10-Q 1 d10q.txt FORM 10-Q ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------- FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 29, 2001 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 0-21499 ------------------- SPECIALTY CATALOG CORP. (Exact Name of Registrant as Specified in Its Charter) DELAWARE 04-3253301 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 21 BRISTOL DRIVE 02375 SOUTH EASTON, MASSACHUSETTS (Zip Code) (Address of principal executive offices) (508) 238-0199 (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No Number of shares of the Registrant's Common Stock outstanding as of November 9, 2001: 4,337,886. ================================================================================ 1 SPECIALTY CATALOG CORP. INDEX PART I. FINANCIAL STATEMENTS

Page No. -------- Item 1. Condensed Consolidated Financial Statements as of ~~June~~September 3029, 2001, December 30, 2000 and ~~July~~September 130, 2000, for the Thirteen Weeks Ended ~~June~~September 3029, 2001 and ~~July~~September 130, 2000 and for the ~~Twenty~~Thirty-~~Six~~Nine Weeks Ended ~~June~~September 3029, 2001 and ~~July~~September 130, 2000 Condensed Consolidated Statements of Operations 3-4 Condensed Consolidated Balance Sheets 5 Condensed Consolidated Statements of Cash Flows 6 Notes to Condensed Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 1213 PART II. OTHER INFORMATION Item 24. ~~Changes~~Submission inof ~~Securities~~Matters ~~and~~to ~~Use~~a Vote of ~~Proceeds~~Security 15Holders 17 Item 5. Other Information 1618 Item 6. Exhibits and Reports on Form 8-K 1719 Signatures 1820

2 PART I. FINANCIAL STATEMENTS Item 1. Condensed Consolidated Financial Statements SPECIALTY CATALOG CORP. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)

Thirteen Weeks Ended ~~June~~September 3029, 2001 ~~July~~September 130, 2000 ------------------ ------------------ Revenues: Net sales .................................................................... $ 1311,~~244~~234,~~157~~849 $ 1411,~~484~~702,~~695~~415 Shipping & handling income ................................................... 21,~~042~~532,~~875~~258 21,~~138~~714,~~392~~115 Royalties .................................................................... 136,~~183~~061 5735,~~119~~657 ------------- ------------ Total revenues .................................................................. 1512,~~300~~773,~~215~~168 1613,~~680~~452,~~206~~187 Cost of sales (including buying, occupancy and order fulfillment costs) .......................................................... 54,~~491~~862,~~006~~327 5,~~836~~074,~~990~~399 ------------- ------------ Gross profit .................................................................... 97,~~809~~910,~~209~~841 108,~~843~~377,~~216~~788 Operating expenses: Operating expenses ........................................................... 7,~~686~~050,~~578~~873 87,~~885~~560,~~760~~518 Depreciation and amortization ................................................ ~~466~~487,~~304~~339 ~~416~~437,~~329~~633 ------------- ------------ Total operating expenses ........................................................ 87,~~152~~538,~~882~~212 97,~~302~~998,~~089~~151 ------------- ------------ Income from operations .......................................................... 1372,~~656,327~~629 1379,~~541,127~~637 Interest expense, net ........................................................... ~~206~~253,~~751~~849 ~~225~~265,~~683~~627 ------------- ------------ Income before income taxes ...................................................... 1118,~~449,576~~780 1114,~~315,444~~010 Income tax provision ............................................................ ~~593~~49,~~098~~928 ~~539~~46,~~329~~738 ------------- ------------ Net income ...................................................................... ~~856~~68,~~478~~852 ~~776~~67,~~115~~272 Other comprehensive income (loss) - foreign currency translation adjustment ..... 97159,~~019~~877 81(24,~~204~~544) ------------- ------------ Comprehensive income ............................................................ $ ~~759~~228,~~459~~729 $ ~~694~~42,~~911~~728 ============= ============ Earnings per share - Basic EPS: Net income per share ...................................................... $ 0.2002 $ 0.1802 ============ ============ Weighted average shares outstanding ....................................... 4,337,886 4,~~340~~337,~~353~~886 ============ ============ Earnings per share - Diluted EPS: Net income per share ...................................................... $ 0.1902 $ 0.1701 ============ ============ Weighted average shares outstanding ....................................... 4,~~592~~628,~~700~~889 4,~~615~~643,~~365~~556 ============ ============

See notes to condensed consolidated financial statements. 3 SPECIALTY CATALOG CORP. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)

~~Twenty~~Thirty-~~Six~~Nine Weeks Ended ~~June~~September 3029, ~~2001~~September ~~July 1~~30, ~~2000~~------------- ------------- 2001 2000 ------------ ---- Revenues: Net sales ................................................................... $ 2738,~~512~~747,~~930~~779 $ 2840,~~366~~068,~~448~~861 Shipping & handling income .................................................. 45,~~292~~824,~~347~~605 45,~~250~~964,~~034~~149 Royalties ................................................................... 3743,~~185~~246 ~~138~~174,~~666~~325 ------------- ------------ Total revenues ................................................................. 3144,~~842~~615,~~462~~630 3246,~~755~~207,~~148~~335 Cost of sales (including buying, occupancy and order fulfillment costs) ......................................................... 1116,~~738~~600,~~223~~550 1116,~~667~~741,~~129~~528 ------------- ------------ Gross profit ................................................................... 2028,~~104~~015,~~239~~080 2129,~~088~~465,~~019~~807 Operating expenses: Operating expenses .......................................................... 1623,~~601~~652,~~179~~052 1826,~~582~~142,~~052~~570 Depreciation and amortization ............................................... ~~916~~1,~~460~~403,799 ~~816~~1,~~030~~253,663 ------------- ------------ Total operating expenses ....................................................... 1725,~~517~~055,~~639~~851 1927,~~398~~396,~~082~~233 ------------- ------------ Income from operations ......................................................... 2,~~586~~959,~~600~~229 12,~~689~~069,~~937~~574 Interest expense, net .......................................................... ~~470~~723,~~071~~920 ~~441~~707,~~682~~309 ------------- ------------ Income before income taxes ..................................................... 2,~~116~~235,~~529~~309 1,~~248~~362,~~255~~265 Income tax provision ........................................................... ~~866~~916,~~548~~476 ~~511~~558,~~769~~507 ------------- ------------ Net income ..................................................................... 1,~~249~~318,~~981~~833 ~~736~~803,~~486~~758 Other comprehensive loss - foreign currency translation adjustment ............. ~~250~~(90,~~826~~949) 76(101,~~537~~081) ------------- ------------ Comprehensive income ........................................................... $ ~~999~~1,~~155~~227,884 $ ~~659~~702,~~949~~677 ============= ============ Earnings per share - Basic EPS: Net income per share ..................................................... $ 0.2930 $ 0.1719 ============= ============ Weighted average shares outstanding ...................................... 4,337,886 4,~~345~~343,~~973~~208 ============= ============ Earnings per share - Diluted EPS: Net income per share ..................................................... $ 0.2829 $ 0.1617 ============= ============ Weighted average shares outstanding ...................................... 4,~~539~~573,~~968~~203 4,~~631~~666,~~735~~078 ============= ============

See notes to condensed consolidated financial statements. 4 SPECIALTY CATALOG CORP. CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)

