAL R. PULLEY has been Senior Vice President of SC Publishing since October 1995. From November 1994 to October 1995, Mr. Pulley worked as an independent consultant. From 1990 to November 1994, Mr. Pulley served as CEO of Polymerics, Inc. a leading manufacturer of arts and crafts supplies. From 1970 through 1990, Mr. Pulley held a variety of senior positions at Binney & Smith, Ryder System, Perfect Building Group, Borden Inc., Lifesavers, Inc. and Pepsi-Cola of North America. From 1958 to 1970 Mr. Pulley worked in marketing at Procter & Gamble. Mr. Pulley holds a B.S. degree from the University of Utah and a M.B.A. degree from U.C.L.A. 34 ALAN S. COOPER has been a director of the Company since February 1996. Mr. Cooper has been general counsel of Dickstein Partners Inc., a private investment firm, since March 1992. Prior to joining Dickstein Partners Inc., he was an attorney with Rosenman & Colin in New York City from August 1983 to February 1992. Mr. Cooper is a director of Hills Stores Company. Mr. Cooper received his B.S. and J.D. degrees from the University of Pennsylvania. MARTIN E. FRANKLIN has been a director of the Company since November 1994. Mr. Franklin is currently Chairman and Chief Executive Officer of BEC Group, Inc., a NYSE company, and non-executive Chairman of Eyecare Products plc, a London Stock Exchange Company. Mr. Franklin was Chairman and Chief Executive Officer of Benson Eyecare Corporation, the predecessor company to BEC Group, from October 1992 through May 1996. Mr. Franklin has been the Chairman of the Board and Chief Executive Officer of Pembridge Holdings, Inc. since 1990 and sits on various other private company boards. From 1988 to 1990, Mr. Franklin was Managing Director of Pembridge Associates, Inc. Both Pembridge Associates, Inc. and Pembridge Holdings specialize in merchant banking and related services. Mr. Franklin received a B.A. in Political Science from the University of Pennsylvania. SAMUEL L. KATZ has been a director of the Company since November 1994. He has been the Senior Vice President-Acquisitions of HFS Incorporated, a public corporation engaged in the lodging and real estate franchising businesses, since January 1996. From June 1993 to December 1995, Mr. Katz was a Vice President of Dickstein Partners Inc. From February 1992 to June 1993, Mr. Katz was the Co-Chairman of Saber Capital Inc., a private investment firm. From February 1988 to January 1992, Mr. Katz served as an Associate and then a Vice President of the Blackstone Group, an investment and merchant bank, where he focused on leveraged buy-out transactions. Mr. Katz is a director of Hills Stores Company. Mr. Katz received his B.A. in Economics from Columbia University in 1986. GUY NAGGAR has been a director of the Company since November 1994. Since 1981 he has been Chairman of Dawnay, Day & Co. Limited, a U.K. investment bank founded in 1928, which is a member of the London Investment Banking Association. Immediately prior to becoming Chairman of Dawnay, Day & Co. Limited, Mr. Naggar was a Director of the Charterhouse Group Limited and of its subsidiary, Charterhouse Japhet Limited. EMPLOYMENT AGREEMENTS The Company has entered into an employment agreement with Steven L. Bock pursuant to which Mr. Bock will serve as the Chairman of the Board and Chief Executive Officer of the Company for a term expiring on December 31, 1999, at a salary of $280,000, subject to annual increases which will bring the annual salary in the last year of the term to $310,000. Mr. Bock will be eligible for a performance bonus ranging between 1% to 100% of his base salary, based upon the Company's performance against its annual plan approved by the Board. Upon executing the employment agreement, Mr. Bock was granted options under the Plan to purchase 75,000 shares of Common Stock at the initial public offering price and options to purchase 75,000 shares of Common Stock at a price of $5.33 per share, granted outside of the Plan. Options to purchase 15,000 shares of Common Stock will vest and become exercisable each year for five years, subject to accelerated vesting under certain circumstances. Mr. Bock will receive deferred bonus compensation of $187,500 accrued under his prior employment agreement with the Company which will be paid in three equal installments on January 1, 1997, June 30, 1997 and January 1, 1998. The Company currently maintains an $8.5 million key person life insurance policy on Mr. Bock, although this amount may be reduced. The Company has entered into an employment agreement with Stephen M. O'Hara pursuant to which Mr. O'Hara will serve as President of the Company for a term expiring on December 31, 1999 at a salary of $205,000 subject to annual increases which will bring the annual salary in the last year of the term to $235,000. Mr. O'Hara will be eligible for a performance bonus ranging between 1% to 100% of his base salary, based upon the Company's performance against its annual plan approved by the Board. Upon executing the employment agreement, Mr. O'Hara was granted options under the Plan to purchase 25,000 shares of Common Stock at the initial public offering price. Options to purchase 5,000 shares of Common Stock will vest and be exercisable each year for five years, subject to accelerated vesting under certain circumstances. Mr. O'Hara will receive deferred bonus compensation of $35,000 accrued under his prior employment agreement with the Company which will be paid in three equal installments on January 1, 1997, June 30, 1997 and January 1, 1998. The Company currently maintains a $5.5 million key person life insurance policy on Mr. O'Hara, although this amount may be reduced. 35 The Company may terminate Mr. Bock's employment: (i) upon his death or permanent disability; (ii) if he engages in conduct that constitutes "cause;" (iii) if, after 1996, the Company fails to meet certain financial targets; or (iv) upon a change of control. Mr. Bock may terminate his agreement if there is a material reduction of his responsibilities or a material breach of the agreement by the Company. Mr. O'Hara or the Company may terminate this employment agreement at any time, with notice. In the event Mr. Bock's employment is terminated for any reason other than "cause" or death, Mr. Bock will receive a severance payment of from one year to two years of base salary. In the event Mr. O'Hara's employment is terminated for any reason other than "cause" or death, Mr. O'Hara will receive a severance payment of from six months to one year of base salary. Both employment agreements contain noncompetition restrictions effective during the term of employment and for a period of two years thereafter. For the term of the employment agreements, and for any period thereafter during which the Company is obligated to pay severance, the Company must provide $1 million of life insurance for the benefit of each of Messrs. Bock and O'Hara. In the event the Company fails to maintain such insurance, upon the death of Mr. Bock or Mr. O'Hara, the Company must pay such officer's estate a death benefit of $1 million. EXECUTIVE COMPENSATION The following table shows the cash compensation paid by the Company and its subsidiaries, as well as certain other compensation paid or accrued, during the fiscal years ended December 30, 1995, and December 31, 1994 and January 1, 1993 to the Chief Executive Officer of the Company and each of the other three most highly compensated executive officers ("Named Officers"). SUMMARY COMPENSATION TABLE - ------------------------------------------------------------------------------- LONG-TERM ANNUAL COMPENSATION COMPENSATION - ------------------------------------------------------------------------------ FISCAL NUMBER OF NAME AND PRINCIPAL POSITIONS YEAR SALARY BONUS OPTIONS - ------------------------------------------------------------------------------ Steven L. Bock................... 1995 $ 270,294 $ 65,960 -- Chairman and Chief Executive Of- ficer 1994 212,116 100,000 310,226(1) 1993 216,923 -- -- Stephen M. O'Hara................ 1995 $ 194,718 $ 35,000 -- President 1994 166,424 81,850 272,773(2) 1993 167,360 -- -- J. William Heise................. (3) -- -- -- Chief Financial Officer Jerral R. Pulley................. 1995(4) $ 25,962 $ 5,000 -- Senior Vice President (1) Represents options granted in 1994 at an exercise price of $0.31 per share, all of which became exercisable upon the date hereof. (2) Represents options granted in 1994 at an exercise price of $0.31 per share, of which options to purchase 218,218 shares became exercisable upon the date hereof, and options to purchase 54,555 shares will become exercisable one year from the date hereof. (3) Mr. Heise became acting chief financial officer in March 1996 and on August 1, 1996, he was hired permanently at an annual salary of $130,000. (4) Mr. Pulley was hired in October 1995 at an annual salary of $125,000. AGGREGATED OPTION VALUES FOR FISCAL YEAR ENDED - ------------------------------------------------------------------------------- NUMBER OF UNEXERCISED VALUE OF UNEXERCISED OPTIONS/SARS IN-THE-MONEY OPTIONS/SARS NAME AT DECEMBER 30, 1995 AT DECEMBER 30, 1995($)(1) - ---------------------------------------------------------------------------------------- EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ----------- ------------- ------------- -------------- Steven L. Bock.......... -- 310,226 -- -- Stephen M. O'Hara....... -- 272,773 -- -- (1) There was no public trading market for the Common Stock as of December 30, 1995. Accordingly, no value can be ascribed to these options. 36 STOCK OPTION PLAN The Company has adopted the Plan to attract and retain officers, non- employee directors, employees, and consultants of the Company or any of its subsidiaries or affiliates. The Plan authorizes the purchase of up to 500,000 shares of Common Stock through the grant of stock options and awards of restricted stock. The Company has granted 252,150 options under the Plan to purchase Common Stock at the initial public offering price. An additional 50,000 options may be granted within the first year following the date hereof to new officers, directors, employees or consultants to the Company, with the balance of the options available for issuance thereafter. The Plan will be administered by either the Board of Directors or a committee of two or more non-employee directors ("Administrator"). In general, the Administrator will determine which eligible officers, directors, employees and consultants of the Company may participate in the Plan and the type, extent and terms of the stock option grants and awards of restricted stock. Options granted to employees may be either incentive stock options within the meaning of Section 422 of the Code ("ISOs") or non-ISOs. Each option has a maximum term of ten years from the date of the grant, subject to early termination. The exercise price of any options granted after this Offering shall be equal to the greater of the market price per share of the Common Stock on the date of grant or the initial public offering price. At the discretion of the Administrator, the exercise price of the options may be paid in cash, with shares of Common Stock having a fair market value equal to the option exercise price, or with other property having a fair market value equal to the option exercise price, including other vested but unexercised options. In the event of a change in control, as defined in the Plan, all options will become immediately vested and exercisable and the restrictions with regard to restricted stock will lapse, unless the Administrator provides otherwise. EMPLOYEE BENEFIT PLANS The Company maintains a qualified defined contribution plan, under the provisions of Section 401(k) of the Code, covering substantially all employees. Under the terms of the plan, eligible employees may make contributions up to 15% of pay, subject to statutory limitations. Contributions not exceeding 5% of an employee's pay are matched 40% by the Company. The Company may, at its discretion, make an additional year-end contribution. Employee contributions are always fully vested. Company contributions vest 20% for each completed year of service, becoming fully vested after five years of service. Matching contributions by the Company under the plan were $47,520, $59,594 and $67,188 in 1993, 1994 and 1995, respectively. No discretionary contributions have been made to the plan. The Company established a supplemental defined contribution plan in 1994. Only senior employees who have not been granted stock options participate in the plan. Under the terms of the plan, these employees may elect to defer up to 50% of any bonus paid for that year. The Company matches 100% of all amounts deferred. In addition, the Company pays interest on all outstanding balances at the prime rate as reported in the Wall Street Journal, but not in excess of 12%. A participant's rights to the deferred amount of regular bonus and income thereon is fully vested and nonforfeitable at all times. A participant's right to the Company's match becomes fully vested and nonforfeitable in cumulative increments of 20% on each of the first through fifth anniversaries of the year end of the year in which the bonus was earned. The total cost of this plan to the Company was $0, $65,000 and $0, in 1993, 1994 and 1995, respectively. As of the date hereof there is $70,000 in accrued and payable bonuses under the plan. The $65,000 contributed in 1994 initiated the plan. The supplemental defined contribution plan will be terminated upon this Offering. COMPENSATION OF DIRECTORS Each current non-employee director is paid annual cash compensation of $7,500, payable quarterly, and has received options to purchase 2,500 shares of Common Stock. These options were issued pursuant to the Plan on the date hereof and are immediately exercisable at the initial public offering price. All directors are reimbursed for expenses incurred on behalf of the Company. BOARD COMMITTEES The Board of Directors has established an Audit Committee comprised of Messrs. Samuel L. Katz, Alan S. Cooper and Martin E. Franklin. Mr. Katz serves as chairman of the committee. The Audit Committee is 37 responsible for recommending to the Board of Directors the appointment of the Company's outside auditors, examining the results of audits, reviewing internal accounting controls and reviewing related party transactions. The Board of Directors has also established a Compensation and Options Committee consisting of Messrs. Cooper and Franklin. Mr. Cooper serves as chairman of this committee. The Company's executive officers are appointed annually by, and serve at the discretion of, the Board of Directors. All directors hold office until the next annual meeting of the Company or until their successors have been duly elected or qualified. There are no family relationships among any of the executive officers or directors of the Company. