UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
ý |
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended August 3, 2002
OR
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 0-22834
SUCCESSORIES, INC.
(Exact name of registrant as specified in its charter)
| ILLINOIS | 36-3760230 | |
| (State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
|
2520 Diehl Road Aurora, Illinois |
60504 |
|
| (Address of principal executive offices) | (Zip Code) |
(630) 820-7200
(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 12 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 ý No o
Registrant had 9,519,923 shares of common stock, $.01 par value, outstanding as of September 12, 2002.
SUCCESSORIES, INC.
INDEX TO FORM 10-Q
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Page Number |
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| PART I. | FINANCIAL INFORMATION | |||||
Item 1. |
Financial Statements |
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Consolidated Balance Sheets |
3 |
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Consolidated Statements of Operations and Comprehensive Loss |
4 |
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Consolidated Statement of Stockholders' Equity |
5 |
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Consolidated Statements of Cash Flows |
6 |
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Notes to Consolidated Financial Statements |
7 |
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Item 2. |
Management's Discussion and Analysis of Financial Condition and Results of Operations |
14 |
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Item 3. |
Quantitative and Qualitative Disclosures About Market Risk |
20 |
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PART II. |
OTHER INFORMATION |
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Item 1. |
Legal Proceedings |
21 |
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Item 4. |
Submission of Matters to a Vote of Security Holders |
22 |
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Item 6. |
Exhibits and Reports on Form 8-K |
22 |
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SIGNATURES AND CERTIFICATIONS |
23 |
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INDEX TO EXHIBITS |
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2
SUCCESSORIES, INC.
Consolidated Balance Sheets
| |
August 3, 2002 |
February 2, 2002 |
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|---|---|---|---|---|---|---|---|---|
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(unaudited) |
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| ASSETS | ||||||||
| Current assets: | ||||||||
| Cash and cash equivalents | $ | 597,000 | $ | 602,000 | ||||
| Accounts and notes receivable, net | 1,640,000 | 2,445,000 | ||||||
| Inventories, net | 4,703,000 | 5,005,000 | ||||||
| Prepaid catalog expenses | 1,132,000 | 1,683,000 | ||||||
| Other prepaid expenses | 873,000 | 857,000 | ||||||
| Total current assets | 8,945,000 | 10,592,000 | ||||||
| Restricted cash | 250,000 | 250,000 | ||||||
| Property and equipment, net | 2,531,000 | 3,914,000 | ||||||
| Notes receivable | — | 17,000 | ||||||
| Deferred financing costs and debt discount, net | 107,000 | 181,000 | ||||||
| Intangibles and other assets, net | 738,000 | 1,007,000 | ||||||
| TOTAL ASSETS | $ | 12,571,000 | $ | 15,961,000 | ||||
| LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||
| Current liabilities: | ||||||||
| Revolving credit loan | $ | 1,055,000 | $ | 1,483,000 | ||||
| Accounts payable | 2,137,000 | 1,488,000 | ||||||
| Accrued expenses and deferred income taxes | 1,428,000 | 1,761,000 | ||||||
| Total current liabilities | 4,620,000 | 4,732,000 | ||||||
| Minority interest | — | 47,000 | ||||||
| Stockholders' equity: | ||||||||
| Convertible preferred stock, $.01 par value; 1,000,000 shares authorized; 503,092 of Series A and 101,667 of Series B shares issued and outstanding; liquidation value $.01 per share plus accrued dividends | 6,000 | 6,000 | ||||||
| Common stock, $.01 par value; 20,000,000 shares authorized; 9,487,578 and 9,313,884 shares issued and outstanding, respectively | 95,000 | 93,000 | ||||||
| Common stock warrants | 2,324,000 | 2,324,000 | ||||||
| Notes receivable from stockholders | (130,000 | ) | (118,000 | ) | ||||
| Additional paid-in capital | 33,453,000 | 33,321,000 | ||||||
| Accumulated deficit | (27,733,000 | ) | (24,380,000 | ) | ||||
| Accumulated other comprehensive loss | (64,000 | ) | (64,000 | ) | ||||
| Total stockholders' equity | 7,951,000 | 11,182,000 | ||||||
| TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY | $ | 12,571,000 | $ | 15,961,000 | ||||
The accompanying notes are an integral part of these statements.