~~June~~September 3029, December 30, ~~July~~September 130, 2001 2000 2000 ----- ----- ---- Assets Current assets: Cash and cash equivalents .....................................~~.....~~ $ 1720,~~533,346~~462 $ 435,276 $ ~~608~~739,~~112~~757 Accounts receivable, net ......................................~~.....~~ 1966,~~166,914~~891 1,521,469 1,~~502~~461,~~619~~900 Inventories ...................................................~~.....~~ 56,~~132~~198,~~249~~463 5,324,460 5,~~667~~935,~~516~~067 Prepaid expenses ..............................................~~.....~~ 3,~~671~~559,~~451~~956 3,561,311 4,~~458~~293,~~275~~724 ------------ ------------ ------------ Total current assets ................................~~.....~~ 11,~~503~~445,~~960~~772 10,842,516 12,~~236~~430,~~522~~448 ------------ ------------ ------------ Property, plant and equipment, net ..................................~~.....~~ 43,~~042~~885,~~273~~209 4,391,445 4,~~561~~537,~~834~~618 Intangible assets, net ..............................................~~.....~~ 3,~~943~~988,~~288~~676 3,942,508 43,~~172~~972,~~925~~786 Deferred income taxes ...............................................~~.....~~ 34,~~862~~013,~~719~~166 4,273,287 4,~~001~~433,~~199~~416 Other assets ........................................................~~.....~~ ~~262~~236,~~851~~292 253,748 ~~169~~200,~~507~~684 ------------ ------------ ------------ Total assets ........................................~~.....~~ $ 23,~~615~~569,~~091~~115 $ 23,703,504 $ 25,~~141~~574,~~987~~952 ============ ============ ============ Liabilities and Shareholders' Equity Current liabilities: Accounts payable and accrued expenses .........................~~.....~~ $ 43,~~023~~970,~~885~~293 $ 3,~~656~~739,~~757~~207 $ 45,~~953~~394,~~065~~205 Liabilities to customers ......................................~~.....~~ 1,~~134~~120,~~736~~823 925,888 1,~~163~~352,~~359~~320 Short-term borrowings .........................................~~.....~~ -- 788,100 56,~~426~~213,~~132~~482 Income taxes payable ..........................................~~.....~~ ~~458~~406,~~520~~584 376,914 ~~588~~359,~~340~~716 Current portion of long-term debt .............................~~.....~~ 1,800,000 1,800,000 21,~~384~~788,~~105~~653 ------------ ------------ ------------ Total current liabilities ...........................~~.....~~ 7,~~417~~297,~~141~~700 7,~~547~~630,~~659~~109 1415,~~515~~108,~~001~~376 ------------ ------------ ------------ Long-term ~~debt~~borrowings ................................................~~...........~~ 65,~~300~~850,000 7,200,000 1,~~959~~797,~~053~~674 Other long-term liabilities .........................................~~.....~~ ~~170~~465,~~885~~629 ~~227~~145,~~929~~479 ~~304~~262,~~499~~056 Commitments and contingencies Shareholders' equity: Common stock ................................................~~.......~~ 52,397 52,397 52,397 Additional paid-in capital ..................................~~.......~~ 16,159,570 16,159,570 16,159,570 Accumulated other comprehensive loss ........................~~.......~~ (~~389~~229,~~776~~899) (138,950) (~~127~~152,~~787~~331) Accumulated deficit .........................................~~.......~~ (3,~~227~~159,~~948~~104) (4,477,923) (4,~~853~~785,~~568~~612) ------------ ------------ ------------ 12,~~594~~822,~~243~~964 11,595,094 11,~~230~~274,~~612~~024 Less treasury stock, at cost, 901,888 shares at ~~June~~September 3029, 2001, December 30, 2000 and ~~July~~September 130, 2000 ...........~~..................~~ (2,867,178) (2,867,178) (2,867,178) ------------ ------------ ------------ Total shareholders' equity ..........................~~........~~ 9,~~727~~955,~~065~~786 8,727,916 8,~~363~~406,~~434~~846 ------------ ------------ ------------ Total liabilities and shareholders' equity ..........~~........~~ $ 23,~~615~~569,~~091~~115 $ 23,703,504 $ 25,~~141~~574,~~987~~952 ============ ============ ============

See notes to condensed consolidated financial statements. 5 SPECIALTY CATALOG CORP. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

~~Twenty~~Thirty-~~Six~~Nine Weeks Ended ~~June~~September 3029, ~~2001~~September ~~July 1~~30, ~~2000~~ ------------- ------------- 2001 2000 ---- ---- Cash flows from operating activities: Net income ............................................................. $ 1,~~249~~318,~~981~~833 $ ~~736~~803,~~486~~758 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization .................................... ~~916~~1,~~460~~403,799 ~~816~~1,~~030~~253,663 Deferred income taxes ............................................ ~~421~~263,~~913~~073 ~~351~~(72,~~587~~948) Changes in operating assets and liabilities: Accounts receivable, net ....................................... ~~328~~550,~~722~~493 (~~321~~294,~~096~~342) Inventories .................................................. ~~147~~(887,~~847~~243) (89378,~~503~~852) Prepaid expenses ............................................... ~~(117~~1,~~504)~~108 (~~455~~293,~~066~~295) Other assets ................................................... (3728,~~542~~805) 33(17,~~388~~336) Accounts payable and accrued expenses .......................... ~~463~~143,~~764~~411 ~~734~~1,~~685~~196,499 Liabilities to customers ....................................... ~~208~~194,~~848~~935 (5183,~~897)~~064 Income taxes payable ........................................... 8829,~~629~~131 ~~155~~(58,~~487~~494) Other long-term liabilities .................................... (8,334) (1629,~~668~~169) ------------ ----------- Net cash provided by operating activities .............................. 32,~~662~~980,~~784~~401 12,~~939~~292,~~433~~548 ------------ ----------- Cash flows from investing activities: Acquisitions, net of cash acquired and liabilities assumed....... (~~436~~482,~~560~~256) -- Purchases of trademarks .......................................... (~~700~~1,200) -- Purchases of property, plant and equipment ....................... (~~344~~517,~~396~~794) (~~872~~1,~~648~~189,923) ------------ ----------- Net cash used in investing activities .................................. (~~781~~1,~~656~~001,250) (~~872~~1,~~648~~189,923) ------------ ----------- Cash flows from financing activities: Repayments on short-term borrowings, net ......................... (788,100) (~~873~~26,~~758~~198) Repayments of long-term ~~debt~~borrowings...............................~~......~~ (~~900~~1,350,000) (~~616~~1,~~728~~338,293) Purchase of treasury stock ....................................... -- (35,446) Proceeds from issuance of other long-term liabilities ........... 583,457 -- Repayments of capital lease obligations .......................... (48103,~~710~~479) (6797,~~138~~080) ------------ ----------- Net cash used in financing activities .................................. (1,~~736~~658,~~810~~122) (1,~~593~~497,~~070~~017) ------------ ----------- Effect of exchange rate changes on cash and cash equivalents ........... (4635,~~248~~843) (2,~~450~~698) ------------ ----------- Increase (decrease) in cash and cash equivalents ....................... 1285,~~098,070~~186 (~~528~~397,~~735~~090) Cash and cash equivalents, beginning of year ........................... 435,276 1,136,847 ------------ ----------- Cash and cash equivalents, end of period ............................... $ 1720,~~533,346~~462 $ ~~608~~739,~~112~~757 ============ =========== Supplemental disclosures of cash flow information:

