ITEM 1. BUSINESS
GENERAL
The Company targets niche consumer product categories, primarily via direct marketing. SC Direct, its principal operating subsidiary in the United States ("SC Direct"), is the U.S.'s leading retailer of women's wigs and hairpieces. Daxbourne International Limited, a subsidiary of SC Direct ("Daxbourne"), is a leading United Kingdom retailer and wholesaler of women's wigs and hairpieces. SC Publishing, another subsidiary of SC Direct ("SC Publishing"), sells continuing education courses to nurses and CPAs.
SC Direct
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(R). In addition, SC Direct sells hats and other fashion accessories to women through its Paula's Hatbox(R) catalog. SC Direct generated net sales of $38.3 million, $32.2 million and $37.2 million for the fiscal years ended 1997, 1996 and 1995, respectively. In 1997, SC Direct mailed approximately 21 million catalogs. Each catalog includes detailed product descriptions and specifications, full color photographs and pricing information. Each catalog is published several times a year, and often different variations of each catalog are distributed.
Paula Young(R) is SC Direct's flagship catalog featuring Paula Young(R) brand wigs. Paula Young(R) wigs are value priced and have "shake and wear" styling as well as quality construction. The Paula Young(R) catalog also offers accessories such as turbans, shampoos, combs and styling heads. In addition, each Paula Young(R) catalog offers a selection of Christine Jordan(TM) wigs, as well as Touch of Class(TM) and Celebrity Secrets(R) brand products. Touch of Class(TM) products include wiglets, add-ons and extensions while Celebrity Secrets(R) offer the Style Enhancer (patent pending) hairpiece products. In addition to its own proprietary brands, SC Direct also offers a small selection of Eva Gabor(R) wigs in the Paula Young(R) catalog. During 1997, SC Direct signed celebrity spokesperson Barbara Eden to endorse the Paula Young(R) brand. The Company believes that such celebrity endorsements will improve the image and acceptability of wigs.
The Christine Jordan(TM) catalog features Christine Jordan(TM) brand wigs, which is SC Direct's premium brand, offering the Company's highest quality wigs. Christine Jordan(TM) 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 is the only brand in the industry to carry five sizes in most of its styles. Select styles of this brand are also offered in the Paula Young(R) catalog.
The Especially Yours(R) catalog features Especially Yours(R) brand wigs and hairpieces with a variety of features specially designed for African-American women, including natural hairline crimping and fiber texture that reflect the natural hair of African-Americans. In late 1997, the Company became the exclusive licensee for the Diahann Carroll(TM) line of wigs, which are now featured in the Especially Yours(R) catalog. The Especially Yours(R) catalog also offers other wig and hairpiece brands, including Paula Young(R) and Celebrity Secrets(R), as well as a selection of hats and other accessories. A selection of Especially Yours(R) brand wigs and hairpieces are also offered in selected Paula Young(R) catalogs.
The Paula's Hatbox(R) catalog sells hats in a wide variety of styles and colors, ranging in style and price from simple caps and visors for under $20 to designer hats for more than $200. Paula's Hatbox(R) also offers a variety of fashion accessories including scarves, hat pins, costume jewelry, shoes and handbags, and a limited selection of fashion apparel.
Daxbourne International Limited
In October 1997, the Company, through its new subsidiary, Daxbourne International Limited, acquired substantially all of the assets of The Daxbourne Group, a leading retailer and wholesaler of women's wigs, hairpieces and related products in the United Kingdom. Daxbourne distributes wigs and hairpieces under its Jacqueline Collection, Pretty Woman and Natural Image brands, and has established a strong presence in the U.K. through catalog, retail and wholesale distribution channels. Net sales of Daxbourne for the period from October 3, 1997 through January 3, 1998 of approximately $1.2 million were included in the Company's year ended January 3, 1998 statement of operations.
Daxbourne's direct marketing business offers through its Jacqueline Collection catalog an extensive selection of women's wigs, hairpieces and accessories under its Jacqueline Collection and Pretty Woman brand names. The Jacqueline Collection catalog also offers accessories such as turbans, shampoos, combs and styling heads. In addition, the catalog offers select styles of Eva Gabor(R) wigs.
Daxbourne also operates three stand-alone retail outlets and nine retail concessions within department stores. These locations offer customers the ability to try on various wig styles and are staffed with experienced sales associates who can assist the customers in their selections. A portion of this business consists of supplying customers who have been referred by the National Health Service Trusts ("NHS"). Daxbourne negotiates with the NHS as to which styles to sell, prices and other services to be offered.
The wholesale business operates under the Natural Image brand and sells to shops, agents and other distributors, including agents and retail outlets that supply wigs to the NHS. The wholesale business also exports a small amount of wigs to customers in other European countries.
SC Publishing
SC Publishing distributes catalogs under its Western Schools(R) brand and specializes in providing continuing education courses ("CE") to nurses and CPAs. SC Publishing's strategy is to build its business by offering quality education and other products needed by the targeted professional at value prices. In 1997, SC Publishing began test marketing professional items targeted toward nurses, including scrubs, stethoscopes and shoes, as well as novelty gift items. In 1997, SC Publishing mailed 5.2 million catalogs, generating net sales of $4.0 million.
INDUSTRY AND MARKETS
Wigs
Based on U.S. Census Bureau import data, approximately 5.7 million wigs are sold annually in the United States which the Company estimates to be $350 million in retail sales. The wig market is comprised of fashion wig wearers and need-based wig wearers. Need-based wig wearers purchase wigs as a necessity, due to a physical condition such as naturally thinning hair or total hair loss, as well as hair loss due to medical procedures and conditions (e.g., alopecia and cancer treatments). Many everyday wig wearers replace their wigs every three to four months, and have a wig "wardrobe," consisting of several wigs, either of the same style and color or of different styles and colors.
In the 1960s, wigs and hairpieces were broadly viewed as a fashion accessory. However, as styles and tastes 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 allocated to inventories of wigs. The Company's catalog business was started to serve the need-based wig customers who were not being adequately serviced by other retail alternatives. The Company believes that only approximately 5 million women, or 25%, of the estimated 20 million American women with thinning hair, currently wear wigs, and that, accordingly, there is substantial opportunity for future growth of the Company's business.
The Caucasian retail wig market, which the Company estimates to be a $225 million market with approximately 3.0 million units sold annually, is serviced by direct mail catalogers and retail outlets, including beauty salons, wig shops and department stores. The Company estimates that catalog sales represent 40% of the units sold and 20% of the sales dollars annually in the Caucasian market and believes that catalogs offer the benefits of privacy, convenience, lower prices and broader product selection. Retail stores provide customers with more personalized service and allow customers to try on the product; however, they generally charge higher prices and offer less convenience, privacy and selection than catalog retailers.
The African-American wig market, unlike the Caucasian market, has yet to undergo any significant transition to direct marketing from retail outlets. Although African-American women comprise approximately 13% of the U.S. female population, they purchase approximately 47% of the wig units sold annually. The Company estimates that annual sales to the African-American wig market are approximately $125 million and 2.7 million units. Only about 5% of African- American wigs are sold through catalogs, with the balance sold primarily in beauty salons and wig shops. The Company's Especially Yours(R) catalog, which targets African-American women, already has the highest sales volume of any catalog offering wigs exclusively for African-American women.
The Company estimates that the international wig and hairpiece market is at least as large as the U.S. market. The Company seeks to leverage its marketing and product knowledge, infrastructure and procurement ability to facilitate international expansion through acquisitions and its licensing program. The Company currently has licensing agreements to sell its products in Germany, Austria, Israel and the U.K.