3
Consolidated Statements of Operations and
Comprehensive Loss
(Unaudited)
| |
Three Months Ended |
Six Months Ended |
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|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
August 3, 2002 |
August 4, 2001 |
August 3, 2002 |
August 4, 2001 |
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| Net product sales | $ | 7,163,000 | $ | 8,058,000 | $ | 15,688,000 | $ | 17,561,000 | ||||||
| Cost of goods sold | 3,630,000 | 4,051,000 | 7,808,000 | 8,617,000 | ||||||||||
| Gross profit on product sales | 3,533,000 | 4,007,000 | 7,880,000 | 8,944,000 | ||||||||||
| Fees, royalties and other income | 228,000 | 283,000 | 416,000 | 509,000 | ||||||||||
| Gross margin | 3,761,000 | 4,290,000 | 8,296,000 | 9,453,000 | ||||||||||
| Operating expenses | 4,894,000 | 5,453,000 | 10,000,000 | 11,531,000 | ||||||||||
| Loss from continuing operations before other expense and income tax | (1,133,000 | ) | (1,163,000 | ) | (1,704,000 | ) | (2,078,000 | ) | ||||||
| Other income (expense): | ||||||||||||||
| Interest expense | (63,000 | ) | (64,000 | ) | (137,000 | ) | (144,000 | ) | ||||||
| Minority interests in subsidiaries | 8,000 | (25,000 | ) | (2,000 | ) | (49,000 | ) | |||||||
| Interest income | 10,000 | 9,000 | 24,000 | 25,000 | ||||||||||
| Other, net | 6,000 | 9,000 | 8,000 | 7,000 | ||||||||||
| Total other expense | (39,000 | ) | (71,000 | ) | (107,000 | ) | (161,000 | ) | ||||||
| Loss from continuing operations before income tax | (1,172,000 | ) | (1,234,000 | ) | (1,811,000 | ) | (2,239,000 | ) | ||||||
| Income tax expense (benefit) | — | 700,000 | (106,000 | ) | 700,000 | |||||||||
| Loss from continuing operations | (1,172,000 | ) | (1,934,000 | ) | (1,705,000 | ) | (2,939,000 | ) | ||||||
| Loss from discontinued operations, net of tax | (1,108,000 | ) | (899,000 | ) | (1,538,000 | ) | (1,237,000 | ) | ||||||
| Loss before extraordinary item | (2,280,000 | ) | (2,833,000 | ) | (3,243,000 | ) | (4,176,000 | ) | ||||||
| Extraordinary loss on early extinguishment of debt | — | — | — | 219,000 | ||||||||||
| Net loss | $ | (2,280,000 | ) | $ | (2,833,000 | ) | $ | (3,243,000 | ) | $ | (4,395,000 | ) | ||
| Dividend to preferred shareholders | 55,000 | 55,000 | 110,000 | 110,000 | ||||||||||
| Loss available to common stockholders | $ | (2,335,000 | ) | $ | (2,888,000 | ) | $ | (3,353,000 | ) | $ | (4,505,000 | ) | ||
| Foreign currency translation adjustment | $ | — | $ | (5,000 | ) | $ | — | (9,000 | ) | |||||
| Comprehensive loss | $ | (2,335,000 | ) | $ | (2,838,000 | ) | $ | (3,353,000 | ) | $ | (4,404,000 | ) | ||
| Loss per share (basic and diluted): | ||||||||||||||
| Loss from continuing operations | $ | (0.13 | ) | $ | (0.21 | ) | $ | (0.19 | ) | $ | (0.33 | ) | ||
| Loss from discontinued operations | $ | (0.12 | ) | $ | (0.10 | ) | $ | (0.17 | ) | $ | (0.13 | ) | ||
| Extraordinary loss on early extinguishment of debt | $ | — | $ | — | $ | — | $ | (0.03 | ) | |||||
| Net loss | $ | (0.25 | ) | $ | (0.31 | ) | $ | (0.36 | ) | $ | (0.49 | ) | ||
The accompanying notes are an integral part of these statements.