During the thirty-nine weeks ended September 30, 2000, the Company received federal income tax refunds of $320,000. See notes to condensed consolidated financial statements. 6 SPECIALTY CATALOG CORP. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 1. Basis of Presentation These unaudited condensed consolidated financial statements should be read in conjunction with the Form 10-K of Specialty Catalog Corp. (the "Company") for the fiscal year ended December 30, 2000, and the consolidated financial statements and footnotes included therein. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the Securities and Exchange Commission rules and regulations. The results of operations for the thirteen weeks and thirty-nine weeks ended September 29, 2001 are not necessarily indicative of the results for the entire fiscal year ending December 29, 2001. The condensed consolidated financial statements for the thirteen weeks and thirty-nine weeks ended September 29, 2001 and September 30, 2000 are unaudited but include, in the Company's opinion, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the results for the periods presented. 2. Accounting Policies The accounting policies underlying the condensed consolidated financial statements are those set forth in Note 1 of the consolidated financial statements included in the Company's Form 10-K for the year ended December 30, 2000. Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. Under SFAS No. 133, certain contracts that were not formerly considered derivatives may now meet the definition of a derivative. The Company adopted SFAS No. 133 effective December 31, 2000. As of December 30, 2000, the adoption of SFAS No. 133 did not have a material impact on the Company's consolidated financial statements. On January 19, 2001, the Company and Fleet National Bank, N.A. (the "Bank") entered into an Interest Rate Swap Agreement based on a notional principal balance of $4.5 million. Under the interest rate swap agreement, the Company receives quarterly LIBOR-based interest rate payments from the Bank, and pays interest quarterly at a fixed rate of 5.57% to the Bank, plus a borrowing margin to the Bank. These interest rate payments are settled net with the Bank. The agreement is effective for a period of two years and terminates on January 19, 2003. The interest rate swap is carried at its fair value. Hedge accounting is not applied and changes in the fair value of the swap are included in interest expense, net. At September 29, 2001, the carrying value of the swap was approximately $174,000, which is included in accrued expenses. Interest expense, net was increased by approximately $89,000 and $174,000 in the thirteen and thirty-nine weeks ended September 29, 2001, respectively, which represents the change in the fair value of the swap during these periods. In July 2001, the Financial Accounting Standards Board ("FASB") released SFAS No. 141, "Business Combinations". SFAS No. 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method. The Company does not believe that the adoption of SFAS No. 141 will have a significant impact on its condensed consolidated financial statements. 7 SPECIALTY CATALOG CORP. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) In July 2001, the FASB released SFAS No. 142, "Goodwill and Other Intangible Assets", which is effective for fiscal years beginning after January 1, 2002. SFAS No. 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. SFAS No. 142 also requires the Company to complete a transitional goodwill impairment test six months from the date of adoption. The Company is currently assessing, but has not yet determined the impact of SFAS No. 142 on its financial position and results of operations. In June 2001, the FASB released SFAS No. 143, "Accounting for Asset Retirement Obligations," which is effective January 1, 2003. SFAS No. 143 addresses the financial accounting and reporting for obligations and retirement costs related to the retirement of tangible long-lived assets. The Company does not expect that the adoption of SFAS No. 143 will have a significant impact on its condensed consolidated financial statements. In August 2001, the FASB released SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which is effective January 1, 2002. SFAS No. 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and the accounting and reporting provisions relating to the disposal of a segment of a business of Accounting Principles Board Opinion No. 30. The Company does not expect that the adoption of SFAS No. 144 will have a significant impact on its condensed consolidated financial statements. Certain amounts in the 2000 financial statements have been reclassified to conform to the 2001 presentation. 3. Reconciliation of Basic and Diluted Earnings per Share The following table (in thousands) shows the amounts used in computing basic and diluted earnings per share for net income and the effects of potentially dilutive options on the weighted average number of shares outstanding.

For the thirteen weeks ended For the ~~twenty~~thirty-~~six~~nine weeks ended ~~June~~September 3029, 2001 ~~July~~September 130, 2000 ~~June~~September 3029, 2001 ~~July~~September 130, 2000 ------------------ ------------------ ------------------ ------------------ Net Net Net Net Income Shares Income Shares Income Shares Income Shares ------ ------ ------ ------ -------- ------ ------ ------ Basic earnings per share ............... $ ~~856~~69 4,338 $ ~~776~~67 4,~~340~~338 $ 1,~~250~~319 4,338 $ ~~736~~804 4,~~346~~343 Effect of dilutive options ............. -- ~~255~~291 -- ~~275~~306 -- ~~202~~235 -- ~~286~~323 ------ ------ ------ ------ -------- ------ ------ ------ Diluted earnings per share ............. $ ~~856~~69 4,~~593~~629 $ ~~776~~67 4,~~615~~644 $ 1,~~250~~319 4,~~540~~573 $ ~~736~~804 4,~~632~~666 ====== ====== ====== ====== ======== ====== ====== ======