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION During the year ended December 30, 1995, the Company did not have a compensation committee, and all deliberations concerning executive officer compensation for each entity were had, and all determinations with respect thereto were made, by the Company's Board of Directors. During such period, Mr. Bock was an executive officer and director of the Company. 38 PRINCIPAL STOCKHOLDERS The table below sets forth certain information regarding the beneficial ownership as of the date hereof and as adjusted to reflect the sale of Common Stock offered hereby, by (i) each person known by the Company to own beneficially five percent or more of the Common Stock, (ii) each of the Company's directors, (iii) each of the Named Officers and (iv) all directors and executive officers as a group. Except as otherwise indicated, (x) the Company believes that each of the beneficial owners of the Common Stock listed in the table, based on information furnished by such owner, has sole investment and voting power with respect to such shares, and (y) the address of the beneficial owner is the address of the principal executive offices of the Company. The information set forth in the table and accompanying footnotes has been furnished by the named beneficial owners. PERCENTAGE(1) ----------------- NUMBER OF SHARES BENEFICIALLY BEFORE AFTER NAME OWNED OFFERING OFFERING - ---- ------------ -------- -------- Steven L. Bock................................. 409,160(2) 11.7% 8.2% Stephen M. O'Hara.............................. 218,218(3) 6.4% 4.4% J. William Heise............................... -- -- -- Jerral R. Pulley............................... -- -- -- Alan S. Cooper................................. 2,500 * * Dickstein Partners 9 West 57th Street New York, New York 10019 Guy Naggar..................................... 2,500(4) * * Dawnay, Day & Co., Ltd 15 Grosvenor Gardens London, England SW1W09D Samuel L. Katz................................. 93,075(4) 2.9% 2.0% HFS, Incorporated 339 Jefferson Road Parsippany, New Jersey 07054 Martin Franklin................................ 230,688(5) 6.7% 4.7% 555 Theodore Fremd Avenue Rye, New York 10580 Dickstein & Co., L.P........................... 1,347,689(6) 42.1% 28.7% 9 West 57th Street New York, New York 10019 Dickstein International Limited................ 1,347,689(6) 42.1% 28.7% 129 Front Street Hamilton, Bermuda Dickstein Focus Fund L.P....................... 1,347,689(6) 42.1% 28.7% 9 West 57th Street New York, New York 10019 Viking Holdings Limited........................ 1,483,553(7) 46.3% 31.6% c/o Abacus Secretaries (Jersey Limited) Limited La Motte Chambers St. Helier, Jersey JE1 1BS Channel Islands All executive officers and directors as a group (8 persons)................................... 956,141(8) 24.1% 17.5% - -------- * Less than 1% 39 (1) Applicable percentage of ownership is based upon 3,201,666 shares of Common Stock outstanding before this Offering and 4,701,666 shares outstanding after this Offering. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission ("Commission") and generally includes voting and investment power with respect to securities. Shares of Common Stock issued upon the exercise of options and warrants currently exercisable or exercisable within 60 days are deemed outstanding for computing the percentage ownership of the person holding such options or warrants, but are not deemed outstanding for computing the percentage ownership of any other person. (2) Includes 310,226 shares of Common Stock underlying stock options which become exercisable upon the consummation of this Offering at a price of $0.31 per share. Excludes 75,000 shares of Common Stock underlying stock options granted outside of the Plan which are not currently exercisable at a price of $5.33 per share and 75,000 shares of Common Stock underlying stock options granted under the Plan which are not currently exercisable at an exercise price per share equal to the initial public offering price. All of Mr. Bock's options which are not currently exercisable vest in increments of 20% per year, commencing on the first anniversary of the date hereof. (3) Includes 218,218 shares of Common Stock underlying stock options which are immediately exercisable at a price of $0.31 per share. Excludes 54,555 shares of Common Stock underlying options granted outside of the Plan exercisable on the first anniversary of the date hereof at a price of $0.31 per share, and 25,000 shares of Common Stock underlying stock options granted under the Plan which vest in increments of 20% per year, commencing on the first anniversary of the date hereof at an exercise price per share equal to the initial public offering price. (4) Includes 2,500 shares of Common Stock underlying stock options issued under the Plan which are immediately exercisable at an exercise price per share equal to the initial public offering price. (5) Includes 228,188 shares of Common Stock issuable upon exercise of Warrants and 2,500 shares of Common Stock underlying stock options issued under the Plan which are immediately exercisable. Does not include 37,147 shares of Common Stock issuable upon the exercise of Warrants held by Mr. Franklin's associates. (6) Of the 1,347,689 total shares reported, Dickstein & Co., L.P. owns beneficially 853,153 of such shares, Dickstein Focus Fund L.P. owns beneficially 135,881 of such shares and Dickstein International owns beneficially 358,655 of such shares. Dickstein & Co., L.P. disclaims beneficial ownership of 135,881 shares owned by Dickstein Focus Fund L.P. and 358,655 shares owned by Dickstein International Limited. Dickstein Focus Fund L.P. disclaims beneficial ownership of 853,153 shares owned by Dickstein & Co., L.P. and 358,655 shares owned by Dickstein International Limited. Dickstein International Limited disclaims beneficial ownership of 853,153 shares owned by Dickstein & Co., L.P. and 135,881 shares owned by Dickstein Focus Fund L.P. Dickstein & Co., L.P., Dickstein International Limited and Dickstein Focus Fund L.P. manage investment funds. Dickstein Partners, L.P. is the general partner of Dickstein & Co., L.P. and Dickstein Focus Fund L.P. Dickstein Partners Inc. is the general partner of Dickstein Partners, L.P. and is the advisor to Dickstein International Limited. Mark B. Dickstein is the President and sole director of Dickstein Partners Inc. (7) Viking is a private investment company. The principal beneficial owners of Viking are Guy Naggar (who holds less than 35% of the outstanding voting securities of Viking) and a trust established solely for the benefit of Mr. Naggar's adult children. Mr. Naggar has no voting or investment control with respect to such trust. (8) Includes 766,444 shares of Common Stock underlying stock options which are currently exercisable and Warrants that are held by Martin Franklin but excludes 266,702 shares underlying options which are not currently exercisable and Warrants which are held by Mr. Franklin's associates. 40 CERTAIN TRANSACTIONS As part of the Plan of Reorganization: (i) Mr. Bock acquired for $30,000 98,934 shares of the Company's Common Stock; (ii) Dickstein & Co. acquired for $2,184,000 867,786 shares of the Company's Common Stock, 7,272 shares of the Company's 13% Preferred Stock and Subordinated Indebtedness in the principal amount of $1,190,000; (iii) Dickstein International acquired for $1,092,000 433,893 shares of the Company's Common Stock, 3,636 shares of the Company's 13% Preferred Stock and Subordinated Indebtedness in the principal amount of $595,000; and (iv) Viking Holdings Limited acquired for $2,626,000 and the forgiveness of a $650,000 note receivable 1,301,680 shares of the Company's Common Stock, 10,908 shares of the Company's 13% Preferred Stock and Subordinated Indebtedness in the principal amount of $1,785,000. All of the Subordinated Indebtedness was transferred to SC Holdings L.L.C. shortly after completion of the Plan of Reorganization. The owners of SC Holdings L.L.C. control the majority of the outstanding Common Stock. In February 1993, the Bankruptcy Court and SC Corporation agreed to lift the stay and permit Signal to sell Stork for $950,000 to a group of investors which included Viking and Steven Bock. In November 1994, Messrs. Bock and O'Hara received stock options to purchase 310,226 shares and 272,773 shares, respectively, of Common Stock at an exercise price of $0.31 per share. On April 28, 1995, the common stock of the Company was reclassified into three classes, Class A, Class B and Class C. The different classes of common stock had different voting rights, with Class A, Class B, and Class C having voting rights of one vote, one-half vote and one and one-half votes, respectively, per share. Except for the different voting rights, the Class A, Class B and Class C common stock had identical rights. As of the date hereof the Class A, Class B and Class C common stock has been reclassified into Common Stock. On June 1, 1996, the Company entered into an agreement with Martin Franklin, a director of the Company, and two associates of Mr. Franklin, pursuant to which Mr. Franklin and his associates loaned the Company $495,000 in Junior Subordinated Indebtedness. The Junior Subordinated Indebtedness has the same interest rate as the Subordinated Indebtedness, 11.5% per annum, except that it is junior in priority to the Subordinated Indebtedness. The Junior Subordinated Indebtedness is due on August 12, 1999. In connection with the Junior Subordinated Indebtedness, the Company has issued for $5,000 to Mr. Franklin and his associates the Warrants to purchase 265,335 shares of Common Stock. The Warrants are exercisable until September 30, 1999 to purchase Common Stock at a price of $1.88 per share. In August 1996, Messrs. Bock, O'Hara, Heise and Pulley received stock options pursuant to the Plan to purchase 75,000, 25,000, 30,000 and 12,500 shares of Common Stock, respectively, at a price equal to the initial public offering price. On October 3, 1996, the Company converted all of the outstanding 13% Preferred Stock into 375,000 shares of Common Stock. The holders of the 13% Preferred Stock, Dickstein & Co., L.P., Dickstein International, Dickstein Focus Fund, Viking, Mark Brodsky, Samuel Katz and Wigs L.P., received 121,248, 43,969, 16,655, 181,873, 5,552, 11,104 and 11,254 shares of Common Stock respectively. Effective upon the date hereof, Mr. Bock has received non-qualified options to purchase 75,000 shares of Common Stock at a price of $5.33 per share. Options to purchase 15,000 shares of Common Stock will vest each year for five years, subject to accelerated vesting under certain circumstances. These options will be exercisable for a period of ten years from the date of grant. DESCRIPTION OF SECURITIES The authorized capital stock of the Company is 11,000,000 shares, consisting of 10,000,000 shares of Common Stock, $.01 par value per share and 1,000,000 shares of Preferred Stock, $1.00 par value per share. As of the date hereof there are 3,201,666 shares of Common Stock outstanding. After the completion of this Offering there will be 4,701,666 shares of Common Stock outstanding. As of the date hereof no shares of Preferred Stock are outstanding. 