4
Consolidated Statement Of Stockholders' Equity
(Unaudited)
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Convertible Preferred Stock |
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|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
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Common Stock |
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Notes Receivable From Stockholders |
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Accumulated Other Comprehensive Loss |
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Common Stock Warrants |
Additional Paid-In Capital |
Accumulated Deficit |
Total Stockholders' Equity |
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Shares |
Amount |
Shares |
Amount |
|||||||||||||||||||||||||
| Balance at February 2, 2002 | 604,759 | $ | 6,000 | 9,313,884 | $ | 93,000 | $ | 2,324,000 | $ | (118,000 | ) | $ | 33,321,000 | $ | (24,380,000 | ) | $ | (64,000 | ) | $ | 11,182,000 | ||||||||
| Net loss | — | — | — | — | — | — | — | (3,243,000 | ) | — | (3,243,000 | ) | |||||||||||||||||
| Notes receivable issued June 6, 2002 | — | — | — | — | — | (12,000 | ) | — | — | — | (12,000 | ) | |||||||||||||||||
| Common Stock transactions: Common Stock issued in conjunction with board of director Fees | — | — | 34,220 | — | — | — | 25,000 | — | — | 25,000 | |||||||||||||||||||
| Preferred stock transactions: Preferred stock dividends | — | — | 139,474 | 2,000 | — — | — | 107,000 | (110,000 | ) | — | (1,000 | ) | |||||||||||||||||
| Balance at August 3, 2002 | 604,759 | $ | 6,000 | 9,487,578 | $ | 95,000 | $ | 2,324,000 | $ | (130,000 | ) | 33,453,000 | $ | (27,733,000 | ) | $ | (64,000 | ) | $ | 7,951,000 | |||||||||
The accompanying notes are an integral part of these statements.
5
Consolidated Statements of Cash Flows
(Unaudited)
| |
Six Months Ended |
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|---|---|---|---|---|---|---|---|---|---|
| |
August 3, 2002 |
August 4, 2001 |
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| Cash flows from operating activities: | |||||||||
| Net loss | $ | (3,243,000 | ) | $ | (4,395,000 | ) | |||
| Adjustments to reconcile net loss to net cash from operating activities: | |||||||||
| Depreciation and amortization | 1,038,000 | 1,139,000 | |||||||
| Amortization of debt discount | 75,000 | 64,000 | |||||||
| Minority interests in subsidiaries | 2,000 | 49,000 | |||||||
| Deferred income tax asset—valuation allowance | — | 700,000 | |||||||
| Loss from discontinuing operations | 1,538,000 | 1,237,000 | |||||||
| Extraordinary loss on early extinguishment of debt | — | 219,000 | |||||||
| (590,000 | ) | (987,000 | ) | ||||||
| Changes in operating assets and liabilities: | |||||||||
| Accounts and notes receivable | 781,000 | 1,151,000 | |||||||
| Inventories | 96,000 | 790,000 | |||||||
| Prepaid catalog expenses | 552,000 | 593,000 | |||||||
| Other prepaid expenses | (64,000 | ) | (141,000 | ) | |||||
| Accounts payable | 574,000 | 245,000 | |||||||
| Accrued expenses | (254,000 | ) | (725,000 | ) | |||||
| Other assets | (93,000 | ) | (243,000 | ) | |||||
| Net cash provided by operating activities | 1,002,000 | 683,000 | |||||||
| Cash flows from investing activities: | |||||||||
| Proceeds from notes receivable issued in connection with sale of property and equipment | 25,000 | 40,000 | |||||||
| Purchase of property and equipment | (22,000 | ) | (148,000 | ) | |||||
| Net cash provided by (used in) investing activities | 3,000 | (108,000 | ) | ||||||
| Cash flows from financing activities: | |||||||||
| Proceeds from sale of common stock | — | 16,000 | |||||||
| Net (repayments) borrowings on revolving credit loan | (428,000 | ) | 1,525,000 | ||||||
| Repayments of long-term debt | — | (3,593,000 | ) | ||||||
| Distributions to joint venture partners | (83,000 | ) | (160,000 | ) | |||||
| Notes receivable issued to stockholders | (12,000 | ) | — | ||||||
| Proceeds from notes receivable issued to stockholders | — | 30,000 | |||||||
| Net cash used in financing activities | (523,000 | ) | (2,182,000 | ) | |||||
| Net cash provided by (used in) continuing operations | 482,000 | (1,607,000 | ) | ||||||
Net cash used in discontinuing operations |
(487,000 |
) |
(206,000 |
) |
|||||
| Net decrease in cash | (5,000 | ) | (1,813,000 | ) | |||||
Cash and cash equivalents, beginning of period |
602,000 |
2,468,000 |
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| Cash and cash equivalents, end of period | $ | 597,000 | $ | 655,000 | |||||
The accompanying notes are an integral part of these statements.