Hats
The Company believes that the fashion hat market, like the wig market, has not been well serviced by existing retail channels of distribution, with no major retailer offering a broad selection of quality hats. 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 principal product lines. Although the women's fashion hat market is estimated to be in excess of a $700 million market, no dominant hat retailer has emerged.
Continuing Education
The nursing, accounting and other industries require their professionals to meet CE requirements on an ongoing basis. Required CE frequency and the number of required hours vary 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 accounting 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 CE represented approximately 76% of SC Publishing's CE sales in 1997. Nearly half of the states in the U.S. currently require nurses to have some form of CE. SC Publishing is exploring the expansion of this market through business-to-business opportunities as well as additional distribution channels. SC Publishing also sells CE to CPAs, who generally are required to obtain minimum levels of CE every year. SC Publishing seeks to compete in this market by offering current CE topics in a convenient manner at competitive prices. Approximately 16% of SC Publishing's net sales were represented by the accounting market. The remaining 8% of sales came from SC Publishing's California real estate CE business which was sold in June 1997.
SC Publishing develops its products by first identifying topics pertinent to its target audiences of nurses and CPAs. For the nursing market, SC Publishing then contracts with qualified authors to develop a course text book and exam materials. Due to the fact that regulations rapidly change in the accounting market and the economics of writing courses, SC Publishing buys existing textbooks and contracts with authors or industry experts to create introductory materials and exams that enhance and test the learning of the materials presented in the textbooks. All courses and exams are subject to peer review by industry experts before publishing.
PRODUCTS
Wigs & Hairpieces
The Company sells a wide range of wigs and hairpieces in the United States, Canada, the United Kingdom and through its international licensing agreements. The Company offers over 50 different wig styles and over 10 different hairpieces in more than 30 colors, including browns, blondes, grays and reds. Most wigs are available in one or two sizes, except for wigs in the Christine Jordan(TM) brand, most of which are offered in five sizes. Wigs provide full coverage, and are lighter in weight and more natural looking compared to wigs from the 1960s. Hairpieces include wiglets, add-ons or extensions, and Style Enhancers (patent pending). 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. Style Enhancers offer full coverage, like a wig, but allow a woman to integrate her own hair with the hairpiece, thus creating a blend of her own natural hair with the hairpiece.
All of the Company's wigs, as well as the majority of wigs sold worldwide, are manufactured using a special synthetic fiber, the market for which is dominated by two Japanese firms, Kaneka Corporation and Toyo Chemical Corporation. Synthetic fiber has several advantages over human hair, including lower cost, permanent styling, truer colors and cleanliness. This synthetic 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 Company expects that most of its wigs and hairpieces 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, such as the recent financial instabilities in the Asian markets, export duties, work stoppages and, in certain parts of the world, political instability and possible governmental intervention. As such, the availability and cost of wigs may be favorably or adversely affected by any of these items. 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.
During 1997, the Company purchased approximately 73% of its wigs and hairpieces directly from foreign manufacturers and the balance from two U.S. importers. Each of the Company's five largest manufacturers represented between 13% and 23% of its overall wig purchases in 1997. 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. The Company plans to continue to increase the percentage of wigs imported directly from manufacturers.
Hats
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. Hats are available in a wide variety of styles from everyday basics to formal designer labels and are constructed from a variety of materials, including straw, wool, and felt, among others.
MARKETING
The Company markets its wigs, hats, fashion accessories and continuing education courses primarily through catalogs. Wig customers are obtained by way of a two-step marketing program. Step one involves obtaining prospective customers by soliciting customer interest through targeted advertising. The Company uses a variety of advertising media, including magazines, newspapers, 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. 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, the Company has been able to convert up to 15% of inquirers into customers within one year of their catalog requests. 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 inquirers and customers are periodically sent a program of targeted mailings designed to reactivate them.
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 core products it offers. Also, by virtue of its large order volume and direct purchasing from wig manufacturers, the Company is able to offer wigs and hairpieces at prices significantly lower than most hair salons and wig shops.
Customers for the Paula's Hatbox(R) catalog are obtained by using the two- step method described above as well as the more traditional one-step approach. In a one-step approach, names are rented from another catalog company or outside list providers based on certain criteria, such as buying habits and nature of the products purchased.
The Company markets its CE courses using a one-step marketing program targeted directly at nursing and accounting professionals whose licenses will expire if they do not obtain further continuing education credits.
The Company continually refines its marketing programs and processes for the purpose of increasing its conversion rate. The Company employs a variety of research methods, including demographic analysis, database modeling, 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 the market for its products among African-American women.
NEW OPPORTUNITIES
The Company intends to continue to build its business in its existing niche markets as well as to 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 continue to pursue the following:
Acquisitions
The Company intends to be aggressive with respect to its acquisition strategy in wigs and hairpieces, which is focused on building market share through further consolidation of the wig and hairpiece market, both in the United States and internationally. The Company is also actively exploring a number of acquisition candidates, aside from wig and hairpiece companies, such as those offering products targeted to senior women or those offering products complementary to wigs and hairpieces.
Licensing Agreements
The Company believes there are opportunities to expand into other countries through licensing agreements. The license agreements, in general, grant each licensee exclusive rights to use the Company's trademarks to sell wigs in the licensee's territory. Under the terms of the license agreement, the Company supplies the licensee the inventory for which the Company is paid its cost for the inventory plus an administrative fee for its shipping and handling costs. The Company also provides marketing advice and catalog development assistance. Pursuant to the license agreements, the licensees, in general, are required to pay royalties on their net sales and expend a specified minimum amount of advertising each year. The Company is currently actively exploring opportunities in other markets.
Business to Business
The Company has been testing business to business opportunities in the United States during the last few years. Since a certain percentage of women may prefer shopping for wigs in retail outlets, the Company, through a business to business catalog, seeks to distribute its products to existing retail channels, such as wig shops and beauty salons. The Company already sells wigs and hairpieces via the business to business concept in the U.K. through Daxbourne.
New Products
The Company seeks to leverage its customer relationships by adding new product lines to its catalogs. By developing and offering new products which customers desire, the Company creates additional sales opportunities and reinforces customer loyalty to the Company's catalogs. For example, the Company is test marketing men's wigs in the Paula Young(R) catalog. In January 1998, the Company introduced a selection of personal care products in its Christine Jordan(TM) catalog and the Company expanded its testing of non-wig products in its Especially Yours(R) catalog.
New Technologies
During 1997, the Company created its own web-site under http://www.paulayoung.com to provide information on the latest selection of wigs, hairpieces and hats. In the upcoming year, the Company will explore adding secure, on-line ordering capabilities to the web-site. The Company regularly monitors other technological advances to determine if any may have applicability to its businesses.
DATABASES
The Company has developed proprietary databases for its wig, hat, African- American and continuing education businesses consisting of customers and 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. The Company has undertaken limited exchanges of lists of inactive customers with wig competitors. 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 and, as such, poses a substantial barrier to entry for any potential competitor in the wig industry.
OPERATIONS
Order Entry and Customer Service
The Company has structured its telemarketing operation and the 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 59% 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 catalogs as call volume requires.
By emphasizing the training of telemarketing 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 and reliability of catalog shopping.
In November 1997, the Company renegotiated its contract for long distance service with AT&T for three years at rates approximately 35% lower than the previous contract. The Company uses Lucent Technology equipment with a 500 line capacity and presently uses about 300 lines in 90 stations. The Company's telephone system permits flexibility in routing calls to maximize teleservice representative efficiency.