Options to purchase 487,301 shares of common stock ranging from $5.33 to $7.15 per share were not included in computing diluted EPS for the thirteen weeks and thirty-nine weeks ended September 29, 2001 because their effects were antidilutive. Options to purchase 529,951 shares of common stock ranging from $5.33 to $7.15 per share were not included in computing diluted EPS for the thirteen weeks and thirty-nine weeks ended September 30, 2000 because their effects were antidilutive. 4. Acquisition On January 29, 2001, the Company's British subsidiary, Daxbourne International Limited, acquired the women's wig and hairpiece business of the Company's former British licensee. The licensee had been the exclusive British licensee of the Company's Paula Young brand of women's wigs and hairpieces since 1994. During the term of the license agreement the licensee developed and circulated the Paula Young Fashion Wigs catalog using the merchandising and creative resources of the Company, thereby establishing Paula Young as a preeminent brand in Britain with a loyal customer following. 8 SPECIALTY CATALOG CORP. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) The purchase price includes (i) an initial fixed payment of approximately $254,000 on the closing date of the transaction, (ii) a fixed payment of approximately $36,000 due at the beginning of each of fiscal years 2002 and 2003 and (iii) a minimum royalty fee of approximately $73,000 per year due on March 31, 2002 and March 31, 2003, offset by the fixed payments in part (ii). The acquisition agreement also provides for the termination of the 1994 license agreement and transfer of the assets of the Paula Young Fashion Wigs catalog ------------------------ business to Daxbourne. Daxbourne's catalog division will now circulate both catalogs -- continuing to circulate its Jacqueline Collection catalog and the --------------------- Paula Young Fashion Wigs catalog. The agreement also called for continued ------------------------ support services from the British licensee for a period of three months ended April 30, 2001. 5. Sale of Assets On May 8, 2001, the Company's subsidiary, SC Publishing, Inc., sold its business of continuing education for accounting professionals to the California Certified Public Accountants Education Foundation. The sales price of $150,000 includes an irrevocable, royalty free, worldwide license to use the trade name Western Schools for accounting courses, all related inventory for existing courses, and title and rights to its accounting 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 approximately $55,000. SC Publishing is retaining its continuing education business for nurses and other mental health professionals which produced approximately ninety-two percent of the 2000 net revenue of the Western Schools division of SC Publishing. 6. Merger Agreement On April 30, 2001, the Company announced that Mr. Guy Naggar, a British investor and substantial stockholder and director of the Company, has submitted a proposal to acquire for cash, through merger, all of the issued and outstanding shares of common stock of the Company, other than his shares and the shares of others who may join him, for $3.75 a share. On May 4, 2001, the Company entered into a definitive Merger Agreement with Specialty Acquisition Corp., a Delaware corporation owned by Mr. Naggar and several other substantial stockholders of the Company. The Merger Agreement provides for a cash merger (the "Merger") in which the holders of common stock of the Company, other than Specialty Acquisition Corp., immediately prior to the Merger, will receive $3.75 per share in cash for each share of common stock of Specialty Catalog Corp owned before the Merger. Other stockholders, including certain members of the Board of Directors of the Company, have joined Mr. Naggar in the proposed transaction. On November 6, 2001, the stockholders of Specialty Catalog Corp. approved the Merger in a Special Meeting held by the Company. Total shares voted on the Merger amounted to 2,949,642 shares, of which 2,947,842 shares voted in favor of the Merger and 1,800 shares voted against the Merger. The Merger was finalized on November 14, 2001. In connection with the Merger, the Company is in the process of revaluing and restating certain asset carrying values. Specifically, this transaction could give rise to limitations relative to the realizability of deferred tax assets given the change in control rules within the tax regulations. The Merger was a "going private" transaction for the Company under the Federal securities laws. Following the Merger, the common stock of the Company is no longer publicly traded or quoted on The Nasdaq National Market and the Company has filed a Form 15 with the Securities and Exchange Commission in order to formally terminate its reporting obligations under the Securities Exchange Act of 1934. 9 SPECIALTY CATALOG CORP. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) A portion of the funds necessary to consummate the Merger was obtained through the sale of $7.5 million worth of its Series A Senior Subordinated Notes to LEG Partners Debenture SBIC, L.P., LEG Partners III SBIC, L.P., LEG Co- Investors, LLC, and LEG Co-Investors II, LLC. In connection with the consummation of the Merger, the Company amended its Amended and Restated Credit Agreement, dated December 27, 2000, with Fleet National Bank. In connection with the amendment, a $9,000,000 five-year term note and a $7,600,000 revolving credit note previously issued by the Company to Fleet National Bank were cancelled and replaced with a $7,200,000 four-year term note and a $8,050,000 revolving credit note. A portion of the proceeds of the notes was used to provide a portion of the funds required to consummate the Merger. The Company expects to use the remainder of such funds for working capital and other general corporate needs. 7. Business Segments and Financial Information by Geographic Location Specialty Catalog Corp. has five reportable segments: Paula Young and Especially Yours under the SC Direct division, Western Schools and American Healthcare Institute ("AHI") under the SC Publishing division and Daxbourne International Limited. The SC Direct division sells women's wigs and hairpieces using two distinct catalogs: Paula Young and Especially Yours. The SC Publishing division distributes catalogs under its Western Schools brand and specializes in providing continuing education courses to nurses and accounting professionals (see sale of assets in Note 5). SC Publishing's other segment, AHI, distributes catalogs under its own name and specializes in providing continuing education seminars and conferences to nurses and other mental health professionals. Daxbourne International Limited is a retailer and wholesaler of women's wigs, hairpieces and related products in the United Kingdom. The accounting policies of the reportable segments are the same as those described in Note 1 of the consolidated financial statements included in the Company's Form 10-K for the year ended December 30, 2000. The Company's reportable segments are strategic business units that offer either different products or operate in different geographic locations. The Company markets its products in two major geographic areas, the United States and the United Kingdom. The SC Direct and SC Publishing divisions market their products and maintain their assets in the United States. Daxbourne International Limited markets its products and maintains its assets in the United Kingdom. 10 SPECIALTY CATALOG CORP. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) A summary of information about the Company's operations by segment for the thirteen weeks and thirty-nine weeks ended September 29, 2001 and September 30, 2000 follows.

Paula Especially Corporate Total SC Western Young Yours Expenses Direct Schools -----~~------~~ -----~~-----~~ --------~~---~~ ------~~------~~ -------~~---~~ Thirteen weeks ended ~~June~~September 3029, 2001 Net sales (including royalties)........... $ 76,~~452~~338,~~638~~606 $2 1,~~260~~968,~~114~~596 $ -- $ 98,~~712~~307,~~752~~202 $1 817,~~240,122~~888 Shipping & handling income................ 1,~~418~~021,~~333~~931 ~~383~~342,~~314~~915 -- 1,~~801~~364,~~647~~846 ~~225~~148,~~443~~720 ----------- ----------- ----------- ------------- ----------- Total revenues............................ 87,~~870~~360,~~971~~537 2,~~643~~311,~~428~~511 -- 119,~~514~~672,~~399~~048 1966,~~465,565~~608 Gross profit.............................. 54,~~537~~452,~~821~~793 1,~~649~~353,~~359~~877 (5758,~~605~~736) 75,~~129~~747,~~575~~934 1753,~~131,069~~235 Operating expenses........................ 32,~~139~~519,~~906~~687 1,~~306~~341,~~122~~400 1,~~225~~474,~~945~~744 5,~~671~~335,~~973~~831 ~~817~~690,~~036~~035 Depreciation and amortization............. -- -- ~~299~~314,~~743~~314 ~~299~~314,~~743~~314 1517,~~905~~115 ----------- ----------- ----------- ------------- ----------- Income (loss) from operations............. 21,~~397~~933,~~915~~106 ~~343~~12,~~237~~477 (1,~~583~~847,~~293~~794) 197,~~157,859~~789 ~~298~~46,~~128~~085 Interest expense, net..................... -- -- ~~165~~211,~~472~~276 ~~165~~211,~~472~~276 -- Income tax provision (benefit)............ -- -- ~~405~~(45,~~650~~301) ~~405~~(45,~~650~~301) ~~122~~18,~~233~~894 Segment assets............................ -- -- 16,~~064~~003,~~565~~053 16,~~064~~003,~~565~~053 54,~~019~~999,~~381~~322 Capital expenditures................... ~~-- -- 121,855 121,855 -- Total SC AHI Publishing Daxbourne Total ----------- ---------- ----------- ------------ Thirteen weeks ended June 30, 2001 Net sales (including royalties)~~...~~.....~~ ~~$ 715,462 $1,955,584 $ 1,589,004 $ 13,257,340 Shipping & handling income.............~~ -- ~~225,443 15,785 2,042,875~~ --~~---------~~ ~~---------- ----------- ------------ Total revenues......................... 715~~144,~~462~~381 2144,~~181,027~~381 ~~1,604,789~~ 15,~~300,215~~150 Gross profit........................... 423,014 1,554,083 1,125,551 9,809,209 Operating expenses..................... 509,725 1,326,761 687,844 7,686,578 Depreciation and amortization.......... 51,582 67,487 99,074 466,304 ----------- ---------- ----------- ------------ Income (loss) from operations.......... (138,293) 159,835 338,633 1,656,327 Interest expense, net.................. -- -- 41,279 206,751 Income tax provision (benefit)......... (56,700) 65,533 121,915 593,098 Segment assets......................... 101,858 5,121,239 2,429,287 23,615,091 Capital expenditures................... -- -- 3,728 125,583 Paula Especially Corporate Total SC Western Young Yours Expenses Direct Schools -----~~------~~ -----~~-----~~ --------~~---~~ ------~~------~~ -------~~---~~ Thirteen weeks ended ~~July~~September 130, 2000 Net sales (including royalties)........... $ 86,~~524~~818,~~780~~274 $2 1,~~011~~571,~~122~~674 $ -- $ 108,~~535~~389,~~902~~948 $1 896,~~060,013~~268 Shipping & handling income................ 1,~~575~~233,~~941~~262 ~~346~~293,~~658~~365 -- 1,~~922~~526,~~599~~627 ~~206~~179,~~144~~571 ----------- ----------- ----------- ------------- ----------- Total revenues............................ 108,~~100~~051,~~721~~536 21,~~357~~865,~~780~~039 -- 129,~~458~~916,~~501~~575 1,~~266~~075,~~157~~839 Gross profit.............................. 65,~~617~~060,~~353~~442 1,~~473~~086,~~943~~002 (57,~~605~~606) 86,~~033~~088,~~691~~838 ~~912~~765,~~273~~716 Operating expenses........................ 43,~~036~~259,~~656~~115 1,~~202~~195,~~975~~983 1,~~247~~173,~~908~~109 65,~~487~~628,~~539~~207 ~~837~~700,~~623~~881 Depreciation and amortization............. -- -- ~~280~~301,~~423~~335 ~~280~~301,~~423~~335 10,~~179~~299 ----------- ----------- ----------- ------------- ----------- Income (loss) from operations............. 21,~~580~~801,~~697~~327 ~~270~~(109,~~968~~981) (1,~~585~~532,~~936~~050) 1159,~~265,729~~296 6454,~~471~~536 Interest expense, net..................... -- -- ~~170~~207,~~253~~355 ~~170~~207,~~253~~355 -- Income tax provision (benefit)............ -- -- ~~443~~(19,~~822~~709) ~~443~~(19,~~822~~709) 2622,~~431~~361 Segment assets............................ -- -- 15,~~395~~606,~~686~~603 15,~~395~~606,~~686~~603 4,~~501~~630,~~208~~721 Capital expenditures................... ~~-- -- 411,551 411,551 -- Total SC AHI Publishing Daxbourne Total ----------- ---------- ----------- ------------ Thirteen weeks ended July 1, 2000 Net sales (including royalties)~~...~~.....~~ ~~$ 1,659,645 $2,719,658 $ 1,286,254 $ 14,541,814 Shipping & handling income.............~~ -- ~~206,144 9,649 2,138,392~~ --~~---------~~ ~~---------- ----------- ------------ Total revenues......................... 1~~299,~~659,645~~713 2299,~~925,802~~713 ~~1,295,903~~ 16,680,206 Gross profit........................... 1,005,635 1,917,908 891,617 10,843,216 Operating expenses..................... 963,319 1,800,942 597,279 8,885,760 Depreciation and amortization.......... 35,475 45,654 90,252 416,329 ----------- ---------- ----------- ------------ Income (loss) from operations.......... 6,841 71,312 204,086 1,541,127 Interest expense, net.................. -- -- 55,430 225,683 Income tax provision (benefit)......... 2,657 29,088 66,419 539,329 Segment assets......................... 808,717 5,309,925 4,436,376 25,141,987 Capital expenditures................... 21,050 21,050 7,364 439,965433