6
SUCCESSORIES, INC.
Notes To Consolidated Financial Statements
(Unaudited)
NOTE 1. DESCRIPTION OF THE BUSINESS
Successories, Inc. and its subsidiaries (collectively the "Company") design, manufacture, and market a diverse range of motivational and self-improvement products, most of which are the Company's own proprietary designs. The Company considers itself a single line of business with products that are marketed primarily under the Successories trade name through direct marketing (catalog, electronic commerce and telemarketing), retail (Company-owned stores)—See Note 3 "Discontinued Operations", sales to franchisees and wholesale distribution channels. The Company operates a chain of Successories retail stores located in the United States and Canada. The Company also operates a franchising program whereby franchisees are granted the right to market the Company's products under the Successories trademark.
NOTE 2. BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared, without audit, in accordance with generally accepted accounting principles for interim financial information and in conjunction with the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring matters) considered necessary for a fair presentation have been included.
The Company's fiscal year ends on the Saturday closest to January 31. References to the three and six months ended August 3, 2002, and August 4, 2001, refer to the thirteen and twenty-six weeks ended on the dates indicated.
Certain prior year amounts have been reclassified to conform with the current year presentation. The results of operations for the six months ended August 3, 2002 are not necessarily indicative of the results to be expected for the full year. These financial statements should be read in conjunction with the Company's financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended February 2, 2002.
NOTE 3: DISCONTINUED OPERATIONS
On May 7, 2002 in the process of reviewing its strategic options, the Company decided to take immediate steps to develop and implement a plan to close all of its 100% owned retail stores. The 100% owned retail store segment, which has not been as profitable as the other segments in the past few years, reported a loss of $1,903,000 for the year-ended February 2, 2002 and is projected to have a loss in the current fiscal year.
As a result, in the second quarter ended August 3, 2002, the Company started negotiating early lease terminations and evaluating asset impairment charges related to the 100% owned retail stores. The results of operations and costs associated with the Company's plans to close the 100% owned retail stores have been reflected as discontinued operations in the accompanying consolidated financial statements.
During the second quarter ended August 3, 2002, the Company recorded $722,000 in disposal costs as a result of lease termination contracts entered to-date for four stores and asset impairment charges for certain stores with negative cash flow projections anticipated through store closing date.
7
Loss from discontinued operations is comprised of the following:
| |
Three Months Ended |
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|---|---|---|---|---|---|---|---|
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August 3, 2002 |
August 4, 2001 |
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| Operating (loss) | (386,000 | ) | (599,000 | ) | |||
| Asset impairment charges | 602,000 | — | |||||
| Lease termination costs | 120,000 | — | |||||
| Income tax expense | — | 300,000 | |||||
| (Loss) from discontinued operations | $ | (1,108,000 | ) | $ | (899,000 | ) | |
| |
Six Months Ended |
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|---|---|---|---|---|---|---|---|
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August 3, 2002 |
August 4, 2001 |
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| Operating (loss) | (816,000 | ) | (937,000 | ) | |||
| Asset impairment charges | 602,000 | — | |||||
| Lease termination costs | 120,000 | — | |||||
| Income tax expense | — | 300,000 | |||||
| (Loss) from discontinued operations | $ | (1,538,000 | ) | $ | (1,237,000 | ) | |
As of August 3, 2002 and February 2, 2002, the assets of discontinued operations were $794,000 and $1,815,000, and the liabilities were $699,000 and $706,000, respectively. The assets and liabilities of the discontinued operations have been included in the accompanying consolidated balance sheet.