Fulfillment
The Company's fulfillment goal is the prompt delivery of ordered merchandise. Orders received are usually shipped by the next day, primarily via third class 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 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 1997, the Company shipped an average of approximately 3,500 packages per business day.
Returns
The Company's return policy allows customers to return products for prompt refund or exchange. The Company believes that its 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.
Inventory Management
The Company's inventory management goal is to balance 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. 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 and accessory vendors, the Company's ability to negotiate a reorder commitment from the vendor. The Company continuously analyzes 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 designed 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 design 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 approximately 26.2 million catalogs in fiscal 1997, compared to 25.0 million catalogs in fiscal 1996.
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, retail stores, including hair salons and wig shops, department stores, specialty stores and discount stores. The Company believes that the Company's catalogs have a competitive advantage in providing greater selection, convenience and privacy than traditional retail outlets. 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 its extensive advertising programs.
The Company's CE catalogs compete with other mail order catalogs, in-house CE, professional associations, and seminar providers. The CE industry has many small providers, including local universities, but few large providers. Potential competition may emerge from new distribution channels such as the Internet and interactive television. Accordingly, SC Publishing competes aggressively on price, course content and selection, and customer service.
EMPLOYEES
As of January 3, 1998, the Company employed a total of 349 employees, consisting of 113 salaried full-time employees, 119 full-time hourly employees, and 117 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.
TRADEMARKS, PATENTS AND TRADE NAMES
The Company has twelve trademarks registered in the United States, two trademarks registered in the United Kingdom, and has three trademark applications and one patent application pending with the U.S. Patent and Trademark Office. The Company also has four trademarks registered under California state law. In the course of normal business, the Company often utilizes new trade names. 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 sales taxes. The Company believes that Massachusetts is the only jurisdiction where it is currently required to collect sales taxes.
ITEM 1A.
ITEM 1A. EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company are as follows:
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 has been a director of the Juvenile Diabetes Foundation, Bay State Chapter, since January, 1998. Mr. Bock is also 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 when the Company was under bankruptcy protection of the 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 former 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 Senior Vice President and 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.
ITEM 2.
ITEM 2. PROPERTIES
The Company occupies a 43,000 square foot office building in South Easton, Massachusetts, and a 50,000 square foot warehouse facility in a town adjacent to South Easton. In November 1997, the Company renewed the lease on its South Easton facility for a three year and four month term with two one year renewal options following the initial term. The Company began a five year and five month lease on April 1, 1997 for its warehouse facility. This facility has been used to consolidate all fulfillment operations.
As part of the Daxbourne acquisition, the Company acquired a 6,000 square foot building in London, England, which is used by Daxbourne for office and warehouse operations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is, from time to time, a party to routine litigation arising in the normal course of its business. At the present time, the Company is not involved in any litigation, nor is the Company aware of any potential 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 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.
On December 28, 1992, SC Corporation d/b/a SC Direct and its subsidiaries Wigs by Paula, Inc. ("Wigs"), Western Schools, Inc., the predecessor of SC Publishing, After the Stork, Inc. and Brotman Acquisition Corp. filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code 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. 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.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders of the Company during the fourth quarter of the fiscal year covered by this report.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of the Company began trading in October 1996 (subsequent to the public offering) on the Nasdaq National Market under the symbol "CTLG". The following table sets forth the high and low quotations from Nasdaq. Prior to the offering in October 1996, no established public trading market existed.
The number of recordholders of the Company's common stock as of March 20, 1998 was approximately 25.
The Company has not paid a dividend with respect to its common stock nor does the Company anticipate paying dividends in the foreseeable future. Under the terms of the Company's existing debt agreements, the Company is not permitted to pay dividends.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
ITEM 6. SELECTED FINANCIAL DATA (CONTINUED)
- -------- (1) 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. For the fiscal year ended December 31, 1994, net income reflects a gain from an extraordinary item of $12,078,489, net of income taxes, resulting from the forgiveness of debt upon the Company's emergence from bankruptcy. In 1997, net income reflects a $218,699 extraordinary loss on the early retirement of debt (net of an income tax benefit of $149,083). (2) In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share", which was effective for financial statements issued for periods ending after December 15, 1997. This statement required the adoption of new calculation methodologies and enhanced disclosures of basic and diluted earnings per share computations. As required, the Company has adopted SFAS No. 128 in the fourth quarter of 1997 and has restated prior year earnings per share presentations to conform to SFAS No. 128. See the consolidated financial statements and notes thereto. (3) Long-term debt reflects, as of January 1, 1994, amounts subject to settlement under reorganization proceedings. (4) The fiscal year ended January 3, 1998 includes three months of activity of the Company's newly owned subsidiary, Daxbourne International Limited, which was acquired by the Company on October 3, 1997. For the three months ended January 3, 1998, Daxbourne had net sales of $1,172,376, gross profit of $844,171 and net income of $80,375. The fiscal year ended January 3, 1998 contains 53 weeks compared to the 52 week fiscal year for all previous years presented.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Unless otherwise indicated, "1997" means the Company's fiscal year ended January 3, 1998, "1996" means the Company's fiscal year ended December 28, 1996, and "1995" means the Company's fiscal year ended December 30, 1995. The discussion and analysis below should be read in conjunction with the Financial Statements of the Company and the notes to the financial statements. 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.
INTRODUCTION
The Company targets niche consumer product categories, primarily via direct marketing. SC Direct, its principal operating subsidiary in the United States ("SC Direct"), is the U.S.'s leading retailer of women's wigs and hairpieces. Daxbourne International Limited ("Daxbourne"), a subsidiary of SC Direct, is a leading United Kingdom retailer and wholesaler of women's wigs and hairpieces. SC Publishing, another subsidiary of SC Direct ("SC Publishing"), sells continuing education courses to nurses and CPAs.
In October 1997, the Company, through its new subsidiary, Daxbourne International Limited, acquired substantially all of the assets of The Daxbourne Group, a leading retailer and wholesaler of women's wigs, hairpieces and related products in the United Kingdom. Net sales from Daxbourne International Limited for the period from October 3, 1997 through January 3, 1998, which is included in the Company's year ended January 3, 1998, represented 2.7% of the Company's net sales.
The Company is on a 52/53 week fiscal year, ending on the Saturday closest to December 31. The fiscal years ended January 3, 1998, December 28, 1996 and December 30, 1995 consisted of 53/52/52 weeks, respectively.
RESULTS OF OPERATIONS
1997 Compared to 1996
Net sales increased $7.2 million, or 19.8%, from $36.3 million in 1996 to $43.5 million in 1997. The sales increase resulted from (i) higher customer response rates driven by expanded promotional pricing on the Company's products, (ii) an increase of 4.8% in the number of catalogs mailed in 1997 compared to 1996, principally due to additional mailings of two of the Company's newer catalogs, Paula's Hatbox(R) and Especially Yours(R), (iii) the addition of Daxbourne net sales, which added $1.2 million in sales for 1997 and (iv) one additional week of sales related to the Company having a 53 week fiscal year in 1997 compared to a 52 week fiscal year in 1996.
Gross margin dollars increased $5.0 million, or 21.3%, from $23.5 million in 1996 to $28.5 million in 1997. The gross margin percentage increased from 64.7% in 1996 to 65.6% in 1997. This percentage increase resulted from (i) a larger percentage of the Company's products being purchased at lower prices directly from overseas factories and (ii) a reduction in the cost of shipping to customers packages weighing less than one pound. The overall increase in gross margin percentage was, however, reduced by promotional pricing strategies on many of the Company's products which resulted in a decrease in the average order size in 1997 compared to 1996, as well as a shift in the mix of products sold from higher margin to lower margin products, such as hats.