~~Paula Especially Corporate~~ Total SC ~~Western Total SC Young Yours Expenses Direct Schools~~ AHI Publishing ~~-----~~Daxbourne Total ----- -------- --~~----~~ ------- --- -----~~-----~~ ~~Twenty-six~~Thirteen weeks ended ~~June~~September 3029, 2001 Net sales (including royalties)........... $~~15,708,242~~ $4596,~~520,234~~233 $ ~~-- $20~~1,~~228~~414,~~476~~121 $~~2,970,577~~ $1,~~201~~519,~~325~~587 $411,~~171~~240,~~902~~910 Shipping & handling income....... ~~2,924~~.~~121~~........ ~~778,087~~ -- 3148,~~702,208~~720 ~~562~~18,~~741~~692 ~~-- 562~~1,~~741~~532,258 ----------- -~~---------~~ ----------- ----------- ---------- -~~---------~~ ~~----------~~ Total revenues............................ 18596,~~632,363~~233 51,~~298~~562,~~321~~841 ~~-- 23,930,684 3,533,318~~ 1,~~201~~538,~~325~~279 412,~~734~~773,~~643~~168 Gross profit.............................. 11339,~~454,274~~644 31,~~206~~092,~~602~~879 ~~(116~~1,~~354) 14~~070,~~544,522~~028 27,~~645~~910,~~876~~841 ~~699,370 3,345,246~~ Operating expenses........................ 6314,~~867,057~~605 ~~2,784,848 2,729,005 12,380,910~~ 1,~~701~~004,~~005~~640 1710,~~153,522~~402 27,~~854~~050,~~527~~873 Depreciation and amortization............. ~~-- -- 591~~51,~~213~~580 ~~591~~68,~~213~~695 29104,~~111~~330 99487,~~209~~339 ~~128,320~~ ----------- -~~---------~~ ----------- ----------- ---------- -~~---------~~ ~~---------~~ Income (loss) from operations............. ~~4,587,217 421,754~~ (326,~~436,572~~541) 119,~~572,399~~544 ~~915~~255,~~760~~296 ~~(553~~372,~~361)~~629 ~~362,399~~ Interest expense, net..................... --200 --200 ~~385~~42,~~557~~373 ~~385~~253,~~557~~849 ~~-- 104 104~~ Income tax provision (benefit)............ ~~-- -- 485~~(10,~~377~~963) ~~485~~7,~~377~~931 ~~375~~87,~~462~~298 ~~(226~~49,~~921)~~928 ~~148,541~~ Segment assets............................ ~~-- -- 16~~(51,~~064,565~~588) 164,~~064~~947,~~565~~734 52,~~019~~618,~~381~~328 ~~101~~23,~~858 5~~569,~~121,239~~115 Capital expenditures...................... ~~-- -- 215~~2,~~310~~646 ~~215~~17,~~310~~796 5711,~~695~~221 9173,~~164~~398 ~~66,859 Paula Especially Corporate~~ Total SC ~~Western Total SC Young Yours Expenses Direct Schools~~ AHI Publishing ~~-----~~Daxbourne Total ----- -------- --~~----~~ ------- --- -----~~-----~~ ~~Twenty-six~~Thirteen weeks ended ~~July~~September 130, 2000 Net sales (including royalties)........... $~~16,813,497~~ $31,~~727~~128,~~093~~474 $ ~~-- $20,540,590 $~~2,~~761~~024,~~295~~742 $2 1,~~472~~323,~~938~~382 $511,~~234~~738,~~233~~072 Shipping & handling income................ ~~3,020,783 678,979~~ -- 3179,~~699,762~~571 ~~529~~7,~~772~~917 ~~21 529~~1,~~793~~714,115 ----------- -~~---------~~ ----------- ----------- ---------- -~~---------~~ ~~----------~~ Total revenues............................ 191,~~834~~128,~~280~~474 42,~~406~~204,~~072~~313 ~~-- 24~~1,~~240~~331,~~352~~299 313,~~291~~452,~~067~~187 ~~2,472,959 5,764,026~~ Gross profit.............................. 12636,~~723,789~~332 21,~~674~~402,~~480~~048 ~~(116~~886,~~315)~~902 158,~~281~~377,~~954~~788 ~~2,431,504 1,477,715 3,909,219~~ Operating expenses........................ 8655,~~587,566~~248 ~~2,715,620 2,832,164 14,135,350~~ 1,~~723~~356,~~423~~129 1576,~~475,399~~182 37,~~198~~560,~~822~~518 Depreciation and amortization............. ~~-- -- 542~~38,~~174~~734 ~~542~~49,~~174~~033 2087,~~851~~265 69437,~~319~~633 ~~90,170~~ ----------- -~~---------~~ ----------- ----------- ---------- -~~---------~~ ~~----------~~ Income (loss) from operations............. ~~4,136,223~~ (4157,~~140~~650) (3,~~490,653~~114) ~~604~~223,~~430~~455 ~~687~~379,~~230~~637 ~~(67,003) 620,227~~ Interest expense, net..................... --1,239 --1,239 ~~325~~57,~~457~~033 ~~325~~265,~~457~~627 ~~-- -- --~~ Income tax provision (benefit)............~~............~~ ~~-- -- 114~~(24,~~363~~147) ~~114,363 281,763~~ (271,~~471~~786) ~~254~~68,~~292~~233 46,738 Segment assets............................ ~~-- -- 15~~896,~~395,686~~697 155,~~395~~527,~~686~~418 4,~~501~~440,~~208~~931 ~~808~~25,~~717 5~~574,~~309,925~~952 Capital expenditures...................... ~~-- -- 791~~11,~~601~~653 ~~791~~28,~~601~~086 --(524) 58327,~~324 58,324~~275