41 COMMON STOCK The holders of shares of Common Stock are entitled to one vote for each share held of record on all matters to be voted on by stockholders. There is no cumulative voting with respect to the election of directors, with the result that the holders of more than 50% of the shares voted can elect all of the directors then being elected. The holders of Common Stock are entitled to receive dividends when, as and if declared by the Board of Directors out of funds legally available therefor. In the event of liquidation, dissolution or winding up of the Company, the holders of Common Stock are entitled to share ratably in all assets remaining available for distribution to them after payment of liabilities and after provision has been made for each class of stock, if any, having preference over the Common Stock. Holders of shares of Common Stock, as such, have no redemption, preemptive or other subscription rights, and there are no conversion provisions applicable to the Common Stock. All of the outstanding shares of Common Stock are, and the shares of Common Stock offered hereby, when issued and paid for as set forth in this Prospectus, will be, fully paid and nonassessable. PREFERRED STOCK The Company's authorized shares of Preferred Stock may be issued in one or more series, and the Board of Directors is authorized, without further action by the stockholders, for any reason and at any time, to designate the rights, preferences, limitations and restrictions of and upon shares of each series, including dividend, voting, redemption and conversion rights. The Board of Directors also may designate par value, preferences in liquidation and the number of shares constituting any series. The Company believes that the availability of Preferred Stock issuable in series will provide increased flexibility for structuring possible future financings and acquisitions, if any, and in meeting other corporate needs. It is not possible to state the actual effect of the authorization and issuance of any series of Preferred Stock upon the rights of holders of Common Stock until the Board of Directors determines the specific terms, rights and preferences of a series of Preferred Stock. However, such effects might include, among other things, restricting dividends on the Common Stock, diluting the voting power of the Common Stock, or impairing liquidation rights of such shares without further action by holders of the Common Stock. In addition, under various circumstances, the issuance of Preferred Stock may have the effect of facilitating, as well as impeding or discouraging, a merger, tender offer, proxy contest, the assumption of control by a holder of a large block of the Company's securities or the removal of incumbent management. Issuance of Preferred Stock could also adversely affect the market price of the Common Stock. The Company has no present plans to issue any shares of Preferred Stock. WARRANTS In connection with the Junior Subordinated Indebtedness, the Company has issued for $5,000 to Mr. Franklin and his associates the Warrants to purchase 265,335 shares of Common Stock. The Warrants are exercisable until September 30, 1999 at an exercise price of $1.88 per share. INDEMNIFICATION OF OFFICERS AND DIRECTORS As permitted by the DGCL, the Company's Certificate of Incorporation, as amended, limits the personal liability of a director or officer to the Company for monetary damages for breach of fiduciary duty of care as a director. Liability is not eliminated for (i) any breach of the director's duty of loyalty to the Company or its stockholders, (ii) acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) unlawful payment of dividends or stock purchases or redemptions pursuant to Section 174 of the DGCL, or (iv) any transaction from which the director derived an improper personal benefit. The Company has also entered into indemnification agreements with each of its directors and executive officers. The indemnification agreements provide that the directors and executive officers will be indemnified to the fullest extent permitted by applicable law against all expenses (including attorneys' fees), judgments, fines and amounts reasonably paid or incurred by them for settlement in any threatened, pending or completed action, suit or proceeding, including any derivative action, on account of their services as a director or officer of the Company or of any subsidiary of the Company or of any other company or enterprise in which they are serving 42 at the request of the Company. No indemnification will be provided under the indemnification agreements, however, to any director or executive officer in certain limited circumstances, including on account of knowingly fraudulent, deliberately dishonest or willful misconduct. To the extent the provisions of the indemnification agreements exceed the indemnification permitted by applicable law, such provisions may be unenforceable or may be limited to the extent they are found by a court of competent jurisdiction to be contrary to public policy. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers, and controlling persons of the Company pursuant to the foregoing provisions, or otherwise, the Company has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. DELAWARE LAW The Company is subject to Section 203 of the DGCL, which prevents an "interested stockholder" (defined in Section 203, generally, as a person owning 15% or more of a corporation's outstanding voting stock) from engaging in a "business combination" with a publicly-held Delaware corporation for three years following the date such person became an interested stockholder, unless: (i) before such person became an interested stockholder, the board of directors of the corporation approved the transaction in which the interested stockholder became an interested stockholder or approved the business combination; (ii) upon consummation of the transaction that resulted in the interested stockholder's becoming an interested stockholder, the interested stockholder owns at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced (subject to certain exceptions); or (iii) following the transaction in which such person became an interested stockholder, the business combination is approved by the Board of Directors of the corporation and authorized at a meeting of stockholders by the affirmative vote of the holders of 66% of the outstanding voting stock of the corporation not owned by the interested stockholder. A "business combination" includes mergers, stock or asset sales and other transactions resulting in a financial benefit to the interested stockholder. The provisions of Section 203 of the DGCL could have the effect of delaying, deferring or preventing a change in control of the Company. SHAREHOLDERS' AGREEMENT All of the existing holders of Common Stock and options to purchase Common Stock are parties to a Shareholders' Agreement dated November 30, 1994 which will terminate upon the completion of this Offering. This agreement (i) prohibits the sale, pledge, transfer or disposal of shares of Common Stock prior to the earlier of November 24, 1997 or the date on which the Company shall have fully utilized its Federal income tax NOL's ("Ownership Change Date") and (ii) restricts the sale, pledge, transfer or disposal of shares of Common Stock subsequent to the Ownership Change Date. The Shareholders' Agreement terminates on the earliest of (i) the date of dissolution or liquidation of the Company, (ii) such time as any one shareholder or other person owns all the shares of Common Stock, (iii) the date of the consummation of a public offering of Common Stock under the Securities Act or (iv) such time as all the parties to the Shareholders' Agreement elect to terminate such agreement. The Shareholders' Agreement provides for Dickstein & Co., L.P., Dickstein International Limited and Dickstein Focus Fund, L.P. (collectively "Dickstein") and Viking each to appoint two Directors. Dickstein has appointed Messrs. Cooper and Katz to the Board and Viking has appointed Messrs. Franklin and Naggar to the Board. TRANSFER AGENT The transfer agent for the Common Stock is Continental Stock Transfer & Trust Company, New York, New York. 43 SHARES ELIGIBLE FOR FUTURE SALE Upon completion of this Offering, the Company will have 4,701,666 shares of Common Stock outstanding, not including shares of Common Stock issuable upon exercise of the Officer's Options, Warrants and Underwriter's Purchase Option and assuming no exercise of the over-allotment option granted to the Underwriter and options outstanding under the Plan. Of these outstanding shares, the 1,500,000 shares sold to the public in this Offering may be freely traded without restriction or further registration under the Securities Act, except that any shares that may be held by an "affiliate" of the Company (as that term is defined in the rules and regulations under the Securities Act) may be sold only pursuant to a registration under the Securities Act or pursuant to an exemption from registration under the Securities Act including the exemption provided by Rule 144 adopted under the Securities Act. 3,201,666 shares of Common Stock are "restricted securities" as that term is defined in Rule 144 under the Securities Act ("Restricted Shares"), and may not be sold unless such sale is registered under the Securities Act, or is made pursuant to an exemption from registration under the Securities Act, including the exemption provided by Rule 144. Of such shares, 3,065,803 will be available for sale pursuant to Rule 144 commencing January 14, 1997, and 135,863 will be available for sale pursuant to Rule 144 commencing February 1998, in each case subject to the lock-up agreements described below. In general, under Rule 144 as currently in effect, a stockholder (or stockholders whose shares are aggregated) who has beneficially owned any Restricted Shares for at least two years (including a stockholder who may be deemed to be an affiliate of the Company), will be entitled to sell, within any three-month period, that number of shares that does not exceed the greater of (i) 1% of the then outstanding shares of Common Stock or (ii) the average weekly trading volume of the Common Stock during the four calendar weeks preceding the date on which notice of such sale is given to the Commission provided certain public information, manner of sale and notice requirements are satisfied. A stockholder who is deemed to be an affiliate of the Company, including members of the Board of Directors and senior management of the Company, will still need to comply with the restrictions and requirements of Rule 144, other than the two-year holding period requirement, in order to sell shares of Common Stock that are not Restricted Securities, unless such sale is registered under the Securities Act. A stockholder (or stockholders whose shares are aggregated) who is deemed not to have been an affiliate of the Company at any time during the 90 days preceding a sale by such stockholder, and who has beneficially owned Restricted Shares for at least three years, will be entitled to sell such shares under Rule 144 without regard to the volume limitations described above. The Commission is currently considering a reduction in the required holding periods under Rule 144. No predictions can be made of the effect, if any, that future sales of shares of the availability of shares for sale will have on the market price prevailing from time to time. Nevertheless, sales of substantial amounts of the Common Stock in the public market could adversely affect the then- prevailing market price. All of the officers and directors of the Company and all other stockholders of the Company immediately prior to the effective date have agreed that for a period of 12 months from the date of this Prospectus they will not sell any of such shares without the consent of the Underwriter; provided, however, that such prohibition extends for a period of only six months from the date of this Prospectus with respect to the 375,000 shares of Common Stock acquired in the Preferred Conversion. In addition, any employee, officer or director of or consultant to the Company who purchased his or her shares pursuant to a written compensatory plan or contract may be entitled to rely on the resale provisions of Rule 701 under the Securities Act ("Rule 701"). Rule 701 permits affiliates to sell their shares which are subject to Rule 701 ("Rule 701 shares") under Rule 144 without complying with the holding period requirements of Rule 144. Rule 701 further provides that non-affiliates may sell Rule 701 shares in reliance on Rule 144 without having to comply with the public information, volume limitation or notice provisions of Rule 144. In both cases, a holder of Rule 701 shares is required to wait until 90 days after the date of this Prospectus. All holders of stock options under the Plan have agreed not to dispose of Rule 701 shares for a period of 12 months from the date of this Prospectus without the consent of the Underwriter. 