Selling, general and administrative expenses ("SG&A") increased $3.2 million, or 15.8%, from $20.2 million for the year ended 1996 to $23.4 million for the year ended 1997. This increase was primarily due to (i) an increase in catalog production costs of approximately $900,000 for 1997 compared to 1996, due primarily to a 4.8% increase in the number of catalogs mailed in 1997 compared to 1996, (ii) the addition of Daxbourne activity for 1997, which added approximately $550,000 of SG&A in 1997, (iii) additional expenses related to
the Company's 53 week fiscal year ended 1997 compared to 1996's 52 week fiscal year and (iv) additional variable costs due to increased sales activity, additional headcount, increased rent expense and increased administrative expenses relating to being a public company.
On June 27, 1997, the Company's subsidiary, SC Publishing, sold its business of continuing education for California real estate professionals. The Company believed that, because this was a single state business, it was no longer a strategic fit with the broader focus of the nurse and CPA markets. The sales price of $212,250 included a license to use the trade name Western Schools(R) for real estate courses, all related inventory for existing courses, and title and rights to its real estate courses, both existing and under development. The Company recognized a pre-tax gain of $121,980, included in SG&A, on the sale of these assets. The Company will also receive an annual royalty fee each year for a three-year period equal to the greater of (i) $25,000 and (ii) 5% of the revenue received by the buyer from sales of courses sold under the Company's trade name.
Net interest expense for the Company decreased approximately $836,000, or 51.7%, from $1.7 million for the year ended 1996 to approximately $821,000 for the year ended 1997, reflecting (i) lower average principal amounts outstanding for the year on the Company's debt and (ii) lower interest rates. This decrease was offset by added interest expense as a result of additional borrowing for the Daxbourne acquisition in October 1997.
1996 Compared to 1995
Net sales decreased $6.3 million, or 14.8%, from $42.6 million in 1995 to $36.3 million in 1996. This decrease was primarily caused by a 14.4% reduction in the number of catalogs mailed during 1996 compared to 1995. Fewer catalogs were mailed because (i) a reduction in advertising during the second half of 1995 and all of 1996 resulted in fewer prospective customers requesting catalogs; and (ii) historical mailing results did not project that sufficient revenues would be generated to cover the costs of printing and mailing catalogs to certain segments of the customer mailing list in view of the increases in the cost of paper and postage which had occurred since the beginning of 1995. While these actions resulted in lower sales, the Company believed they were important in generating operating income in 1996.
Gross margin increased from 61.4% in 1995 to 64.7% in 1996. This increase resulted from (i) the continued expansion of the Company's direct import program, which resulted in a larger percentage of product being purchased at lower prices directly from overseas factories; and (ii) a reduction in the cost of shipping to customers packages weighing less than one pound, which reduced total shipping costs.
SG&A expenses decreased $2.6 million, or 11.4%, from $22.8 million in 1995 to $20.2 million in 1996. This decrease resulted from mailing fewer catalogs to customers and reducing page counts in certain catalogs in order to reduce paper and postage costs. The decrease also reflected fewer mailings to prospective customers as a result of the Company's decision to reduce advertising expenditures during the second half of 1995 and all of 1996. Total catalogs mailed decreased by 4.2 million, or 14.4%, from 29.2 million in 1995 to 25.0 million in 1996. Total catalog production costs decreased by $1.5 million, or 23.4%, from $6.4 million in 1995 to $4.9 million in 1996. Catalog production costs were adversely affected by the cost of paper during the first six months of 1996. During the last six months of 1996, the Company was able to take advantage of some reductions in the cost of paper. Advertising expense for 1996 decreased $2.9 million, or 17.8%, from $16.3 million in 1995 to $13.4 million in 1996.
Net interest expense decreased $0.2 million, or 10.5%, from $1.9 million in 1995 to $1.7 million in 1996, reflecting lower principal amounts outstanding on the Company's bank loan and lower interest rates. The Company's bank debt was reduced in October 1996 by $5.9 million of proceeds from the Company's initial public offering, of which $4.45 million was applied to the Company's term loan and $1.45 million was applied to the Company's line of credit.
LIQUIDITY AND CAPITAL RESOURCES
Cash flows provided by operating activities increased by nearly $3.5 million from approximately $300,000 for 1996 to $3.8 million for 1997. Cash flows provided by financing activities generated approximately $700,000 as a result of the Company refinancing its long-term debt and advances on its lines of credit. Cash flows provided by operating and financing activities were offset by $5.2 million of cash used in investing activities, primarily due to the Daxbourne acquisition.
In October 1996, the Company successfully completed an initial public offering ("IPO") for 1.5 million shares of its common stock priced at $6.50 per share. Net proceeds to the Company were $7.8 million. The proceeds from the IPO were used to pay down $5.9 million of bank debt, to bring accounts payable into a current position and to provide additional working capital. The reduction of the bank debt reduced future scheduled payments by approximately one-third and gave the Company full availability of its $2 million revolving credit line.
In March 1997, the Company entered into an $11 million credit facility with BankBoston, N.A. (the "BKB Agreement") for the purpose of refinancing its existing senior and subordinated debt and to provide for the capital expenditures and working capital needs of the Company. The BKB Agreement provided for a $5 million term loan (the "Term Loan") and a $6 million revolving line of credit (the "Line of Credit"). The Term Loan and the Line of Credit bear interest rates based on either a base rate, as defined in the BKB agreement, or a LIBOR contract rate. As of January 3, 1998, the Term Loan was under a LIBOR contract rate of 6.75% for $4,500,000 and 7.69% for $250,000. As of January 3, 1998, a portion of the Line of Credit was under LIBOR contract rates ranging from 7.40% to 7.69% and the remainder of the Line of Credit was at the base rate of 8.75%. The Company is required to pay a commitment fee varying from 0.375% to 0.50% per annum on the unused portion of the commitment. At January 3, 1998, $3,054,115 was available under this Line of Credit.
In March 1997, the Company used the proceeds from the Term Loan and $500,000 under the Line of Credit to pay off its remaining indebtedness to Banque Nationale de Paris ("BNP"). In conjunction with this repayment, the Company recorded a $161,567 extraordinary loss on the early retirement of debt (net of an income tax benefit of $107,711). Also in March 1997, the Company repaid $1,896,913 of principal and accrued interest on the Company's subordinated debt, with $1,765,767 repaid from proceeds from the Line of Credit and $131,146 repaid by offsetting a note receivable from a stockholder. In April 1997, the Company used proceeds from the Line of Credit to repay its remaining senior subordinated debt in the amount of $2,901,496 of principal and accrued interest.
Due to its working capital constraints, on June 1, 1996, the Company entered into an agreement with Martin E. Franklin, a director of the Company, and two associates of Mr. Franklin, pursuant to which Mr. Franklin and such associates loaned the Company $495,000. 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. In April 1997, the holders of these warrants elected to apply amounts owed to them under the junior subordinated note as consideration to be paid for 265,335 shares of the Company's Common Stock. In conjunction with this transaction, the Company recorded a $57,132 extraordinary loss on the early retirement of debt (net of an income tax benefit of $41,372).