11 SPECIALTY CATALOG CORP. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited)

~~Daxbourne~~Paula Especially Corporate Total SC Western Young Yours Expenses Direct Schools ----- ----- -------- ~~Twenty~~-~~six~~----- ------- Thirty-nine weeks ended ~~June~~September 3029, 2001 Net sales (including royalties).....~~.....~~ $322,~~149~~046,~~737~~848 $276,~~550~~488,~~115~~830 $ -- $28,535,678 $3,788,465 Shipping & handling income..........~~.....~~ 273,~~398~~946,052 41,~~292~~121,~~347~~002 -- 5,067,054 711,461 ----------- ---------- ----------- ----------- ---------- Total revenues......................~~.....~~ 325,~~177~~992,~~135~~900 317,~~842~~609,~~462~~832 -- 33,602,732 4,499,926 Gross profit........................~~.....~~ 215,~~214~~907,~~471~~067 4,560,479 (175,090) 20,~~104~~292,~~239~~456 3,399,111 Operating expenses..................~~.....~~ 19,~~365~~386,~~742~~744 164,~~601~~126,~~179~~248 4,203,749 17,716,741 2,391,040 Depreciation and amortization.......~~.....~~ ~~196~~-- -- 905,~~927~~527 ~~916~~905,~~460~~527 46,226 ----------- ---------- ----------- ----------- ---------- Income (loss) from operations.......~~....~~ ~~651~~6,~~802~~520,323 2434,~~586~~231 (5,~~600~~284,366) 1,670,188 961,845 Interest expense, net...............~~....~~ 84-- -- 596,~~410~~833 ~~470~~596,~~071~~833 -- Income tax provision (benefit)......~~....~~ ~~232~~-- -- 440,~~630~~076 ~~866~~440,~~548~~076 394,356 Segment assets......................~~....~~ 2-- -- 16,~~429~~003,~~287~~053 2316,~~615~~003,~~091~~053 4,999,322 Capital expenditures................~~....~~ 62-- -- 359,~~227~~691 ~~344~~359,~~396~~691 ~~Daxbourne~~72,845 Paula Especially Corporate Total SC Western Young Yours Expenses Direct Schools ----- ----- -------- ~~Twenty~~-~~six~~----- ------- Thirty-nine weeks ended ~~July~~September 130, 2000 Net sales (including royalties).....~~....~~ $223,~~730~~631,~~291~~771 $5,298,767 $ -- $28,~~505~~930,~~114~~538 $3,657,563 Shipping & handling income..........~~....~~ 204,~~479~~254,045 4972,~~250~~344 -- 5,~~034~~226,389 709,343 ----------- ---------- ------------ ----------- ---------- Total revenues......................~~....~~ 227,~~750~~885,~~770~~816 326,~~755~~271,~~148~~111 -- 34,156,927 4,366,906 Gross profit........................~~....~~ 117,~~896~~784,~~846~~231 3,760,482 (173,921) 21,~~088~~370,~~019~~792 3,197,220 Operating expenses..................~~....~~ 111,~~247~~846,~~880~~681 183,~~582~~911,~~052~~603 4,005,273 19,763,557 2,424,304 Depreciation and amortization.......~~....~~ ~~183~~-- -- 843,~~686~~509 ~~816~~843,~~030~~509 31,150 ----------- ---------- ------------ ----------- ---------- Income (loss) from operations....... ~~465~~5,~~280~~937,550 1(151,~~689~~121) (5,~~937~~022,703) 763,726 741,766 Interest expense, net...............~~...~~ ~~116~~-- -- 532,~~225~~812 ~~441~~532,~~682~~812 -- Income tax provision ~~143,114 511,769~~ (benefit)......~~........................~~ -- -- 94,654 94,654 304,124 Segment assets......................~~...~~ 4-- -- 15,~~436~~606,~~376~~603 2515,~~141~~606,~~987~~603 4,630,721 Capital expenditures................~~...~~ 22-- -- 1,~~723~~081,314 ~~872~~1,~~648~~081,314 16,433