44 REGISTRATION RIGHTS The Company has entered into a registration rights agreement with all of its current stockholders. Under this registration rights agreement, the Company has provided to each of Dickstein and Viking, for so long as it owns at least 15% of the outstanding Common Stock, a "demand" registration right whereby each of Dickstein and Viking can, with certain restrictions, on one occasion require the Company to register under the Securities Act the Company's equity securities it holds. All of the stockholders and the holders of the Warrants have "piggyback" registration rights whereby each of them can, with certain restrictions, require the Company to include the Company's equity securities it holds in any registration statement filed by the Company. The Company will pay all registration expenses related to any demand registration excluding underwriting commissions. The Company will pay all of the expenses relating to the registrations, other than underwriting discounts and commissions. In connection with this Offering, the current stockholders have agreed not to exercise their registration rights for a period of one year following this Offering without the prior written consent of the Underwriter. The Company will register securities pursuant to the Registration Rights Agreement on Form S-3 or any other available form. The Company intends to file one or more registration statements on Form S-8 under the Securities Act to register approximately 500,000 shares underlying options granted or to be granted under the Plan for resale under the Securities Act. The Company has agreed with the Underwriter that it will not file any Form S-8 registration statement for one year following the date of this Prospectus. Shares covered by these registration statements will thereupon be eligible for sale in the public markets to the extend applicable. UNDERWRITING GKN Securities Corp. ("Underwriter") has agreed, subject to the terms and conditions of the Underwriting Agreement, to purchase from the Company a total of 1,500,000 shares of Common Stock. The obligations of the Underwriter under the Underwriting Agreement are subject to approval of certain legal matters by counsel and various other conditions precedent, and the Underwriter is obligated to purchase all of the shares of Common Stock offered by this Prospectus (other than the shares of Common Stock covered by the over- allotment option described below), if any are purchased. The Underwriter has advised the Company that it proposes to offer the shares of Common Stock to the public at the initial public offering price set forth on the cover page of this Prospectus and to certain dealers at that price less a concession not in excess of $0.31 per share of Common Stock. The Underwriter may allow, and such dealers may reallow, a concession not in excess of $0.10 per share of Common Stock to certain other dealers. After this Offering, the offering price and other selling terms may be changed by the Underwriter. The Company has agreed to indemnify the Underwriter against certain liabilities, including liabilities under the Securities Act. The Company has also agreed to pay to the Underwriter an expense allowance on a nonaccountable basis equal to 2.5% of the gross proceeds derived from the sale of the shares of Common Stock underwritten (including the sale of any shares of Common Stock subject to the Underwriter's over-allotment option), $50,000 of which has been paid to date. The Company also has agreed to pay all expenses in connection with qualifying the shares of Common Stock offered hereby for sale under the laws of such states as the Underwriter may designate and registering this Offering with the National Association of Securities Dealers, Inc., including fees and expenses of counsel retained for such purposes by the Underwriter. The Company has granted to the Underwriter an option, exercisable during the 45-day period after the date of this Prospectus, to purchase from the Company at the offering price, less underwriting discounts and the non-accountable expense allowance, up to an aggregate of 225,000 additional shares of Common Stock for the sole purpose of covering over-allotments, if any. 45 In connection with this Offering, the Company has agreed to sell to the Underwriter, for an aggregate of $100, the Underwriter's Purchase Option to purchase up to an aggregate of 150,000 shares of Common Stock at a price of $7.15 per share, for a period of four years, commencing on the first and ending on the fifth anniversary of the effective date of this Offering. The Underwriter's Purchase Option may not be transferred, sold, assigned or hypothecated during the one-year period following the date of this Prospectus except to officers of the Underwriter and the selected dealers and their officers or partners. The Underwriter's Purchase Option grants to the holders thereof certain "piggyback" and demand rights for periods of seven and five years, respectively, from the date of this Prospectus with respect to the registration under the Securities Act of the shares issuable upon exercise of the Underwriter's Purchase Option. Pursuant to the Underwriting Agreement, all of the officers, directors and stockholders of the Company as of the date of this Prospectus have agreed not to sell any of their shares of Common Stock until the expiration of 12 months from the date of this Prospectus without the prior consent of the Underwriter, provided, however, that holders of 375,000 shares of Common Stock issued in the Preferred Conversion shall be permitted to sell such shares commencing six months after the effective date of this Offering. During the three year period following the date of this Prospectus, the Underwriter shall have the right to purchase for the Underwriter's account or to sell for the account of such persons any securities sold by any of such persons in the open market. The Underwriting Agreement provides that, for a period of three years from the date of this Prospectus, the Underwriter may send a non-voting representative to observe each meeting of the Board of Directors. Prior to this Offering, there has been no public market for any of the Company's Common Stock. Accordingly, the initial public offering price of the Common Stock has been arbitrarily determined by negotiation between the Company and the Underwriter and does not necessarily bear any relation to established valuation criteria. Factors considered in determining such price, in addition to prevailing market conditions, include an assessment of the prospects for the industry in which the Company competes, the Company's management and the Company's capital structure. LEGAL MATTERS The legality of the securities offered hereby will be passed upon for the Company by Kane Kessler, P.C., New York, New York. Graubard Mollen & Miller, New York, New York, has served as counsel to the Underwriter in connection with this Offering. EXPERTS The consolidated financial statements as of December 30, 1995, December 31, 1994 and January 1, 1994 and for each of the three years in the period ended December 30, 1995 included in this Prospectus have been audited by Deloitte & Touche LLP, independent auditors, as stated in their reports appearing herein and elsewhere. Such consolidated financial statements have been included herein in reliance upon the reports of such firm given upon their authority as experts in auditing and accounting. 46 AVAILABLE INFORMATION The Company has filed with the Commission a registration statement ("Registration Statement") under the Securities Act with respect to the Securities offered hereby. This Prospectus does not contain all of the information set forth in the Registration Statement and the exhibits thereto, certain portions having been omitted from this Prospectus in accordance with the rules and regulations of the Commission. For further information with respect to the Company, the securities offered by this Prospectus and such omitted information, reference is made to the Registration Statement, including any and all exhibits and amendments thereto. Statements contained in this Prospectus concerning the provisions of any documents filed as an exhibit are of necessity brief descriptions thereof and are not necessarily complete, and in each instance reference is made to the copy of the document filed as an exhibit to the Registration Statement, each such statement being qualified in its entirety by this reference. Following the effectiveness of the Registration Statement, the Company will be subject to the informational requirements of the Securities Exchange Act of 1934, as amended, and in accordance therewith will file reports, proxy statements and other information with the Commission. Such reports, proxy statements and other information may be inspected and copied at the public reference facilities of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549; Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661; and 7 World Trade Center, New York, New York 10048. Copies of such material, including the Registration Statement, can be obtained from the Public Reference Section of the Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. The Commission also maintains a site on the World Wide Web that contains reports, proxy and information statements and other information regarding registrants that file electronically. The address of such site is http://www.sec.gov. The Company intends to furnish its stockholders with annual reports containing audited financial statements, quarterly reports containing unaudited financial information and such other periodic reports as the Company may determine to be appropriate or as may be required by law. 47 SPECIALTY CATALOG CORP. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PAGE ---- Independent Auditors' Report............................................. F-2 Financial Statements as of December 30, 1995 and December 31, 1994 and for the Three Years Ended December 30, 1995, December 31, 1994 and January 1, 1993 Unaudited Financial Statements as of June 29, 1996 and for the Six Months Ended June 29, 1996 and July 1, 1995: Consolidated Balance Sheets............................................ F-3 Consolidated Statements of Operations.................................. F-4 Consolidated Statements of Stockholders' Deficit....................... F-5 Consolidated Statements of Cash Flows.................................. F-6 Notes to Consolidated Financial Statements............................. F-8 F-1 INDEPENDENT AUDITORS' REPORT The accompanying consolidated financial statements give effect to the completion of the 325.51-for-one split of the Company's outstanding common stock which will take place on the effective date of the offering. The following report is in the form which will be furnished by Deloitte & Touche on completion of the stock split of the Company's common stock described in Note 15 to the consolidated financial statements and assuming that from August 16, 1996 to the date of such completion no other material events have occurred that would affect the accompanying consolidated financial statements or required disclosure therein. To the Board of Directors of Specialty Catalog Corp. We have audited the accompanying consolidated balance sheets of Specialty Catalog Corp. as of December 30, 1995 and December 31, 1994 and the related consolidated statements of operations and consolidated statements of stockholders' deficit and cash flows for the three years ended December 30, 1995, December 31, 1994 and January 1, 1994. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Specialty Catalog Corp. as of December 30, 1995 and December 31, 1994 and the results of its operations and its cash flows for the three years ended December 30, 1995, December 31, 1994 and January 1, 1994, in conformity with generally accepted accounting principles. April 19, 1996 (except for Note 15, for which the date is August 16, 1996) New York, New York F-2 SPECIALTY CATALOG CORP. CONSOLIDATED BALANCE SHEETS PRO FORMA DECEMBER 31, DECEMBER 30, JUNE 29, JUNE 29, 1994 1995 1996 1996 ------------ ------------ ------------ ------------ (UNAUDITED) ASSETS Current assets: Cash................... $ 946,280 $ 113,364 $ 864,176 $ 1,364,176 Accounts receivable, less allowance for doubtful accounts of $42,000, $160,000 and $51,000 at December 31, 1994, December 30, 1995 and June 29, 1996, respectively.... 579,148 1,367,929 1,138,469 1,138,469 Inventories............ 4,221,266 5,073,743 4,090,560 4,090,560 Prepaid expenses....... 3,174,543 3,462,818 3,586,891 3,586,891 ------------ ------------ ------------ ------------ Total current assets.... 8,921,237 10,017,854 9,680,096 10,180,096 ------------ ------------ ------------ ------------ Fixed assets: Property and equipment. 3,787,949 3,982,348 4,118,407 4,118,407 Less accumulated depreciation and amortization.......... (3,011,164) (3,040,751) (3,178,992) (3,178,992) ------------ ------------ ------------ ------------ Total fixed assets...... 776,785 941,597 939,415 939,415 ------------ ------------ ------------ ------------ Deferred income taxes... 7,130,175 6,779,356 6,779,356 6,779,356 ------------ ------------ ------------ ------------ Other assets............ 536,154 431,553 377,857 377,857 ------------ ------------ ------------ ------------ Total assets............ $ 17,364,351 $ 18,170,360 $ 17,776,724 $ 18,276,724 ============ ============ ============ ============ LIABILITIES AND STOCK- HOLDERS' DEFICIT Current liabilities: Line of credit......... $ -- $ 1,050,000 $ 1,450,000 $ 1,450,000 Accounts payable and accrued expenses...... 2,928,018 4,730,936 4,601,486 4,601,486 Liabilities to customers............. 1,267,752 755,902 630,800 630,800 Income taxes........... 111,450 81,945 232,930 232,930 Current portion of long-term debt........ 2,500,000 2,750,000 2,950,000 2,950,000 ------------ ------------ ------------ ------------ Total current liabili- ties................... 6,807,220 9,368,783 9,865,216 9,865,216 ------------ ------------ ------------ ------------ Long-term debt.......... 11,500,000 8,750,000 7,450,000 7,450,000 Subordinated debt-re- lated party............ 