On October 3, 1997, the Company amended the existing BKB Agreement (the "Amended BKB Agreement") and entered into an additional $4.0 million credit agreement with BankBoston, N.A., acting through its London Branch (the "BKB U.K. Agreement"), in connection with the Company's acquisition of The Daxbourne Group. The Amended BKB Agreement extended the maturity date of borrowings from March 2001 to October 2001, with the Term Loan having a new four year repayment schedule with $1.25 million due in each of the next three years and $1,000,000 due in 2001.
The BKB U.K. Agreement provides for an approximate $1.8 million term loan (the "U.K. Term Loan") and for an approximate $2.2 million revolving line of credit (the "U.K. Line of Credit"). The U.K. Term Loan and the U.K. Line of Credit bear interest rates based on either a Sterling base rate, as defined by the BKB U.K.
Agreement, or a LIBOR contract rate. The BKB U.K. Agreement matures in October 2001, with the U.K. Term Loan having a four year repayment schedule with approximate repayments of $318,000 due in 1998, $470,000 due in 1999, $544,000 due in 2000, and $498,000 due in 2001. As of January 3, 1998, the U.K. Term Loan and U.K. Line of Credit were under a LIBOR contract rate of 9.03%. The Company is required to pay a commitment fee varying from 0.375% to 0.50% per annum on the unused portion of the commitment. At January 3, 1998, $335,933 was available under the U.K. Line of Credit.
The Amended BKB Agreement and the BKB U.K. Agreement (collectively the "Consolidated Credit Facility") are cross collateralized by a first perfected security interest in all tangible and intangible assets of the Company. The Consolidated Credit Facility is subject to certain consolidated covenants, including but not limited to leverage and debt service coverage ratios, minimum earnings requirements, and a restriction on the payment of cash dividends on the Company's common stock.
In October 1997, the Company, through its new subsidiary, Daxbourne International Limited, acquired substantially all of the assets of The Daxbourne Group, a leading retailer and wholesaler of women's wigs, hairpieces and related products in the U.K. Daxbourne distributes wigs and hairpieces under its Jacqueline Collection, Pretty Woman and Natural Image brands, and has established a strong presence in the U.K. through catalog, retail and wholesale distribution channels.
As part of this transaction, the Company acquired substantially all of the assets of The Daxbourne Group, including inventory, real property, physical plant and equipment, intangible assets and other assets used in connection with the business. As aggregate consideration for this acquisition, the Company paid $3,629,000 at the closing of the transaction (the "Closing"), incurred acquisition costs of approximately $762,000, agreed to assume certain trade liabilities totaling $387,000, and agreed to pay approximately $493,000, without interest, to the seller on the one year anniversary of the Closing. The Company financed this acquisition primarily through its BKB U.K. Agreement, with $1.8 million of proceeds from the U.K. Term Loan and $1.8 million from the U.K. Line of Credit.
Beginning in 1998, the Company began to build out its former warehouse space in its South Easton facility to allow for further expansion of the other operating groups of the Company. Costs of the renovation are expected to be approximately $300,000.
The Company's cash flow from operations and available credit facilities are considered adequate to fund planned business operations and both the short- term and long-term capital needs of the Company. However, certain events, such as additional significant acquisitions, could require new external financing.
INFORMATION SYSTEMS AND THE YEAR 2000
The Company is in the process of installing a new comprehensive catalog information system purchased from an outside vendor. The system is currently undergoing modification, both by the vendor and by the Company's internal staff. The system is scheduled to be implemented for SC Direct by mid-to-late 1998. The new system has been represented by its vendor to be Year 2000 compliant. Following the implementation of SC Direct, it is anticipated that the system will be modified to deal with the special processing needs of SC Publishing. It is anticipated that these modifications will take between three and six months to complete, with implementation being completed in early-to- mid 1999. The entire cost of the new system, including new hardware, is estimated to be between $1.2 and $1.4 million, of which approximately $600,000 was capitalized during 1997. The Company expects to capitalize the cost of purchasing the new software and hardware. The Company also has installed new financial reporting software, which has also been represented by its vendor as being Year 2000 compliant.
The Company plans on reviewing, in the near future, its remaining hardware and software, primarily personal computers and related software for Year 2000 compliance and will either replace or modify as appropriate. The Company does not believe the cost of any such modifications will be material. The Company plans on reviewing Year 2000 compliance with its most significant vendors and suppliers by the end of 1998.
RISK FACTORS
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. 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.
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 possible significant increase in the price of fiber, may have a material adverse effect on the Company's wig and hairpiece sales and profit margins.
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 supplied between 13% and 23% of the Company's overall wig purchases in 1997. 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.
Dependence Upon Foreign Suppliers; Exchange Rates; and Currency Fluctuations. The Company expects that most of its wigs and hairpieces 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, such as the recent financial instabilities in the Asian markets, export duties, work stoppages and, in certain parts of the world, political instability and possible governmental intervention. As such, the availability and cost of wigs may be favorably or adversely affected by any of these items. 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.
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. Women suffering from hair loss 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 (marketed under the name Rogaine(R) as well as other names), 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 may have a material adverse effect on the Company's core wig business. In addition, the development of any therapies, such as new cancer treatments, that would eliminate hair loss as a side effect, may have a material adverse effect on the Company's business.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
All other schedules for which provision is made in the applicable regulations of the Securities and Exchange Commission have been omitted because the information is disclosed in the Consolidated Financial Statements or because such schedules are not required or are not applicable.
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of Specialty Catalog Corp.
We have audited the accompanying consolidated balance sheets of Specialty Catalog Corp. as of January 3, 1998 and December 28, 1996 and the related consolidated statements of operations and consolidated statements of stockholders' equity and cash flows for the three years ended January 3, 1998, December 28, 1996 and December 30, 1995. Our audits also included the consolidated financial statement schedule listed in the Index at Item 8. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule 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 January 3, 1998 and December 28, 1996 and the results of its operations and its cash flows for the three years ended January 3, 1998, December 28, 1996 and December 30, 1995, in conformity with generally accepted accounting principles. Also, in our opinion, such consolidated financial statement schedule when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects the information set forth therein.
Deloitte & Touche LLP
/s/ Deloitte & Touche LLP Boston, Massachusetts February 27, 1998
SPECIALTY CATALOG CORP.
CONSOLIDATED BALANCE SHEETS
See notes to consolidated financial statements.
SPECIALTY CATALOG CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
See notes to consolidated financial statements.
SPECIALTY CATALOG CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
See notes to consolidated financial statements.
SPECIALTY CATALOG CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See notes to consolidated financial statements.
SPECIALTY CATALOG CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS--(CONTINUED)
SUMMARY OF NONCASH TRANSACTIONS:
During the year ended January 3, 1998, the Company offset $131,146 of note receivable from a stockholder against the portion of the subordinated notes owed to that stockholder.
During the year ended January 3, 1998, the Company converted $495,000 of junior subordinated debt and $5,000 of accrued interest into $2,653 of common stock and $497,347 of additional paid-in capital as a result of several shareholders' election to apply amounts owed to them under the junior subordinated note as consideration in the exercise of warrants held by them.
During the year ended January 3, 1998, the Company recorded capital lease obligations of $159,421 related to the acquisition of data processing equipment.
During the year ended January 3, 1998, the Company recorded deferred purchase price consideration of $492,510 in connection with the acquisition of The Daxbourne Group (see footnote 9).
During the year ended January 3, 1998, an officer of the Company exercised 55,000 stock options for which the Company recorded a deduction in its income tax payable and an increase in additional paid in capital of $126,087.
During the years ended December 28, 1996 and December 30, 1995, the Company issued $237,216 and $445,333, respectively, of subordinated debt in lieu of payment of interest.