12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations In addition to the historical information contained herein, this Quarterly Report on Form 10-Q for the Company may contain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 ("Exchange Act"), including, but not limited to, the Company's expected future revenues, operations and expenditures, estimates of the potential markets for the Company's products, assessments of competitors and potential competitors and projected timetables for the market introduction of the Company's products. Investors are cautioned that forward-looking statements are inherently uncertain. Actual performance and results of operations may differ materially from those projected or suggested in the forward-looking statements due to certain risks and uncertainties, including, but not limited to, the following risks and uncertainties: (i) the Company's indebtedness and future capital requirements, (ii) increasing postal rates, paper prices and media costs, (iii) limited sources of fiber used to make the Company's products, (iv) the limited number of suppliers of the Company's products, (v) the Company's dependence upon foreign suppliers, especially in China, Indonesia and Korea, (vi) the customary risks of doing business abroad, including fluctuations in the value of currencies, (vii) the potential development of a cure for hair loss and cancer treatment improvements, (viii) the effectiveness of the Company's catalogs and advertising programs, (ix) the Company's competition, (x) the impact of acquisitions on the Company's prospects and (xi) the completion of the transaction contemplated by the merger agreement. Additional information concerning certain risks and uncertainties that could cause actual results to differ materially from those projected or suggested in the forward-looking statements is contained in the Company's filings with the Securities and Exchange Commission, including those risks and uncertainties discussed under the caption "Risk Factors" in the Company's Form 10-K for the year ended December 30, 2000. The forward-looking statements contained herein represent the Company's judgment as of the date of this Quarterly Report on Form 10-Q, and the Company cautions readers not to place undue reliance on such statements. Thirteen Weeks Ended September 29, 2001 Compared to the Thirteen Weeks Ended September 30, 2000 Revenues decreased to $12.8 million for the thirteen weeks ended September 29, 2001 from $13.4 million for the thirteen weeks ended September 30, 2000, a decrease of approximately $679,000 or 5.1 percent. This change in revenues was due to decreases in SC Direct's, Western Schools' and AHI's revenues of approximately $245,000, $109,000 and $532,000, respectively, offset by increases in Daxbourne's revenues of approximately $207,000. The overall revenue decrease in SC Direct was caused by reducing the number of catalogs circulated and increasing promotional offerings during the thirteen weeks ended September 29, 2001 compared to the thirteen weeks ended September 30, 2000. The Paula Young business sales decreased by approximately $691,000, offset by a revenue increase in the Especially Yours business of approximately $446,000. This total revenue decrease was offset by a decrease in merchandise return rates resulting from the Company's initiatives initiated during the latter half of fiscal year 2000 of several marketing, creative, operational and merchandising changes. Western Schools revenue decrease was the result of the sale of the company's CPA business in May 2001. Revenues from Western Schools CPA business during the thirteen weeks ended September 30, 2000 amounted to approximately $95,000. AHI's revenue decrease was caused by the elimination of unprofitable seminars during the thirteen weeks ended September 29, 2001 compared to the thirteen weeks ended September 30, 2000 as well as a lighter attendance at seminars held in the New York/New Jersey areas subsequent to the September 11, 2001 terrorist attacks on the World Trade Center in New York City. Daxbourne's revenue increase primarily related to the acquisition of the Paula Young UK business in January 2001 which had revenues of approximately $123,000 for the thirteen weeks ended September 29, 2001. 13 Gross profit as a percentage of revenues decreased to 61.9 percent for the thirteen weeks ended September 29, 2001 from 62.3 percent for the thirteen weeks ended September 30, 2000 as a result of merchandise sales mix changes and additional promotional offerings in its catalogs. Gross profit decreased to $7.9 million for the thirteen weeks ended September 29, 2001 from $8.4 million for the thirteen weeks ended September 30, 2000, a decrease of approximately $467,000 or 5.6 percent. This decrease was due to the decrease in revenues discussed above as well as the decrease in the gross profit rate also discussed above. Operating expenses decreased to $7.5 million for the thirteen weeks ended September 29, 2001 from $8.0 million for the thirteen weeks ended September 30, 2000, a decrease of approximately $460,000 or 5.8 percent. As mentioned above, the decrease in operating expenses was due to the Company's decisions to reduce catalog circulation and reduce the amount of advertising used to generate new customers. Interest expense, net of interest income, decreased to approximately $254,000 for the thirteen weeks ended September 29, 2001 from approximately $266,000 for the thirteen weeks ended September 30, 2000, a decrease of approximately $12,000 or 4.5 percent. The decrease was attributable to lower interest rates on variable rate borrowings not hedged by the interest rate swap agreement and by lower average principal amounts outstanding on the Company's bank facility during the thirteen weeks ended September 29, 2001 compared to the thirteen weeks ended September 30, 2000, offset by the loss recorded on the fair value of the interest rate swap agreement of approximately $89,000. Thirty-Nine Weeks Ended September 29, 2001 Compared to the Thirty-Nine Weeks Ended September 30, 2000 Revenues decreased to $44.6 million for the thirty-nine weeks ended September 29, 2001 from $46.2 million for the thirty-nine weeks ended September 30, 2000, a decrease of $1.6 million or 3.5 percent. This change in revenues was due to decreases in SC Direct's and AHI's revenues of approximately $554,000 and $1.8 million, respectively, offset by increases in Western Schools' and Daxbourne's revenues of approximately $133,000 and $633,000, respectively. The overall revenue decrease in SC Direct was caused by reducing the number of catalogs circulated during the thirty-nine weeks ended September 29, 2001 compared to the thirty-nine weeks ended September 30, 2000. The Paula Young business sales decreased by $1.9 million, offset by a revenue increase in the Especially Yours business of $1.3 million. This total revenue decrease was offset by a decrease in merchandise return rates resulting from the Company's initiatives initiated during the latter half of fiscal year 2000 of several marketing, creative, operational and merchandising changes. AHI's revenue decrease was caused by the elimination of unprofitable seminars during the thirty-nine weeks ended September 29, 2001 compared to the thirty-nine weeks ended September 30, 2000. Daxbourne's revenue increase was due to increased sales at its Hot Hair retail establishments as well as to the acquisition of the Paula Young UK business in January 2001 which had revenues of approximately $337,000 for the thirty-nine weeks ended September 29, 2001. Gross profit as a percentage of revenues decreased to 62.8 percent for the thirty-nine weeks ended September 29, 2001 from 63.8 percent for the thirty-nine weeks ended September 30, 2000 as a result of merchandise sales mix changes and additional promotional offerings in its catalogs. Gross profit decreased to $28.0 million for the thirty-nine weeks ended September 29, 2001 from $29.5 million for the thirty-nine weeks ended September 30, 2000, a decrease of approximately $1.5 million or 5.1 percent. This decrease was due to the decrease in revenues discussed above as well as the decrease in the gross profit rate also discussed above. Operating expenses decreased to $25.1 million for the thirty-nine weeks ended September 29, 2001 from $27.4 million for the thirty-nine weeks ended September 30, 2000, a decrease of approximately $2.3 14 million or 8.4 percent. As mentioned above, the decrease in operating expenses was due to the Company's decisions to reduce catalog circulation and reduce the amount of advertising used to generate new customers. Interest expense, net of interest income, increased to approximately $724,000 for the thirty-nine weeks ended September 29, 2001 from approximately $707,000 for the thirty-nine weeks ended September 30, 2000, an increase of approximately $17,000 or 2.4 percent. The increase was attributable to the loss recorded on the fair value of the interest rate swap agreement of approximately $174,000, offset by lower average principal amounts outstanding on the Company's bank facility and by lower interest rates on variable rate borrowings not hedged by the interest rate swap agreement during the thirty-nine weeks ended September 29, 2001 compared to the thirty-nine weeks ended September 30, 2000. Liquidity and Capital Resources Net cash flows provided by the Company for the thirty-nine weeks ended September 29, 2001 were approximately $285,000. Cash flows provided by operating activities for the thirty-nine weeks ended September 29, 2001 were $3.0 million, offset by uses of $1.0 million in investing activities and $1.7 million in financing activities. The major factors that caused the difference between net income and net cash flows provided by operations for the thirty-nine weeks ended September 29, 2001 were increases in: depreciation and amortization expense of $1.4 million and deferred income taxes of approximately $263,000. The Company used $1.0 million in investing activities, of which approximately $518,000 was for computer and equipment purchases, approximately $437,000 was used to acquire the Paula Young UK license from the Company's former British licensee, and approximately $45,000 was used by Daxbourne to acquire a small retail salon in the London area during August 2001. The $1.7 million in net cash used in financing activities was primarily due to: (i) the repayment of $1,350,000 of long-term borrowings, (ii) the repayment of short-term borrowings of approximately $788,000, and (iii) the repayment of approximately $103,000 of capital leases, offset by cash receipts of approximately $584,000 for other long-term liabilities related to fixed asset purchases previously paid by the Company during the thirty-nine weeks ended September 29, 2001 and the fiscal year ended December 30, 2000. On December 27, 2000, the Company entered into a $12.25 million credit agreement (the "Agreement") with Fleet National Bank, N.A. (the "Bank") for the purpose of refinancing its existing senior debt and to provide for the working capital needs of the Company. The new credit facility, which may be increased to $13.0 million in 2002, replaces the Company's former credit facilities with the Bank. The Agreement includes a $9.0 million five-year term note (the "Term Loan") and a $3.25 million two-year revolving credit agreement (the "Line of Credit"). The amount available on the Line of Credit increases as principal amortization payments on the Term Loan are paid, such that the total Agreement remains at $12.25 million over the two years of the Line of Credit agreement. The Line of Credit provides for revolving credit loans and letters of credit with floating rates based on margins over LIBOR or prime at the Company's option. The Term Loan is for five years and is amortized at the rate of $450,000 a quarter beginning January 1, 2001. As of September 29, 2001, $7.65 million of the Term Loan was under LIBOR contract rates ranging from 5.77 percent to 6.17 percent (including the Bank's lending margin). At September 29, 2001, $3.1 million was available under the Line of Credit. The Agreement is collateralized by a first perfected security interest in all tangible and intangible assets of the Company, subject to certain permitted liens. The Agreement is subject to certain consolidated covenants, including but not limited to, leverage and debt service coverage ratios, minimum earnings requirements, limitation on capital expenditures, excess cash flow recapture, and a restriction on the payment of cash dividends on the Company's common stock. 