3,680,186 4,125,519 4,362,735 4,743,674 Other long-term liabili- ties................... 31,241 341,939 511,542 -- Commitments and contin- gencies Stockholders' deficit: 13% preferred stock, $100 par value: 30,000 shares authorized; 22,491 shares issued and outstanding....... 2,249,100 2,249,100 2,249,100 Common stock, $.01 par value: 10,000,000 shares authorized; 2,826,666 shares is- sued and outstanding at December 31, 1994.. 28,267 32,017 Class A common stock, $.01 par value; 16,000 shares authorized; 6,017.77 shares issued and outstanding at De- cember 30, 1995....... -- 19,589 19,589 Class B common stock, $.01 par value; 2,000 shares authorized; 1,332.94 shares issued and outstanding at De- cember 30, 1995....... -- 4,339 4,339 Class C common stock, $.01 par value; 2,000 shares authorized; 1,332.94 shares issued and outstanding at De- cember 30, 1995....... -- 4,339 4,339 Additional paid-in cap- ital.................. 4,934,157 4,641,774 4,495,586 7,459,289 Deferred compensation... -- -- -- (87,750) Note receivable--stock- holder................. (148,710) (140,174) (140,174) (140,174) Accumulated deficit..... (11,717,110) (11,194,848) (11,045,548) (11,045,548) ------------ ------------ ------------ ------------ Total stockholders' def- icit................... (4,654,296) (4,415,881) (4,412,769) (3,782,166) ------------ ------------ ------------ ------------ Total liabilities and stockholders' deficit.. $ 17,364,351 $ 18,170,360 $ 17,776,724 $ 18,276,724 ============ ============ ============ ============ See notes to consolidated financial statements. F-3 SPECIALTY CATALOG CORP. CONSOLIDATED STATEMENTS OF OPERATIONS FISCAL YEAR ENDED SIX MONTHS ENDED --------------------------------------- ------------------------ JANUARY 1, DECEMBER 31, DECEMBER 30, JULY 1, JUNE 29, 1994 1994 1995 1995 1996 ----------- ------------ ------------ ----------- ----------- (UNAUDITED) Net sales............... $33,801,265 $38,178,792 $42,568,120 $22,419,386 $18,754,741 Cost of sales (including buying, occupancy and order fulfillment costs)................. 13,867,938 15,648,066 16,423,590 8,859,075 7,003,241 ----------- ----------- ----------- ----------- ----------- Gross profit............ 19,933,327 22,530,726 26,144,530 13,560,311 11,751,500 ----------- ----------- ----------- ----------- ----------- Operating expenses: Selling, general and administrative expenses.............. 16,767,738 17,771,721 22,835,086 11,155,582 10,590,938 Restructuring charges.. -- -- 512,943 512,943 -- ----------- ----------- ----------- ----------- ----------- Total operating ex- penses................. 16,767,738 17,771,721 23,348,029 11,668,525 10,590,938 ----------- ----------- ----------- ----------- ----------- Income from operations.. 3,165,589 4,759,005 2,796,501 1,891,786 1,160,562 ----------- ----------- ----------- ----------- ----------- Interest expense--net... (431,322) (661,022) (1,917,664) (958,197) (909,216) ----------- ----------- ----------- ----------- ----------- Income before reorganization items, income taxes, cumulative effect of change in accounting principle and extraordinary item..... 2,734,267 4,097,983 878,837 933,589 251,346 Reorganization items.... 1,037,979 2,889,707 -- -- -- ----------- ----------- ----------- ----------- ----------- Income before income taxes, cumulative effect of change in accounting principle and extraordinary item. 1,696,288 1,208,276 878,837 933,589 251,346 Income taxes............ 704,017 497,954 356,575 379,037 102,046 ----------- ----------- ----------- ----------- ----------- Income before cumulative effect of change in accounting principle and extraordinary item. 992,271 710,322 522,262 554,552 149,300 Cumulative effect of change in accounting for income taxes....... 8,985,122 -- -- -- -- ----------- ----------- ----------- ----------- ----------- Income before extraordi- nary item.............. 9,977,393 710,322 522,262 554,552 149,300 Extraordinary item--gain on debt discharge--net of income taxes of $1,094,649............. -- 12,078,489 -- -- -- ----------- ----------- ----------- ----------- ----------- Net income.............. $ 9,977,393 $12,788,811 $ 522,262 $ 554,552 $ 149,300 ----------- ----------- ----------- ----------- ----------- Preferred stock divi- dends.................. -- (31,241) (292,383) (146,191) (146,188) ----------- ----------- ----------- ----------- ----------- Net income available to common shareholders.... $ 9,977,393 $12,757,570 $ 229,879 $ 408,361 $ 3,112 =========== =========== =========== =========== =========== Per common share Income before extraor- dinary items.......... $ 0.33 $ 0.23 $ 0.08 $ 0.14 $ 0.00 Income from cumulative effect................ 2.98 -- -- -- -- Net income per share.... $ 3.31 $ 4.23 $ 0.08 $ 0.14 $ 0.00 ----------- ----------- ----------- ----------- ----------- Weighted average shares outstanding............ 3,015,078 3,015,078 3,015,078 3,015,078 3,570,523 =========== =========== =========== =========== =========== See notes to consolidated financial statements. F-4 SPECIALTY CATALOG CORP. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT COMMON STOCK CLASS A CLASS B CLASS C PREFERRED STOCK ADDITIONAL -------------------- ----------------- -------------- -------------- ----------------- PAID-IN SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT CAPITAL ---------- -------- --------- ------- ------- ------ ------- ------ ------ ---------- ---------- Balance, January 2, 1993.......... 1,000,000 $ 10,000 -- $ -- -- $ -- -- $ -- -- $ -- $4,115,300 Net income...... -- -- -- -- -- -- -- -- -- -- -- ---------- -------- --------- ------- ------- ------ ------- ------ ------ ---------- ---------- Balance, January 1, 1994.......... 1,000,000 10,000 -- -- -- -- -- -- -- -- 4,115,300 Cancellation of SC Corporation common shares in connection with reorganization and settlement of bankruptcy proceedings..... (1,000,000) (10,000) -- -- -- -- -- -- -- -- 10,000 Issuance of SC Corporation common shares in connection with reorganization and settlement of bankruptcy proceedings..... 868,365 8,684 -- -- -- -- -- -- -- -- 859,681 Issuance of preferred stock. -- -- -- -- -- -- -- -- 22,491 2,249,100 -- Exchange of SC Corporation common shares for Specialty Catalog Corp. common shares at the rate of 1/100 share of Specialty Catalog Corp. stock for each share of SC Corporation common stock for one............. 1,958,301 19,583 -- -- -- -- -- -- -- -- (19,583) Net income...... -- -- -- -- -- -- -- -- -- -- -- Redeemable preferred stock dividends....... -- -- -- -- -- -- -- -- -- -- (31,241) ---------- -------- --------- ------- ------- ------ ------- ------ ------ ---------- ---------- Balance, December 31, 1994......... 2,826,666 28,267 -- -- -- -- -- -- 22,491 2,249,100 4,934,157 Exchange of common shares for Class A, Class B, and Class C shares.. (2,826,666) (28,267) 1,958,880 19,589 433,893 4,339 433,893 4,339 -- -- -- Net income...... -- -- -- -- -- -- -- -- -- -- -- Redeemable preferred stock dividends....... -- -- -- -- -- -- -- -- -- -- (292,383) ---------- -------- --------- ------- ------- ------ ------- ------ ------ ---------- ---------- Balance, December 30, 1995......... -- -- 1,958,880 19,589 433,893 4,339 433,893 4,339 22,491 2,249,100 4,641,774 Net income (unaudited)..... -- -- -- -- -- -- -- -- -- -- -- Redeemable preferred stock dividends (unaudited)..... -- -- -- -- -- -- -- -- -- -- (146,188) ---------- -------- --------- ------- ------- ------ ------- ------ ------ ---------- ---------- Balance, June 29, 1996 (unaudited). -- $ -- 1,958,880 $19,589 433,893 $4,339 433,893 $4,339 22,491 $2,249,100 $4,495,586 ========== ======== ========= ======= ======= ====== ======= ====== ====== ========== ========== ACCUMULATED DEFICIT ------------- Balance, January 2, 1993.......... $(34,483,314) Net income...... 9,977,393 ------------- Balance, January 1, 1994.......... (24,505,921) Cancellation of SC Corporation common shares in connection with reorganization and settlement of bankruptcy proceedings..... Issuance of SC Corporation common shares in connection with reorganization and settlement of bankruptcy proceedings..... Issuance of preferred stock. Exchange of SC Corporation common shares for Specialty Catalog Corp. common shares at the rate of 1/100 share of Specialty Catalog Corp. stock for each share of SC Corporation common stock for one............. Net income...... 12,788,811 Redeemable preferred stock dividends....... -- ------------- Balance, December 31, 1994......... (11,717,110) Exchange of common shares for Class A, Class B, and Class C shares.. Net income...... 522,262 Redeemable preferred stock dividends....... -- ------------- Balance, December 30, 1995......... (11,194,848) Net income (unaudited)..... 149,300 Redeemable preferred stock dividends (unaudited)..... -- ------------- Balance, June 29, 1996 (unaudited). $(11,045,548) ============= See notes to consolidated financial statements. F-5 SPECIALTY CATALOG CORP. CONSOLIDATED STATEMENTS OF CASH FLOWS FISCAL YEAR ENDED SIX MONTHS ENDED --------------------------------------- ------------------------ JANUARY 1, DECEMBER 31, DECEMBER 30, JULY 1, JUNE 29, 1994 1994 1995 1995 1996 ----------- ------------ ------------ ----------- ----------- (UNAUDITED) CASH FLOWS FROM OPERAT- ING ACTIVITIES: Net income............. $ 9,977,393 $ 12,788,811 $ 522,262 $ 554,552 $ 149,300 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Interest paid through issuance of debt...... -- -- 445,333 211,611 237,216 Provision for bad debts................. 26,004 34,180 146,004 12,195 -- Depreciation and amor- tization.............. 776,440 748,628 249,127 116,878 141,536 Deferred income taxes.. 415,004 1,439,943 350,819 -- -- Cumulative effect of change in accounting for income taxes...... (8,985,122) -- -- -- -- Changes in operating assets and liabilities: Accounts receivable... (222,666) 120,860 (934,785) (299,842) 229,460 Inventories........... (1,145,222) (817,280) (852,477) 4,714 983,183 Prepaid expenses...... (1,600,109) (120,628) (288,275) (1,358,709) (124,073) Other assets.......... (205,745) (383,072) 104,935 57,528 53,122 Accounts payable and accrued expenses..... 1,818,219 (1,944,118) 1,802,918 1,265,962 (129,450) Provision for estimated returns.... 104,000 150,299 (356,033) (522,299) (237,138) Other liabilities to customers............ (263,141) (8,654) (155,817) 37,399 112,036 Income taxes.......... (79,971) (43,077) (29,505) 337,984 150,985 Other long-term liabilities.......... -- -- 18,315 5,422 23,415 Change due to reorganization activities: Extraordinary gain on debt discharge....... -- (13,173,138) -- -- -- ----------- ------------ ----------- ----------- ----------- Net cash provided by (used in) operating activities............. $ 615,084 $ (1,207,246) $ 1,022,821 $ 423,395 $ 1,589,592 ----------- ------------ ----------- ----------- ----------- CASH FLOWS FROM INVEST- ING ACTIVITIES: Purchases of property and equipment......... (268,037) (447,919) (413,146) (206,639) (138,780) Repayments of note re- ceivable.............. -- -- 7,409 -- -- ----------- ------------ ----------- ----------- ----------- Net cash used in invest- ing activities......... $ (268,037) $ (447,919) $ (405,737) $ (206,639) $ (138,780) ----------- ------------ ----------- ----------- ----------- CASH FLOWS FROM FINANC- ING ACTIVITIES: Issuance of common stock................. -- 827,042 -- -- -- Issuance of redeemable preferred stock....... -- 2,142,840 -- -- -- Settlement of long-term obligations........... -- (20,237,480) -- -- -- Issuance of long-term debt.................. -- 17,680,186 -- -- -- Repayments of long-term debt.................. -- -- (2,500,000) (500,000) (1,100,000) Advances on line of credit................ 