During the years ended December 28, 1996 and December 30, 1995, the Company declared dividends on preferred stock of $146,188 and $292,383, respectively. In conjunction with the Company's initial public offering, all shares of preferred stock were converted into common stock and all accumulated dividends, and accrued interest on those dividends, through the date of the offering were irrevocably waived by the holders of the preferred stock as of August 13, 1996.
See notes to consolidated financial statements.
SPECIALTY CATALOG CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FISCAL YEARS ENDED JANUARY 3, 1998, DECEMBER 28, 1996 AND DECEMBER 30, 1995
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business--Specialty Catalog Corp. (the "Company") targets niche consumer product categories, primarily via direct marketing. 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. Daxbourne International Limited, a subsidiary of SC Direct, is a leading U.K. retailer and wholesaler of women's wigs and hairpieces. SC Publishing, another subsidiary of SC Direct, sells continuing education courses to nurses and CPAs.
Principles of Consolidation--The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All material inter-company balances and transactions have been eliminated in consolidation.
Translation of Foreign Currencies--The financial statements of the Company's foreign subsidiary are translated from the local currency into U.S. dollars using the current exchange rate at the balance sheet date for assets and liabilities and the average exchange rate prevailing during the period for revenues and expenses. The local currency of its foreign subsidiary is considered to be the functional currency. Exchange gains and losses on inter- company balances of a long-term investment nature are recorded as a charge or credit to stockholders' equity, while other transaction gains and losses are recorded directly to the consolidated statements of operations.
Cash and Cash Equivalents--Cash and cash equivalents consist of cash and temporary investments with maturities of three months or less when purchased.
Inventories--Inventories are stated at the lower of cost or market. Cost is determined using the weighted average cost method. 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 for selling purposes is capitalized and amortized over the expected period of future benefit, generally two to four months. For the years ended January 3, 1998, December 28, 1996 and December 30, 1995, advertising expense was $13.7 million, $13.4 million and $16.3 million, respectively.
Property, Plant and Equipment--Property, plant and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation is computed using 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.
Intangibles--Intangible assets consisting of goodwill, covenants not to compete, customer lists, trademarks, and tradenames are amortized using the straight-line method over useful lives of five to thirty years. Management's policy regarding intangible assets is to evaluate the recoverability of its intangible assets when the facts and circumstances suggest that these assets may be impaired. Evaluations consider factors including operating results, business and strategic plans, economic projections, and market emphasis. Evaluations compare expected cumulative, undiscounted operating incomes or cash flows with net book values of related intangible assets. Unrealizable intangible asset values are charged to operations. There were no impairment charges during the fiscal years presented.
SPECIALTY CATALOG CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Other Assets--Other assets consist primarily of deferred financing costs. Deferred financing costs which were incurred by the Company in connection with the BankBoston, N.A. agreements in the U.S. and the U.K. (see footnote 7) are amortized over the life of the underlying indebtedness using the straight-line method. At January 3, 1998, deferred financing costs were $180,190. Deferred financing costs which were incurred by the Company in connection with the Banque Nationale de Paris ("BNP") note were charged as an extraordinary loss in 1997 as part of the refinancing agreement with BankBoston, N.A. The Company recorded an extraordinary charge of $161,567, net of an income tax benefit of $107,711. At December 28, 1996, deferred financing costs were $287,804 under the BNP agreement.
Income Taxes--The Company uses the asset and liability method of accounting for deferred income taxes. The provision for income taxes includes income taxes currently payable and those deferred because of temporary differences between the financial statement and tax bases of assets and liabilities.
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--Statement of Financial Accounting Standards ("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 sheets 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 January 3, 1998 and December 28, 1996, due to the short-term maturities of these investments. The carrying value and fair value of the Company's long-term debt at January 3, 1998 was $6,579,758.
Stock-Based Compensation--In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation," which became effective for the Company for periods beginning after December 15, 1995. SFAS No. 123 requires expanded disclosures of stock- based compensation arrangements with 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 Accounting Principles Board ("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 has disclosed the required pro forma effect on net income and basic and diluted earnings per share (see footnote 11).
Earnings Per Share--In February 1997, the Financial Accounting Standards Board issued SFAS No. 128, "Earnings Per Share", which is effective for financial statements issued for periods ending after December 15, 1997. This statement required the adoption of new calculation methodologies and enhanced disclosures of basic and diluted earnings per share computations. As required, the Company has adopted SFAS No. 128 in the fourth quarter of 1997 and has restated prior year earnings per share presentations to conform to SFAS No. 128. The Company has prepared a reconciliation of income before extraordinary items available to common shareholders and weighted average shares used in the calculations for basic and diluted earnings per share (see footnote 12).
SPECIALTY CATALOG CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Newly Issued Accounting Statements--In June 1997, the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income," which became effective for the Company for periods beginning after December 15, 1997. SFAS No. 130 establishes standards for reporting and displaying comprehensive income and its components (revenues, expenses, gains, and losses) in a full set of general purpose financial statements. Reclassification of financial statements for earlier periods provided for comparative purposes is required. The Company believes that the adoption of SFAS No. 130 will not have a material impact on the Company's financial condition or results of operations.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" which became effective for the Company for periods beginning after December 15, 1997. SFAS No. 131 establishes standards for the way public companies report selected information about operating segments in annual financial statements and requires those companies to report selected information about segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. SFAS No. 131 supersedes SFAS No. 14, "Financial Reporting Segments of a Business Enterprise," but retains the requirement to report information about major customers. The Company has not yet determined the effects that SFAS No. 131 will have on its financial statements.
Fiscal Year--The Company is on a 52/53 week fiscal year, ending on the Saturday closest to December 31. The fiscal years ended January 3, 1998, December 28, 1996 and December 30, 1995 consisted of 53/52/52 weeks, respectively. Unless otherwise indicated, "1997" means the Company's fiscal year ended January 3, 1998, "1996" means the Company's fiscal year ended December 28, 1996, and "1995" means the Company's fiscal year ended December 30, 1995.
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. Management bases its estimates on historical experiences and on various assumptions which are believed to be reasonable under the circumstances. The primary estimates underlying the Company's financial statements include allowances for doubtful accounts, allowances for returns, and inventory valuation.
Reclassifications--Certain amounts in the 1995 and 1996 financial statements have been reclassified to conform to the 1997 presentation.
2. PREPAID EXPENSES
Prepaid expenses at January 3, 1998 and December 28, 1996 consist of the following:
SPECIALTY CATALOG CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 3. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following at January 3, 1998 and December 28, 1996:
-------- (i) Lesser of the estimated useful lives of the related assets or the lease term.
Depreciation and amortization was $308,326, $275,062 and $247,982 for the years ended January 3, 1998, December 28, 1996 and December 30, 1995, respectively.
4. INTANGIBLE ASSETS
Intangible assets consist of the following at January 3, 1998 and December 28, 1996:
Amortization expense was $84,624, $1,345 and $1,145 for the years ended January 3, 1998, December 28, 1996 and December 30, 1995, respectively.
5. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses at January 3, 1998 and December 28, 1996 consist of the following:
SPECIALTY CATALOG CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 6. LIABILITIES TO CUSTOMERS
Liabilities to customers at January 3, 1998 and December 28, 1996 consist of the following:
Deferred revenue reflects cash received from customers for ordered 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 January 3, 1998 and December 28, 1996:
In March 1997, the Company entered into an $11 million credit facility with BankBoston, N.A. (the "BKB Agreement") for the purpose of refinancing its existing senior and subordinated debt and to provide for the capital expenditures and working capital needs of the Company. The BKB Agreement provided for a $5 million term loan (the "Term Loan") and a $6 million revolving line of credit (the "Line of Credit"). The Term Loan and the Line of Credit bear interest rates based on either a base rate, as defined in the BKB agreement, or a LIBOR contract rate. As of January 3, 1998, the Term Loan was under a LIBOR contract rate of 6.75% for $4,500,000 and 7.69% for $250,000. As of January 3, 1998, a portion of the Line of Credit was under LIBOR contract rates ranging from 7.40% to 7.69% and the remainder of the Line of Credit was at the base rate of 8.75%. The Company is required to pay a commitment fee varying from 0.375% to 0.50% per annum on the unused portion of the commitment. At January 3, 1998, $3,054,115 was available under this Line of Credit.
In March 1997, the Company used the proceeds from the Term Loan and $500,000 under the Line of Credit to pay off its remaining indebtedness to Banque Nationale de Paris ("BNP"). In conjunction with this repayment, the Company recorded a $161,567 extraordinary loss on the early retirement of debt (net of an income tax benefit of $107,711). Also in March 1997, the Company repaid $1,896,913 of principal and accrued interest on the SC Holdings LLC Subordinated Note and SC Holdings PIK Note, with $1,765,767 repaid from proceeds from the Line of Credit and $131,146 repaid by offsetting a note receivable from a stockholder. In April 1997, the Company used proceeds from the Line of Credit to repay its remaining senior subordinated debt in the amount of $2,901,496 of principal and accrued interest.
Due to its working capital constraints, on June 1, 1996, the Company entered into an agreement with Martin E. Franklin, a director of the Company, and two associates of Mr. Franklin, pursuant to which Mr. Franklin and
SPECIALTY CATALOG CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) such associates loaned the Company $495,000. 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. In April 1997, the holders of these warrants elected to apply amounts owed under the junior subordinated note as consideration to be paid for 265,335 shares of the Company's Common Stock. In conjunction with this transaction, the Company recorded a $57,132 extraordinary loss on the early retirement of debt (net of an income tax benefit of $41,372).
On October 3, 1997, the Company amended the existing BKB Agreement (the "Amended BKB Agreement") and entered into an additional $4.0 million credit agreement with BankBoston, N.A., acting through its London Branch (the "BKB U.K. Agreement"), in connection with the Company's acquisition of The Daxbourne Group (see footnote 9). The Amended BKB Agreement extended the maturity date of borrowings from March 2001 to October 2001, with the Term Loan having a new four year repayment schedule with $1.25 million due in each of the next three years and $1,000,000 due in 2001.
The BKB U.K. Agreement provides for an approximate $1.8 million term loan (the "U.K. Term Loan") and for an approximate $2.2 million revolving line of credit (the "U.K. Line of Credit"). The U.K. Term Loan and the U.K. Line of Credit bear interest rates based on either a Sterling base rate, as defined by the BKB U.K. Agreement, or a LIBOR contract rate. The BKB U.K. Agreement matures in October 2001, with the U.K. Term Loan having a four year repayment schedule with approximate repayments of $318,000 due in 1998, $470,000 due in 1999, $544,000 due in 2000, and $498,000 due in 2001. As of January 3, 1998, the U.K. Term Loan and U.K. Line of Credit were under a LIBOR contract rate of 9.03%. The Company is required to pay a commitment fee varying from 0.375% to 0.50% per annum on the unused portion of the commitment. At January 3, 1998, $335,933 was available under this U.K. Line of Credit.
The Amended BKB Agreement and the BKB U.K. Agreement (collectively the "Consolidated Credit Facility") are cross collateralized by a first perfected security interest in all tangible and intangible assets of the Company. The Consolidated Credit Facility is subject to certain consolidated covenants, including but not limited to leverage and debt service coverage ratios, minimum earnings requirements, and a restriction on the payment of cash dividends on the Company's common stock. The aggregate maturities of long-term debt after January 3, 1998 are as follows:
8. SALE OF ASSETS
On June 27, 1997, the Company's subsidiary, SC Publishing, sold its business of continuing education for California real estate professionals. The sales price of $212,250 included a license to use the trade name Western Schools(R) for real estate courses, all related inventory for existing courses, and title and rights to its real estate courses, both existing and under development. The Company recognized a pre-tax gain, included in selling, general, and administrative expenses, on the sale of these assets of $121,980. The Company will also receive an annual royalty fee each year for a three-year period equal to the greater of (i) $25,000 and (ii) 5% of the revenue received by the buyer from sales of courses sold under the Company's trade name.
SPECIALTY CATALOG CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 9. DAXBOURNE ACQUISITION
In October 1997, the Company, through its new subsidiary, Daxbourne International Limited, acquired substantially all of the assets of Daxbourne Limited and its wholly owned subsidiaries, which consisted of Postinstant Limited and MC Hairways Limited (collectively, the "Sellers" or "The Daxbourne Group").
As part of this transaction, the Company acquired substantially all of the assets of The Daxbourne Group including inventory, real property, physical plant and equipment, intangible assets and other assets used in connection with the Sellers' business. As aggregate consideration for this acquisition, the Company paid $3,629,000 at the closing of the transaction (the "Closing"), incurred acquisition costs of approximately $762,000, agreed to assume certain trade liabilities of the Sellers totaling $387,000, and agreed to pay approximately $493,000, without interest, to the Sellers on the one year anniversary of the Closing. The excess of consideration paid including deferred consideration, over the fair value of net assets acquired, recorded as goodwill in the accompanying balance sheet, totaled $1,792,964 (see footnote 4). The Company financed this acquisition primarily through its BKB U.K. Agreement with $1.8 million of proceeds from the U.K. Term Loan and $1.8 million of proceeds from the U.K. Line of Credit.
10. PREFERRED STOCK
On November 30, 1994, the Company issued 22,491 shares of 13% Preferred Stock. Coincidental with the Company's initial public offering on October 17, 1996, all outstanding shares of preferred stock were converted into 375,000 shares of common stock. All accumulated dividends, and accrued interest on those dividends through the date of the offering, were irrevocably waived by the holders of the preferred stock as of August 13, 1996.
11. STOCKHOLDERS' EQUITY
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 were entitled to one vote per share while holders of Class B and Class C shares were entitled to one-half vote per share and one and one-half votes per share, respectively. All dividend and liquidation rights remained 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.
On October 17, 1996, the Company completed an initial public offering of 1.5 million shares of its common stock at an initial offering price of $6.50 per share. Net proceeds to the Company after offering expenses were $7,754,760. Coincidental with the offering, the Company increased the number of authorized common shares from 6,510,200 to 10 million, converted on a one-for-one basis the outstanding shares of Class A, Class B and Class C shares into common stock, and effected a 325.51-for-one split of outstanding common stock. All numbers of common shares and per share data in the accompanying consolidated financial statements for the years ended December 28, 1996 and December 30, 1995 have been adjusted for the stock split.
Stock Compensation Plan--On October 17, 1996, the Company adopted the 1996 Stock Incentive Plan (the "Plan") which authorized the issuance of up to 500,000 shares of Common Stock through the grant of stock options and awards of restricted stock. Each option has a maximum term of ten years from the date of grant,
SPECIALTY CATALOG CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) subject to early termination. The per share exercise price for options granted under the plan will (i) not be less than the fair market value of a share of the Company's common stock on the date of the grant and (ii) not be less than the initial public offering price of $6.50 per share.