15 The Company's cash flow from operations and available credit facilities are considered adequate to fund planned business operations and both the short-term and long-term capital needs of the Company. However, certain events, such as an additional significant acquisition, could require new external financing. Recently Issued Accounting Pronouncements SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. Under SFAS No. 133, certain contracts that were not formerly considered derivatives may now meet the definition of a derivative. The Company adopted SFAS No. 133 effective December 31, 2000. As of December 30, 2000, the adoption of SFAS No. 133 did not have a material impact on the Company's consolidated financial statements. In July 2001, the FASB released SFAS No. 141, "Business Combinations". SFAS No. 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method. The Company does not believe that the adoption of SFAS No. 141 will have a significant impact on its condensed consolidated financial statements. In July 2001, the FASB released SFAS No. 142, "Goodwill and Other Intangible Assets", which is effective for fiscal years beginning after January 1, 2002. SFAS No. 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. SFAS No. 142 also requires the Company to complete a transitional goodwill impairment test six months from the date of adoption. The Company is currently assessing, but has not yet determined the impact of SFAS No. 142 on its financial position and results of operations. In June 2001, the FASB released SFAS No. 143, "Accounting for Asset Retirement Obligations," which is effective January 1, 2003. SFAS No. 143 addresses the financial accounting and reporting for obligations and retirement costs related to the retirement of tangible long-lived assets. The Company does not expect that the adoption of SFAS No. 143 will have a significant impact on its condensed consolidated financial statements. In August 2001, the FASB released SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which is effective January 1, 2002. SFAS No. 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and the accounting and reporting provisions relating to the disposal of a segment of a business of Accounting Principles Board Opinion No. 30. The Company does not expect that the adoption of SFAS No. 144 will have a significant impact on its condensed consolidated financial statements. Quantitative and Qualitative Disclosures About Market Risk The Company's primary exposures to market risks include fluctuations in interest rates on its short-term and long-term borrowings of $7.65 million as of September 29, 2001 under its credit facility. Management does not believe that the risk inherent in the variable-rate nature of these instruments will have a material adverse effect on the Company's consolidated financial statements. However, no assurance can be given that such a risk will not have a material adverse effect on the Company's financial statements in the future. 16 As of September 29, 2001, the outstanding balance on all of the Company's credit facilities was $7.65 million. Based on this balance, less the amount covered by the interest rate swap agreement, an immediate change of one percent in the interest rate would cause a change in interest expense of approximately $32,000 on an annual basis. The Company's objective in maintaining these variable rate borrowings is the flexibility obtained regarding early repayment without penalties and lower overall cost as compared with fixed-rate borrowings. The foreign currencies to which the Company has the most significant exchange rate exposure are the British Pound, Chinese Yuan, Indonesian Rupiah and Korean Won. The Company expects that most of its wigs and hairpieces will continue to be manufactured in China, Indonesia and Korea in the future. Although a substantial portion of the Company's transactions with these countries occurs in US dollars, the Company's operations are subject to fluctuations in the value of these countries' currencies. Although to date such exchange rate exposures have not had a significant effect on the Company's business operations, no assurance can be given that such exchange rate exposures will not have a material adverse effect on the Company's business operations in the future. PART II. OTHER INFORMATION ITEM 4. Submission of Matters to a Vote of Security Holders The Company held a special meeting of shareholders on Tuesday, November 6, 2001. The following represents the results of the voting on proposals submitted to a vote of shareholders at such meeting: a. Proposal to adopt the Agreement and Plan of Recapitalization and Merger, dated as of May 4, 2001, as amended by Amendment No. 1 dated August 31, 2001, between Specialty Catalog Corp. and Specialty Acquisition Corp.: Total Shares Voted 2,949,642 Number of Votes in Favor 2,947,842 Number of Votes Against 1,800 Number of Votes Abstained 0 The Agreement and Plan of Recapitalization and Merger between Specialty Catalog Corp. and Specialty Acquisition Corp. was approved by the shareholders on November 6, 2001. b. Proposal to grant to the proxies the discretionary authority to adjourn the special meeting to satisfy conditions to the closing of the Agreement and Plan of Recapitalization and Merger: Votes in favor Votes against -------------- ------------- 2,748,903 200,739 The proposal to grant to the proxies the discretionary authority to adjourn the special meeting was approved. 17 ITEM 5. Other Information Merger Agreement On April 30, 2001, the Company announced that Mr. Guy Naggar, a British investor and substantial stockholder and director of the Company, has submitted a proposal to acquire for cash, through merger, all of the issued and outstanding shares of common stock of the Company, other than his shares and the shares of others who may join him, for $3.75 a share. On May 4, 2001, the Company entered into a definitive Merger Agreement with Specialty Acquisition Corp., a Delaware corporation owned by Mr. Naggar and several other substantial stockholders of the Company. The Merger Agreement provides for a cash merger (the "Merger") in which the holders of common stock of the Company, other than Specialty Acquisition Corp., immediately prior to the Merger, will receive $3.75 per share in cash for each share of common stock of Specialty Catalog Corp owned before the Merger. Other stockholders, including certain members of the Board of Directors of the Company, have joined Mr. Naggar in the proposed transaction. On November 6, 2001, the stockholders of Specialty Catalog Corp. approved the Merger in a Special Meeting held by the Company. Total shares voted on the Merger amounted to 2,949,642 shares, of which 2,947,842 shares voted in favor of the Merger and 1,800 shares voted against the Merger. The Merger was finalized on November 14, 2001. In connection with the Merger, the Company is in the process of revaluing and restating certain asset carrying values. Specifically, this transaction could give rise to limitations relative to the realizability of deferred tax assets given the change in control rules within the tax regulations. The Merger was a "going private" transaction for the Company under the Federal securities laws. Following the Merger, the common stock of the Company is no longer publicly traded or quoted on The Nasdaq National Market and the Company has filed a Form 15 with the Securities and Exchange Commission in order to formally terminate its reporting obligations under the Securities Exchange Act of 1934. A portion of the funds necessary to consummate the Merger was obtained through the sale of $7.5 million worth of its Series A Senior Subordinated Notes to LEG Partners Debenture SBIC, L.P., LEG Partners III SBIC, L.P., LEG Co- Investors, LLC, and LEG Co-Investors II, LLC. In connection with the consummation of the Merger, the Company amended its Amended and Restated Credit Agreement, dated December 27, 2000, with Fleet National Bank. In connection with the amendment, a $9,000,000 five-year term note and a $7,600,000 revolving credit note previously issued by the Company to Fleet National Bank were cancelled and replaced with a $7,200,000 four-year term note and a $8,050,000 revolving credit note. A portion of the proceeds of the notes was used to provide a portion of the funds required to consummate the Merger. The Company expects to use the remainder of such funds for working capital and other general corporate needs. 18 ITEM 6. Exhibits and Reports on Form 8-K (a) Exhibits None. (b) Reports on Form 8-K This Report on Form 10-Q contains information that would normally otherwise be disclosed in a Report on Form 8-K. The information disclosed in this Report on Form 10-Q describes the closing of transactions contemplated by the Agreement and Plan of Recapitalization and Merger between Specialty Catalog Corp. and Specialty Acquisition Corp. See the Merger Agreement note of the condensed consolidated financial statements. 19 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SPECIALTY CATALOG CORP. Dated: November 19, 2001 By: /s/ Joseph Grabowski ---------------------------- President and Chief Executive Officer Dated: November 19, 2001 By: /s/ Thomas McCain ---------------------------- Thomas McCain Senior Vice President and Chief Financial Officer 20

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