2,972,147 -- 1,050,000 -- 400,000 ----------- ------------ ----------- ----------- ----------- Net cash provided by (used in) financing activities............. $ 2,972,147 $ 412,588 $(1,450,000) $ (500,000) $ (700,000) ----------- ------------ ----------- ----------- ----------- CASH FLOWS FROM REORGA- NIZATION ACTIVITIES: Decrease in obligations subject to settlement under reorganization proceedings........... $(1,495,935) $ -- $ -- $ -- $ -- ----------- ------------ ----------- ----------- ----------- Increase (decrease) in cash................... 1,823,259 (1,242,577) (832,916) (283,244) 750,812 Cash, beginning of year. 365,598 2,188,857 946,280 946,280 113,364 ----------- ------------ ----------- ----------- ----------- Cash, end of year....... $ 2,188,857 $ 946,280 $ 113,364 $ 663,036 $ 864,176 ----------- ------------ ----------- ----------- ----------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for: Interest............... $ 382,754 $ 493,624 $ 1,533,826 $ 712,748 $ 592,851 =========== ============ =========== =========== =========== Income taxes.......... $ 316,837 $ 174,735 $ 35,261 $ 41,053 $ 42,669 =========== ============ =========== =========== =========== See notes to consolidated financial statements. F-6 SUMMARY OF NONCASH TRANSACTIONS: During the six-month periods ended June 29, 1996 and July 1, 1995 and the year ended December 30, 1995, the Company issued $237,216, $211,611 and $445,333 of subordinated debt in lieu of payment of interest. During the six-month periods ended June 29, 1996 and July 1, 1995 and the years ended December 30, 1995 and December 31, 1994, the Company declared dividends on preferred stock of $146,188, $146,191, $292,383 and $31,241 which have not been paid at June 29, 1996. In 1994 the Company received a note in the amount of $147,583 in exchange for common and preferred stock. See notes to consolidated financial statements. F-7 SPECIALTY CATALOG CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 30, 1995, DECEMBER 31, 1994 AND JANUARY 1, 1994 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Business--Specialty Catalog Corp. (the "Company") is a direct marketer targeting niche consumer product categories. SC Corporation, the Company's principal operating subsidiary doing business under the name SC Direct ("SC Direct"), is the leading U.S. retailer of women's wigs and hairpieces. SC Publishing, Inc. ("SC Publishing"), a wholly-owned subsidiary of SC Direct, sells continuing education courses to nurses, real estate professionals and Certified Public Accountants. Principles of Consolidation--The accompanying consolidated financial statements include the accounts of the Company, SC Direct, and SC Publishing. All material intercompany balances and transactions have been eliminated in consolidation. Pro Forma Balance Sheet--The June 29, 1996 pro forma balance sheet gives effect to the conversion of 13% Preferred Stock ("13% Preferred Stock") into 375,000 shares of common stock, the waiver of all accrued dividends and interest on the 13% Preferred Stock, the issuance of the stock options described in note 15 and the issuance of debt and related warrants also described in note 15. Accounts Receivable--The Company records an allowance to provide for uncollectible accounts receivable. This allowance is determined based on the historical rate of bad debts applied to current balances. In 1995 and 1994, the Company had write-offs of accounts receivable against this allowance of $34,221 and $34,180, respectively. Bad debt expense for the years ended December 30, 1995, December 31, 1994 and January 1, 1994 was $146,004, $34,180, and $26,004, respectively. Amounts collected for previously written off accounts are credited to miscellaneous income. Accounting Estimates--The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Inventories--Inventories are stated at the lower of first-in, first-out cost or market. A reserve for obsolete inventory is recorded based on the expected realizable value of merchandise. The cost of inventory includes the cost of merchandise, freight, duty, brokerage fees and marine insurance. Prepaid Expenses--The costs incurred to develop, print and place direct response advertisements to obtain names of potential customers are recorded as prepaid expenses until the time the advertisement is published, mailed or otherwise made available to potential customers. Direct response advertising is capitalized and amortized over the expected period of future benefit, generally two to four months. The adoption of Statement of Principles 93-7, "Reporting on Advertising Costs," did not have a material impact on the calculation of deferred catalog costs since the Company employed a similar methodology in the past. For 1993, 1994, and 1995, advertising expense was $11.6 million, $12.2 million and $16.3 million, respectively. Property and Equipment--Property and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation is computed on the straight-line method over the estimated useful lives of the respective assets. Amortization is computed on the straight-line method over the lesser of the estimated useful lives of the related assets or the lease terms. F-8 SPECIALTY CATALOG CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Other Assets--Trademarks are stated at cost less accumulated amortization. Amortization is computed on a straight-line basis over 37 years. At December 31, 1995 and 1994, the Company had $33,870 and $21,482 of unamortized trademarks included in other assets. Deferred financing costs which were incurred by the Company in connection with the Banque Nationale de Paris ("BNP") note (Note 7) are charged to operations as additional interest expense over the life of the underlying indebtedness using the straight-line method. At December 30, 1995 and December 31, 1994 deferred financing costs were $397,091 and $510,545, respectively. Income Taxes--In 1993, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." SFAS No. 109 requires that deferred income taxes be determined based on the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred income tax assets and liabilities. A valuation allowance is recorded when realization of a deferred tax asset is not assured. In connection with the adoption of this statement, the Company recognized a cumulative effect of $8,985,122 in 1993. Revenue--The Company recognizes sales and the related costs of sales at the time the merchandise is shipped to customers. The Company allows for merchandise returns at the customer's discretion within the period stated in the Company's sales policy. An allowance is provided for returns based on historical return rates applied to recent shipments. Fair Value of Financial Instruments--SFAS No. 107, "Disclosures About Fair Value of Financial Instruments," requires disclosure of the fair value of financial instruments, both assets and liabilities recognized and not recognized in the consolidated balance sheet of the Company, for which it is practicable to estimate fair value. The estimated fair value of financial instruments which are presented herein have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required in interpreting market data to develop estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of amounts the Company could realize in a current market exchange. The fair value of the Company's cash and cash equivalents, accounts receivable, accounts payable, and line of credit approximate their carrying values at December 30, 1995, due to the short-term maturities of these investments. The carrying value and fair value of the Company's note receivable at December 30, 1995 was $140,174. The fair value of the note receivable is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The fair value of the Company's long-term debt at December 30, 1995 was $15,636,397. The carrying value of the Company's long term debt at December 30, 1995 was $15,625,519. The fair value of the Company's long-term debt is based on discounted future cash flows using current interest rates for financial instruments with similar characteristics and maturity. Net Income Per Share--Net income per share is calculated using the weighted average number of common shares outstanding during each of the periods retroactively restated to give effect to the 325.51-for-one stock split. Newly Adopted Accounting Statements--In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation," which was effective for the Company beginning January 1, 1996. SFAS No. 123 requires expanded disclosures of stock-based compensation arrangements with F-9 SPECIALTY CATALOG CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) employees and encourages (but does not require) compensation cost to be measured based on fair value of the equity instruments awarded. Companies are permitted, however, to continue to apply APB Opinion No. 25, which recognizes compensation cost based on the intrinsic value of the equity instrument awarded. The Company will continue to apply APB Opinion No. 25 to its stock- based compensation awards to employees and will disclose the required pro forma effect on net income and earnings per share. Effective January 1, 1996, the Company adopted SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." This statement establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles and goodwill related to those assets to be held and used and for long-lived assets and certain identifiable intangibles which are to be disposed of. The adoption of this statement had no effect on the financial position, or results of operations or cash flows of the Company. Fiscal Year--The Company is on a 52/53 week fiscal year, ending on the Saturday closest to December 31. The fiscal years ended December 30, 1995, December 31, 1994 and January 1, 1994, each consisted of 52 weeks. Reclassifications--Certain amounts in the 1993 and 1994 financial statements have been reclassified to conform to the 1995 presentation. Unaudited Financial Statements--In the opinion of management of the Company, the accompanying unaudited financial statements reflect all adjustments which were of a normal recurring nature necessary for a fair presentation of the Company's financial position, results of operations and cash flows for the six months ended June 30, 1996 and June 30 1995. 2. CORPORATE ORGANIZATION AND BANKRUPTCY PROCEEDINGS On December 28, 1992, SC Corporation and its subsidiaries Wigs by Paula, Inc. ("Wigs"), Western Schools, Inc., the predecessor of SC Publishing, After the Stork, Inc. ("Stork") and Brotman Acquisition Corp. ("Brotman") filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code ("Bankruptcy") in the United States Bankruptcy Court for the District of Connecticut, ("Bankruptcy Court"). From that date until November 23, 1994, SC Corporation operated its business as a debtor-in-possession subject to the jurisdiction of the Bankruptcy Court. During that period, the Company did not pay $1,030,757 and $1,688,592 of contractual interest for the years ended December 31, 1994 and January 1, 1994 while under the protection of Bankruptcy. In January 1993, the Bankruptcy Court and SC Corporation agreed to lift the stay and permit Signal Capital Corporation, SC Corporation's senior secured creditor ("Signal"), to sell Stork and Brotman. Stork was sold for $950,000 to a group of purchasers which included Viking Holdings Limited ("Viking") and Steven Bock, the Company's chairman and chief executive officer. Brotman was sold by Signal to a liquidator. SC Corporation's Disclosure Statement with respect to the First Amended and Restated Joint Plan of Reorganization of SC Corporation and its subsidiaries Wigs and SC Publishing ("Plan of Reorganization") was approved by the Bankruptcy Court on September 21, 1994. The Plan of Reorganization was subsequently confirmed by the Bankruptcy Court on October 26, 1994 and the reorganization of SC Corporation was consummated on November 23, 1994. The Plan of Reorganization provided for the payment of $15,508,726 in cash, $1,673,453 in subordinated notes, 10,227 shares of preferred stock valued at $1,022,700 and 295,121 shares of common stock valued at F-10 SPECIALTY CATALOG CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) $295,121 in settlement of $24,102,851 of secured claims, and $3,345,066 in cash, $354,247 in subordinated notes, 2,164 shares of preferred stock valued at $216,400 and 179,353 shares of common stock valued at $179,353 in settlement of $11,665,353 of unsecured claims. The gain on such discharge of pre-petition claims has been recorded as an extraordinary item, net of income taxes of $1,094,649. The Company funded the Plan of Reorganization by selling additional shares of common stock and 13% Preferred Stock ("13% Preferred Stock"), entering into a new senior credit facility, and issuing subordinated notes ("Subordinated Notes"). Subsequent to the consummation of the reorganization, certain stockholders of the Company purchased the subordinated notes and 13% Preferred Stock from the holder of the secured claims at their face values and the common stock from the holders of the secured and unsecured claims at its fair market value. Reorganization items consist of the following: 1994 1993 ----------- ----------- Interest income................................... $ 103,308 $ 24,473 Professional fees................................. (2,133,117) (1,062,452) Executive and employee compensation............... (533,840) -- Other............................................. (326,058) -- ----------- ----------- $(2,889,707) $(1,037,979) =========== =========== The Company was incorporated on November 30, 1994 for the purpose of becoming the parent company of SC Corporation. On that date, the Company issued 2,826,666 shares of its common stock and 22,491 shares of 13% Preferred Stock to the stockholders of SC Corporation in exchange for their shares of SC Corporation common stock and preferred stock. 3. PREPAID EXPENSES Prepaid expenses at December 30, 1995 and December 31, 1994 consists of the following: 1995 1994 ---------- ---------- Deferred catalog costs................................ $2,320,261 $1,747,152 Prepaid advertising................................... 825,064 1,068,566 Other................................................. 317,493 358,825 ---------- ---------- $3,462,818 $3,174,543 ========== ========== 4. PROPERTY AND EQUIPMENT Property and equipment consists of the following at December 30, 1995 and December 31, 1994: USEFUL LIFE 1995 1994 ------- ----------- ----------- Furniture and equipment.................. 7 years $ 1,139,016 $ 1,326,389 Data processing equipment................ 