The Company is currently in the process of pursuing early lease terminations at the remaining 10 stores whose leases extend beyond the current fiscal year and costs associated will be dependent upon the terms and conditions of lease terminations to be negotiated with the landlords. The Company has adopted the provisions of FASB No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," in the second quarter 2002. Under FASB No. 146, the exit costs are recorded when incurred rather than at the date of a commitment to a disposal plan. The additional disposal costs to be incurred are estimated to be approximately $764,000 for early lease terminations and other store closing related expenses. Actual lease termination costs will be determined by the lease termination agreements negotiated with the landlords and could vary significantly if the Company cannot terminate lease agreements before their scheduled maturity. The Company is targeting to complete its plans to close all of its 100% owned retail stores by the end of the current fiscal year 2002.
NOTE 4. INVENTORIES
Inventories are comprised of the following:
| |
August 3, 2002 |
February 2, 2002 |
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|---|---|---|---|---|---|---|---|
| Finished goods—retail 100% owned stores | $ | 414,000 | $ | 678,000 | |||
| Finished goods—corporate | 2,954,000 | 3,147,000 | |||||
| Raw Materials—corporate | 2,010,000 | 1,763,000 | |||||
| 5,378,000 | 5,588,000 | ||||||
| Less: reserve for obsolescence | (675,000 | ) | (583,000 | ) | |||
| $ | 4,703,000 | $ | 5,005,000 | ||||
8
NOTE 5. DEBT
On June 20, 1997, the Company entered into a credit facility agreement with The Provident Bank (the "Bank"), amended most recently on June 13, 2002, the credit facility was comprised of a revolving credit loan, term loan and fixed rate loan. The revolving credit loan provides for maximum borrowings of $3,500.000 through October 31, 2002 and $3,000,000 thereafter and the borrowing base is limited to 80% of eligible receivables plus 45% of eligible inventory. A commitment fee of 0.25% is payable on the daily unused amount of the maximum revolving credit. The facility expires in June 2003, and all borrowings under the facility are secured by substantially all the assets of the Company. The interest rate on the revolving credit loan borrowing is prime plus 2.0%. Interest is payable monthly. The interest rate on the outstanding revolving credit loan was 6.75% at August 3, 2002. As of August 3, 2002, available borrowings on the revolving credit loan were $2,253,000.
On June 13, 2002, the Company obtained an amendment to the credit facility to be adjusted and modify certain financial covenants, which were retroactive to the first quarter ended May 4, 2002. In addition, the amendment adjusted the borrowing base and the revolver limits, prospectively. In connection with the above mentioned amendment, the Company agrees to provide the bank the option to exchange the stock warrants previously issued to the bank in exchange for a success fee equal to 2% of the gross sales price, in the event that the Company is sold.
In the prior year first quarter 2001, the Company pre-paid the entire outstanding Bank term loan and fixed rate loan balance in the amount of $3,590,000. The above noted loans had payment terms through June 2003. The Company recorded an extraordinary loss of $219,000 related to the early debt extinguishment in the prior year quarter ended May 5, 2001. The extraordinary loss represents the write-off of the unamortized debt discount associated with the term loan and fixed rate loan.
The credit facility agreement contains, among other provisions, requirements for maintaining certain earnings levels and financial ratios, limits on capital expenditures and additional indebtedness, and use of proceeds from certain equity offerings.
At August 3, 2002, the Company was in compliance with the debt covenant requirements of the credit facility agreement.