Stock option activity is summarized below:
Options exercisable at January 3, 1998, December 28, 1996 and December 30, 1995 were 648,229, 538,444 and 60,618, respectively. The options outstanding as of January 3, 1998 have weighted average remaining contractual lives of 6.9 years for the $0.31 options issued in 1994, 8.8 years for the $5.33-$6.50 options granted in 1996 and 9.6 years for the $6.50-$6.88 options granted in 1997.
The Company applies APB Opinion No. 25 and related interpretations in accounting for the Plan and therefore no compensation cost has been recognized for options granted under the Plan provisions. Had compensation cost been determined based on the fair value at the grant dates for options granted with the method prescribed by Statement of Financial Accounting Standards No. 123 "Accounting for Stock-based Compensation", the Company's net income and basic and diluted earnings per share would have been changed to the pro forma amounts indicated below:
SPECIALTY CATALOG CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The fair value of each option grant used to compute pro-forma net income and basic and diluted earnings per share disclosures is the estimated present value on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions for 1997 and 1996, respectively: expected volatility of 8.23% and 60.14%, a risk free interest rate of 5.65% and 6.38% and an expected holding period of 6 years.
Stock Warrants--In connection with the issuance of 11.5% junior subordinated notes on August 12, 1996, the Company issued warrants to purchase 265,335 shares of common stock for an aggregate exercise price of $500,000 ($1.8844 per share). As discussed in Note 7, these warrants were exercised in 1997.
12. RECONCILIATION OF BASIC AND DILUTED EARNINGS PER SHARE
The following data shows the amounts used in computing basic and diluted earnings per share for income before extraordinary items and the effects of potentially dilutive securities on the weighted average number of shares outstanding.
Options to purchase 2,500 shares of common stock at $6.88 per share were not included in computing diluted EPS for the year ended January 3, 1998 because their effects are antidilutive. There were not any options during the years ended December 28, 1996 and December 30, 1995 whose effects were excluded because they were antidilutive.
13. RESTRUCTURING CHARGES
During 1995, the Company restructured by consolidating its operations in one geographic area in order to reduce costs and utilize resources more efficiently. Specifically, restructuring charges included:
All expenditures related to this charge were paid in 1995.
SPECIALTY CATALOG CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 14. INCOME TAXES
The provision for income taxes consists of the following at January 3, 1998, December 28, 1996 and December 30, 1995:
Deferred income tax assets and liabilities consist of the following at January 3, 1998 and December 28, 1996:
Reconciliation of the statutory Federal income tax rate and the effective rate of the provision for income taxes for the years ended January 3, 1998, December 28, 1996 and December 30, 1995 is as follows:
SPECIALTY CATALOG CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The Company has recorded a deferred tax asset of $5,560,050 primarily reflecting the benefit of $16,875,378 of net operating loss carryforwards which expire in varying amounts between 1998 and 2010. Realization is dependent on generating sufficient taxable income prior to expiration of the loss carryforwards. The use of the net operating losses is subject to an annual limitation of $1,555,125 due to a change in control of the Company pursuant to Section 382. Although realization is not assured, management believes it is more likely than not that all of the deferred tax asset will be realized.
15. COMMITMENTS AND CONTINGENCIES
Lease Commitments--Certain non-cancelable leases are classified as capital leases, and the leased assets are included as part of "Property, plant and equipment." The obligations of the Company under such leases are collateralized by the leased equipment. Other leases are classified as operating leases and are not capitalized. Future minimum lease payments under capital leases are included in other long-term liabilities and are as follows:
Operating Leases--The Company leases certain administrative, warehousing and other facilities under operating leases. The following is a schedule of future minimum rental payments under non-cancelable operating leases as of January 3, 1998:
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 years ended January 3, 1998, December 28, 1996 and December 30, 1995 was $490,292, $362,676 and $438,450, 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 $1,070,000 at January 3, 1998 as follows:
In addition, the two executive officers, along with all other salaried employees, may earn certain other bonuses based on the Company's achievement of certain operating targets.
SPECIALTY CATALOG CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
16. EMPLOYEE BENEFIT PLAN
The Company maintains a qualified defined contribution plan, under the provisions of Section 401(k) of the Internal Revenue Code, covering substantially all United States 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 $85,678, $71,176 and $67,188 in 1997, 1996 and 1995, respectively. No discretionary contributions have been made to the plan.
17. FINANCIAL INFORMATION BY GEOGRAPHIC AREA
The Company markets its products in two major geographic areas, the United States and the United Kingdom. Certain information by geographic area follows:
- -------- (1) The financial information included in the United Kingdom column represents the assets and liabilities as of January 3, 1998, and activity for the period from October 3, 1997 through January 3, 1998 which are included in the Company's year ended January 3, 1998 consolidated financial statements.
SPECIALTY CATALOG CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 18. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED):
- -------- (1) In 1997, the Company recorded a $218,699 extraordinary loss on the early retirement of debt (net of an income tax benefit of $149,083) (see footnote 7).
(2) During the six-month period ended June 29, 1996 the Company declared preferred stock dividends of $146,188. In conjunction with the Company's initial public offering, all shares of preferred stock were converted into common stock and all accumulated dividends through the date of the offering were irrevocably waived by the holders of the preferred stock as of August 13, 1996.
SPECIALTY CATALOG CORP.
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The response to this item is contained in part under the caption "Executive Officers of the Registrant" in Part I, Item 1A hereof and the remainder is incorporated herein by reference from the discussion responsive thereto under the caption "Election of Directors" in the Company's Proxy Statement relating to the 1998 Annual Meeting of Shareholders.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The response to this item is incorporated by reference from the discussion responsive thereto under the following captions in the Company's Proxy Statement relating to the 1998 Annual Meeting of Shareholders:
"Election of Directors" and "Executive Compensation"
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The response to this item is incorporated by reference from the discussion responsive thereto under the caption "Principal Shareholders" in the Company's Proxy Statement relating to the 1998 Annual Meeting of Shareholders.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The response to this item is incorporated by reference from the discussion responsive thereto under the caption "Certain Transactions" in the Company's Proxy Statement relating to the 1998 Annual Meeting of Shareholders.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(C) EXHIBITS
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
Specialty Catalog Corp.
/s/ Steven L. Bock By: _________________________________ STEVEN L. BOCK CHAIRMAN AND CHIEF EXECUTIVE OFFICER
/s/ J. William Heise By: _________________________________ J. WILLIAM HEISE SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS IN THE CAPACITIES AND ON THE DATE INDICATED.
SIGNATURES TITLE DATE
/s/ Steven L. Bock Chairman of the Board March 26, _____________________________________ and Chief Executive 1998 STEVEN L. BOCK Officer (Principal Executive Officer)
/s/ Stephen M. O'Hara President March 26, _____________________________________ 1998 STEPHEN M. O'HARA
/s/ J. William Heise Senior Vice President March 26, _____________________________________ and Chief Financial 1998 J. WILLIAM HEISE Officer (Principal Financial and Accounting Officer)
/s/ Alan S. Cooper Director March 26, _____________________________________ 1998 ALAN S. COOPER
/s/ Martin E. Franklin Director March 26, _____________________________________ 1998 MARTIN E. FRANKLIN
/s/ Samuel L. Katz Director March 26, _____________________________________ 1998 SAMUEL L. KATZ
/s/ Andrea Pomerantz Lustig Director March 26, _____________________________________ 1998 ANDREA POMERANTZ LUSTIG
/s/ Guy Naggar Director March 26, _____________________________________ 1998 GUY NAGGAR