5 years 2,734,186 2,363,330 Leasehold improvements................... (i) 109,146 98,230 ----------- ----------- 3,982,348 3,787,949 Less accumulated depreciation and amorti- zation.................................. (3,040,751) (3,011,164) ----------- ----------- $ 941,597 $ 776,785 =========== =========== (i) Lesser of the estimated useful lives of the related assets or the lease term. F-11 SPECIALTY CATALOG CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses at December 30, 1995 and December 31, 1994 consist of the following: 1995 1994 ---------- ---------- Accounts payable....................................... $3,368,865 $1,108,589 Accrued compensation................................... 490,227 933,087 Other accrued expenses................................. 871,844 886,342 ---------- ---------- $4,730,936 $2,928,018 ========== ========== 6. LIABILITIES TO CUSTOMERS Liabilities to customers at December 30, 1995 and December 31, 1994 consist of the following: 1995 1994 -------- ---------- Deferred revenue......................................... $114,636 $ 270,453 Reserve for returns...................................... 641,266 997,299 -------- ---------- $755,902 $1,267,752 ======== ========== Deferred revenues reflect cash received from customers for backordered items which have not yet been shipped. The reserve for returns represents estimated merchandise to be returned for refunds in the future based on historical return rates applied to recent shipments. 7. LONG-TERM DEBT Long-term debt consists of the following at December 30, 1995 and December 31, 1994: 1995 1994 ----------- ----------- BNP term advance, Prime Rate plus 2% or Eurodollar Rate plus 3.5%, payable quarterly in amounts between $500,000 and $1,500,000 through May 22, 1999............................................... $11,500,000 $14,000,000 SC Holdings LLC Subordinated Note, 11.5%, payable November 22, 2002.......................... 3,680,186 3,680,186 SC Holdings LLC PIK Note, 11.5%, payable November 22, 2002........................................... 445,333 -- ----------- ----------- 15,625,519 17,680,186 Less current portion................................ 2,750,000 2,500,000 ----------- ----------- $12,875,519 $15,180,186 =========== =========== The Credit Agreement between BNP and the Company ("Agreement") has covenants which prohibit the payment of cash dividends on the Company's Common Stock and 13% Preferred Stock and any principal or interest payments on the Subordinated Notes and require that various financial limits and ratios be maintained. F-12 SPECIALTY CATALOG CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) In addition, the Agreement requires an annual prepayment of outstanding principal equal to 75% of the Company's excess cash flow, as defined. Each prepayment reduces pro rata the remaining scheduled term advance principal payments. The Agreement is secured by all assets of the Company and its subsidiaries. In addition, the Company has pledged the shares of common stock of SC Corporation, and SC Holdings LLC ("Holdings") has pledged its subordinated note, to BNP as additional collateral, and the Company, its subsidiaries and Holdings each have jointly, severally and unconditionally guaranteed the borrowings under the Agreement, up to a certain percentage of each guarantor's adjusted net assets, as defined. The Agreement also provides the Company with a line of credit up to $2,000,000 for working capital and letters of credit. The line of credit may be automatically and permanently reduced each year by a portion of the Company's excess cash flow, as defined. The Company had $1,050,000 and $0 outstanding under the line of credit and $536,000 and $2,000,000 available under the line of credit at December 30, 1995 and December 31, 1994, respectively. Borrowings under the line of credit were at the prime rate plus 2%, which was 10.5% at December 30, 1995. Borrowings under the term advance at December 30, 1995 due within three months are at the three-month Eurodollar rate plus 3.5% while the remainder of the borrowings are at the six-month Eurodollar rate plus 3.5%. Such Eurodollar rates were 9.38% and 9.19%, respectively. The Company is obligated to pay various fees under the Agreement, including an unused line of credit fee of 0.5% of the unused amount under the line. Holdings is a limited liability company whose stockholders own all the issued and outstanding shares of 13% Preferred Stock of the Company and certain of the issued and outstanding shares of Common Stock of the Company. The Company may, at its option through November 22, 1999, and, under certain conditions, through November 22, 2002, pay interest on the Subordinated Notes by issuing additional Subordinated Notes with identical terms and conditions with an aggregate principal amount equal to the amount of interest then payable. In 1995, the Company issued $445,333 of additional Subordinated Notes as payment of interest for the period November 1994 through December 1995. The aggregate maturities of long-term debt after December 30, 1995 are as follows: FISCAL YEAR AMOUNT ----------- ----------- 1996............................................................. $ 2,750,000 1997............................................................. 3,250,000 1998............................................................. 3,750,000 1999............................................................. 1,750,000 2000............................................................. -- 2001 and thereafter.............................................. 4,125,519 ----------- $15,625,519 =========== As described in Note 15, the Company intends to have a public offering of its common shares in late 1996 in order to pay a portion of its outstanding debt. In the event that this offering is not successful, the Company believes that its present cash flows from operations are sufficient in order to meet the above debt service requirements, however, if necessary, the Company plans to refinance the BNP term advance. 8. PREFERRED STOCK On November 30, 1994, the Company issued 22,491 shares of 13% Preferred Stock. F-13 SPECIALTY CATALOG CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The 13% Preferred Stock dividends are cumulative and payable quarterly at the end of each calendar quarter. In addition to the Credit Agreement's prohibition of the payment of cash dividends on the Company's Common Stock and 13% Preferred Stock, the Company may not pay any dividends on any class of its capital stock other than the 13% Preferred Stock or purchase, redeem or otherwise acquire any shares of any class of its capital stock so long as there are any accrued but unpaid dividends on any shares of the 13% Preferred Stock. At December 30, 1995, there were $323,624 of cumulative 13% Preferred Stock dividends in arrears, which is included in other long-term liabilities. Prior to 1995, pursuant to the terms of the 13% Preferred Stock, the Company was required to redeem all the outstanding shares of 13% Preferred Stock on November 30, 2004 at a price equal to the par value of the outstanding shares plus any accrued but unpaid dividends ("Redemption Price"). In 1995, the Board and the holders of the 13% Preferred Stock elected to amend the Company's charter by removing the mandatory redemption provision of the 13% Preferred Stock. In addition, at any time prior to November 30, 2004, the Company may, at its option, redeem any or all shares of the 13% Preferred Stock at the Redemption Price. The holders of the 13% Preferred Stock have no voting rights except as provided by law. In the event of any voluntary or involuntary liquidation, dissolution or winding up of the Company, the holders of the 13% Preferred Stock shall be entitled to receive the Redemption Price before any distribution shall be made to holders of common stock or other capital stock of the Company. If the assets of the Company at such time are insufficient to pay such amounts, such assets shall be distributed pro rata to the holders of the 13% Preferred Stock. 9. STOCKHOLDERS' EQUITY Issuance of Common Stock--As part of the Company's reorganization and settlement of its bankruptcy proceedings, on November 23, 1994 SC issued 868,365 shares of common stock and canceled 1,000,000 shares of old common stock that had been issued prior to the date that SC Corporation filed for reorganization under Chapter 11. On November 30, 1994, the stockholders exchanged their shares of SC Corporation common stock for the Company's common stock at the rate of approximately 100 shares of SC Corporation's common stock for each share of the Company's common stock. In 1995, the Company's Board of Directors and holders of common stock elected to recapitalize the common stock into three classes, Class A, Class B and Class C. Holders of Class A shares are entitled to one vote per share while holders of Class B and Class C shares are entitled to one-half vote per share and one and one-half votes per share, respectively. All dividend and liquidation rights remain unchanged. Upon sale, disposition or other transfer of any share(s) of Class B common stock by the original holder thereof, (i) such share(s) shall automatically and immediately convert into an equal number of shares of Class A common stock, and (ii) an equal number of shares of Class C common stock shall automatically and immediately convert into an equal number of shares of Class A common stock. All shareholders received one share of Class A for each share of common with the exceptions of one shareholder who received one-half share of Class A and one-half share of Class B for each share of common and another shareholder who received one-half share of Class A and one-half share of Class C for each share of common. Shareholders' Agreement--All holders of common stock and options to purchase common stock are parties to a Shareholders' Agreement dated November 30, 1994 which (i) prohibits the sale, pledge, transfer or disposal of shares of common stock prior to the earlier of November 24, 1997 or the date on which the Company shall have fully utilized its Federal income tax net operating loss carryovers ("Ownership Change Date") and (ii) restricts the sale, pledge, transfer or disposal of shares of common stock subsequent to the Ownership Change Date by granting to the other holders of shares of common stock the right of first refusal on any bona fide offer to purchase shares of common stock. The Shareholders' Agreement terminates on the earliest of (i) the date of F-14 SPECIALTY CATALOG CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) dissolution or liquidation of the Company, (ii) such time as any one shareholder or other person owns all the shares of common stock, (iii) the date of the consummation of a public offering of common stock under the Securities Act of 1933 ("Act") or (iv) such time as all the parties to the Shareholders' Agreement elect to terminate such agreement. Registration Rights Agreement--The Company and all holders of common stock are parties to a Registration Rights Agreement dated November 30, 1994 which requires the Company, if it proposes to file a registration statement with respect to its common stock under the Act, to give all holders of common stock the opportunity to include their shares in such registration. In addition, the Registration Rights Agreement requires the Company, upon request from either of its major shareholders, to use its best efforts to effect the registration under the Act of the shares of such major stockholder and (i) to notify all other holders of common stock of such major stockholder's request, and (ii) to use its best efforts to effect the registration under the Act of the shares of all other shareholders who desire such registration. Stock Option Agreements--On November 30, 1994, the Company granted a total of 582,999 options to purchase shares of common stock to two executive officers. The exercise price of the options is $0.3072 per share. At December 30, 1995 and December 31, 1994, 60,618 and 30,309 options were vested, respectively. The remaining options vest over varying periods, with 143,530 options ("Vesting Options") vesting between November 23, 1996 and November 23, 1997, and 378,851 options ("Performance Options") vesting on November 1, 2003. The Performance Options may vest earlier than November 1, 2003 if certain earnings or internal rate of return thresholds are met. 10. RESTRUCTURING CHARGES During 1995, the Company restructured by consolidating its operations in one location in order to reduce costs and utilize resources more efficiently. Specifically, restructuring charges include: Office Closure Costs................................................ $212,860 Employee Severances................................................. 300,083 -------- Total............................................................. $512,943 ======== Actual termination benefits paid in 1995 totaled $214,007. Included in accrued expenses at December 30, 1995 are accrued restructuring related charges of $151,976. 11. INCOME TAXES The provision for income taxes consists of the following at December 30, 1995 and December 31, 1994: 1995 1994 1993 -------- -------- -------- Current: Federal......................................... $ -- $ 5,046 $ -- State........................................... 