On September 11, 2002, the Company obtained approval to extend the step down in maximum borrowings from $3,500,000 to $3,000,000 on the revolving credit loan from October 31, 2002 to January 1, 2003. The Company requested the above extension to provide for adequate revolving credit loan availability for the payout of projected lease termination costs related to the 100% Company owned retail stores, see Note 3 for further information.
The weighted average interest rates on cash interest expense for borrowings outstanding as of August 3, 2002 and August 4, 2001 were 6.8% and 8.9%, respectively.
NOTE 6. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental disclosures to the statements of cash flows are as follows:
| |
Six Months Ended |
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|---|---|---|---|---|---|---|---|
| |
August 3, 2002 |
August 4, 2001 |
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| Cash paid during the period for: | |||||||
| Income taxes | $ | 1,000 | $ | 87,000 | |||
| Interest | 63,000 | 80,000 | |||||
| Non-cash investing and financing Activities: | |||||||
| Preferred stock dividends | $ | 110,000 | $ | 110,000 | |||
| Board of Director Fees | 25,000 | — | |||||
9
NOTE 7. LOSS PER SHARE
The computations of basic and diluted loss per share are as follows:
| |
Three Months Ended |
Six Months Ended |
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|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
August 3, 2002 |
August 4, 2001 |
August 3, 2002 |
August 4, 2001 |
||||||||||
| Numerator for loss from continuing operations per share: | ||||||||||||||
| Loss from continuing operations | $ | (1,172,000 | ) | $ | (1,934,000 | ) | $ | (1,705,000 | ) | $ | (2,939,000 | ) | ||
| Preferred stock dividends | (55,000 | ) | (55,000 | ) | (110,000 | ) | (110,000 | ) | ||||||
| Numerator for loss from continuing operations per share | $ | (1,227,000 | ) | $ | (1,989,000 | ) | $ | (1,815,000 | ) | $ | (3,049,000 | ) | ||
| Numerator for loss from discontinued operations per share | $ | (1,108,000 | ) | $ | (899,000 | ) | $ | (1,538,000 | ) | $ | (1,237,000 | ) | ||
| Numerator for extraordinary loss on early extinguishment of debt per share | $ | — | $ | — | $ | — | $ | (219,000 | ) | |||||
| Numerator for net loss per share: | ||||||||||||||
| Net loss | $ | (2,280,000 | ) | $ | (2,833,000 | ) | $ | (3,243,000 | ) | $ | (4,395,000 | ) | ||
| Preferred stock dividends | (55,000 | ) | (55,000 | ) | (110,000 | ) | (110,000 | ) | ||||||
| Numerator for net loss per share | $ | (2,335,000 | ) | $ | (2,888,000 | ) | $ | (3,353,000 | ) | $ | (4,505,000 | ) | ||
| Denominator for loss per share: | ||||||||||||||
| Weighted average common stock shares | 9,370,261 | 9,214,899 | 9,414,825 | 9,223,924 | ||||||||||
| Basic and diluted loss per share: | ||||||||||||||
| Loss from continuing operations | $ | (0.13 | ) | $ | (0.21 | ) | $ | (0.19 | ) | $ | (0.33 | ) | ||
| Loss from discontinued operations | $ | (0.12 | ) | $ | (0.10 | ) | $ | (0.17 | ) | $ | (0.13 | ) | ||
| Extraordinary loss on early extinguishment of debt | $ | — | $ | — | $ | — | $ | (0.03 | ) | |||||
| Net loss | $ | (0.25 | ) | $ | (0.31 | ) | $ | (0.36 | ) | $ | (0.49 | ) | ||
Stock options, warrants, and convertible preferred stock were not included in the computation of the diluted loss per share, due to their antidilutive effect on the loss per share.
NOTE 8. SEGMENT AND RELATED INFORMATION
The Company has adopted SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information." This Statement establishes standards for the way public business enterprises report information about operating segments in annual financial statements and in interim financial reports issued to shareholders.