5,756 147,614 289,013 -------- -------- -------- 5,756 152,660 289,013 -------- -------- -------- Deferred: Federal......................................... 298,196 293,500 352,753 State........................................... 52,623 51,794 62,251 -------- -------- -------- 350,819 345,294 415,004 -------- -------- -------- Total......................................... $356,575 $497,954 $704,017 ======== ======== ======== F-15 SPECIALTY CATALOG CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Deferred income tax assets and liabilities consist of the following at December 30, 1995 and December 31, 1994: 1995 1994 ---------- ---------- Deferred income tax assets: Net operating loss carryforwards.................... $7,229,484 $7,726,848 Operating reserves.................................. 200,165 983,769 Inventory........................................... 226,990 106,103 Other............................................... 5,044 5,046 ---------- ---------- 7,661,683 8,821,766 ---------- ---------- Deferred income tax liabilities: Extraordinary gain on debt discharge................ -- 1,094,649 Deferred catalog costs.............................. 850,259 551,271 Other............................................... 32,068 45,671 ---------- ---------- 882,327 1,691,591 ---------- ---------- Net deferred income tax asset......................... $6,779,356 $7,130,175 ========== ========== Reconciliation of the statutory Federal income tax rate and the effective rate of the provision for income taxes for the years ended December 30, 1995, December 31, 1994 and January 1, 1994 is as follows: 1995 1994 1993 ---- ---- ---- Statutory Federal income tax rate.......................... 34.0% 34.0% 34.0% State taxes, net of Federal income tax benefits............ 6.6 7.2 7.5 ---- ---- ---- 40.6% 41.2% 41.5% ==== ==== ==== The Company has recorded a deferred tax asset of $6,779,356 reflecting the benefit of $18,073,209 of net operating loss carryforwards which expire in varying amounts between 2005 and 2010. Realization is dependent on generating sufficient taxable income prior to expiration of the loss carryforwards. Although realization is not assured, management believes it is more likely than not that all of the deferred tax asset will be realized. The use of the net operating losses may be subject to certain limitations upon a change in control of the Company. 12. RELATED PARTY TRANSACTIONS The Company has a note receivable from a stockholder in the amount of $140,174 at December 30, 1995. The note bears interest at 9.25% and is repayable in varying annual installments between December 31, 1996 and December 31, 1999. The note was issued in November 1994 in exchange for shares of Common Stock and 13% Preferred Stock and is collateralized by 18,365 shares of Common Stock, 490 shares of 13% Preferred Stock and $80,186 of Subordinated Notes. 13. COMMITMENTS AND CONTINGENCIES Operating Leases--The Company leases certain administrative, warehousing and other facilities and equipment under operating leases. The following is a schedule of future minimum rental payments under noncancelable operating leases as of December 30, 1995: YEAR AMOUNT ---- -------- 1996................................................................ $193,500 1997................................................................ 31,168 -------- $224,668 ======== F-16 SPECIALTY CATALOG CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Management expects that, in the normal course of business, expiring leases will be renewed or replaced by other leases. Rent expense under operating leases for the year ended December 30, 1995, December 31, 1994 and January 1, 1994 was $438,450, $569,212 and $562,907, respectively. Employment and Bonus Agreements--The Company has employment and bonus agreements with two executive officers through December 31, 1999. The Company's salary commitment under these agreements aggregates $2,060,000 at December 30, 1995 as follows: 1996 $ 485,000 1997 505,000 1998 525,000 1999 545,000 ---------- $2,060,000 ========== In addition, the two executive officers may earn certain other bonuses based on the Company's achievement of certain operating criteria. 14. EMPLOYEE BENEFIT PLANS The Company maintains a qualified defined contribution plan, under the provisions of Section 401(k) of the Internal Revenue Code, covering substantially all employees. Under the terms of the plan, eligible employees may make contributions up to 15% of pay, subject to statutory limitations. Contributions not exceeding 5% of an employee's pay are matched 40% by the Company. The Company may, at its discretion, make an additional year-end contribution. Employee contributions are always fully vested. Company contributions vest 20% for each completed year of service, becoming fully vested after five years of service. Matching contributions by the Company under the plan were $67,188, $59,594 and $47,520 in 1995, 1994 and 1993, respectively. No discretionary contributions have been made to the plan. The Company established a supplemental defined contribution plan in 1994 that covers certain employees. Under the terms of the plan, these employees may elect to defer up to 50% of any bonus paid for that year. The Company matches 100% of all amounts deferred. In addition, the Company pays interest on all outstanding balances at the prime rate but not in excess of 12%. A participant's rights to the deferred amount of regular bonus and income thereon shall be fully vested and nonforfeitable at all times. A participant's right to the Company's match shall become fully vested and nonforfeitable in cumulative increments of 20% on each of the first through fifth anniversaries of the bonus date for that year. The total cost of the plan to the Company was $0, $65,000 and $0, in 1993, 1994 and 1995, respectively. The $65,000 contributed in 1994 initiated the plan. 15. SUBSEQUENT EVENTS On June 1, 1996, the Company entered into an agreement with a director and two associates of the director to issue junior subordinated notes for $495,000 payable on August 12, 1999 and bearing interest at 11.5%. In connection with the issuance of these notes, the Company agreed to issue warrants for $5,000 to purchase 265,335 shares of Class A common stock for an aggregate exercise price of $500,000 ($1.8844 per share). The warrants expire on September 30, 1999. The note and related warrants were issued on August 12, 1996. The note has been discounted using an effective interest rate of 21.5%, which represented the Company's borrowing rate for junior subordinated debt at the date of the transaction. The remainder of the value representing $114,061 was assigned to the warrants. In July 1996, the Company signed a letter of intent with an underwriter for an initial public offering of 1.25 million shares of the Company's Common Stock. At the effective date of the offering, the Company will increase F-17 SPECIALTY CATALOG CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) the number of authorized shares of Common Stock from 20,000 to 10,000,000 and preferred stock from 30,000 to 1,000,000 and effect a 325.51-for-one split. The effect of the stock split will be to transfer $19,583 representing the par value of the additional shares issued from additional paid in capital to Common Stock. All numbers of common shares and per share data in the accompanying consolidated financial statements have been retroactively adjusted to effect the stock split. Immediately after the stock split, all outstanding shares of preferred stock will be converted into 375,000 shares of Common Stock. All accumulated dividends and accrued interest on those dividends through the date of the offering have been irrevocably waived by the 13% Preferred Stockholders as of August 13, 1996. In addition, at the date of the offering, the Company will adopt the 1996 Stock Option Plan ("Plan"). It is anticipated that 500,000 authorized but unissued shares of Common Stock will be reserved for issuance under the Plan. The per share exercise price of options granted under the Plan will be not less than 100% of the fair market value of a share of the Company's Common Stock on the date of the grant. In August 1996, the Company amended its Credit Agreement with BNP. This amendment included revisions of certain financial limits and ratios that must be maintained by the Company and is retroactive to December 31, 1995. In August 1996, the Board of Directors granted a total of 175,000 options to purchase shares of Common Stock to two executive officers contingent on the occurrence of the offering. Of these options, 75,000 are exercisable at $5.33 per share and the remainder at the initial public offering price. The options vest equally over five years subject to acceleration under certain contingencies. 16. PRO FORMA AND SUPPLEMENTAL PRO FORMA EARNINGS PER SHARE (UNAUDITED) Pro forma earnings per share of the Company give effect to the conversion of all 13% Preferred Stock into 375,000 Common Shares, and the exercise of options to purchase 657,999 shares of Common Stock more fully described in Notes 7 and 13. Historical net income has been adjusted to give effect to the elimination of accrued dividends on the 13% Preferred Stock. Pro forma earnings per share for the periods ended December 30, 1995 and June 29, 1996 are as follows: DECEMBER 30, JUNE 29, 1995 1996 ------------ -------- Pro forma earnings per share........................... $0.14 $0.04 ===== ===== Supplemental pro forma earnings per share gives effect to the number of shares necessary for the Company to sell at a purchase price of $6.50 per share less the Underwriters' discount, to raise sufficient proceeds (net of estimated offering expenses) to retire $5,900,000 of the Company's indebtedness to BNP. The number of supplemental pro forma shares outstanding also gives effect to the conversion of all shares of 13% Preferred Stock for 375,000 of Common Stock, the exercise of a warrant for 265,335 shares of Common Stock (See note 15) and the exercise of options for 657,999 shares of Common Stock (See notes 9 and 15). Historical net income has been adjusted to give effect to the reduction of interest expense on the BNP indebtedness as a result of repayment of such debts, and to the elimination of accrued dividends on the preferred stock and any interest expense accrued on unpaid accumulated dividends. Supplemental pro forma earnings per share for the periods ended December 30, 1995 and June 29, 1996 are as follows: DECEMBER 30, JUNE 29, 1995 1996 ------------ -------- Supplemental pro forma earnings per share.............. $0.17 $0.06 ===== ===== F-18 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY IN- FORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS OFFERING OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH IN- FORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR BY THE UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITY OTHER THAN THE SECURITIES OFFERED BY THIS PROSPECTUS, OR AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITIES BY ANY PERSON IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED OR IS UNLAWFUL. THE DELIVERY OF THIS PROSPECTUS SHALL NOT, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE OF THIS PROSPECTUS. --------------- TABLE OF CONTENTS PAGE ---- Prospectus Summary........................................................ 3 Reorganization............................................................ 8 Risk Factors.............................................................. 9 Use of Proceeds........................................................... 14 Capitalization............................................................ 15 Dividend Policy........................................................... 15 Dilution.................................................................. 16 Selected Financial and Operating Data..................................... 17 Management's Discussion and Analysis of Financial Condition and Results of Operations............................................................ 19 Business.................................................................. 25 Management................................................................ 34 Principal Stockholders.................................................... 39 Certain Transactions...................................................... 41 Description of Securities................................................. 41 Shares Eligible for Future Sale........................................... 44 Underwriting.............................................................. 45 Legal Matters............................................................. 46 Experts................................................................... 46 Available Information..................................................... 47 Index to Financial Statements............................................. F-1 --------------- UNTIL NOVEMBER 11, 1996 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS OR WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 1,500,000 SHARES LOGO SPECIALTY Catalog CORP. COMMON STOCK ------------- PROSPECTUS ------------- GKN Securities OCTOBER 17, 1996 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- This Prospectus is printed on recycled paper using soy-based inks. LOGO