The Company's reportable segments are the various distribution channels used to market its products. The Company's products have similar purposes and uses in each channel of distribution, but profitability varies among the channels. The Company considers itself a single line of business with products that are marketed through direct marketing (catalog, electronic commerce and telemarketing), retail (Company-owned stores), wholesale and sales to franchisees channels. In addition, the Company generates revenue from providing framing services to outside corporate businesses on a contract fee basis. The Company has four reportable segments—Direct Marketing—Successories, Retail Company-owned stores—See Note 3 "Discontinued Operations," Sales to Franchisees and other segments (Direct
10
Marketing—Golf, Wholesale, Contract Framing and Joint Venture retail stores). At the end of the first quarter in fiscal 2002, the Company discontinued contract framing services for third party products. Any future contract framing services shall be limited primarily to large and multiple unit production runs.
The accounting policies of the reportable segments are the same as those described in Note 2 of Notes to Consolidated Financial Statements in the Company's 10-K. The Company evaluates the performance of its operating segments based on income (loss) before other income (expense), income taxes and extraordinary item.
Summarized financial information concerning the Company's reportable segments is shown in the following table. The "Corporate" row includes corporate related items not allocated to reportable segments.
| |
Net Sales |
Segment Profit (Loss) |
Total Assets |
Capital Expenditures |
Depreciation and Amortization |
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|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Three Months Ended August 3, 2002: | |||||||||||||||
| Direct Marketing Successories | $ | 6,165,000 | $ | 436,000 | $ | 6,390,000 | $ | 3,000 | $ | 67,000 | |||||
| Sales to Franchisees | 528,000 | 7,000 | 601,000 | — | 3,000 | ||||||||||
| Other segments | 470,000 | 32,000 | 628,000 | 5,000 | 12,000 | ||||||||||
| Corporate | — | (1,647,000 | ) | 4,158,000 | 1,000 | 437,000 | |||||||||
| CONTINUING OPERATIONS | $ | 7,163,000 | $ | (1,172,000 | ) | $ | 11,777,000 | $ | 9,000 | $ | 519,000 | ||||
| Retail 100% owned stores | $ | 1,382,000 | $ | (1,108,000 | ) | $ | 794,000 | $ | 1,000 | $ | 694,000 | ||||
| Three Months Ended August 4, 2001: | |||||||||||||||
| Direct Marketing Successories | $ | 6,268,000 | $ | 360,000 | $ | 7,685,000 | $ | 32,000 | $ | 67,000 | |||||
| Sales to Franchisees | 999,000 | 30,000 | 962,000 | — | 3,000 | ||||||||||
| Other segments | 791,000 | 91,000 | 954,000 | — | 14,000 | ||||||||||
| Corporate | — | (2,415,000 | ) | 10,077,000 | 18,000 | 478,000 | |||||||||
| CONTINUING OPERATIONS | $ | 8,058,000 | $ | (1,934,000 | ) | $ | 19,678,000 | $ | 50,000 | $ | 562,000 | ||||
| Retail 100% owned stores | $ | 1,635,000 | $ | (899,000 | ) | $ | 2,136,000 | $ | 31,000 | $ | 378,000 | ||||
| Six Months Ended August 3, 2002: | |||||||||||||||
| Direct Marketing Successories | $ | 13,493,000 | $ | 1,274,000 | $ | 6,390,000 | $ | 12,000 | $ | 133,000 | |||||
| Sales to Franchisees | 1,114,000 | 27,000 | 601,000 | — | 6,000 | ||||||||||
| Other segments | 1,081,000 | 127,000 | 628,000 | 5,000 | 20,000 | ||||||||||
| Corporate | — | (3,133,000 | ) | 4,158,000 | 5,000 | 879,000 | |||||||||
| CONTINUING OPERATIONS | $ | 15,688,000 | $ | (1,705,000 | ) | $ | 11,777,000 | $ | 22,000 | $ | 1,038,000 | ||||
| Retail 100% owned stores | $ | 2,933,000 | $ | (1,538,000 | ) | $ | 794,000 | $ | 3,000 | $ | 788,000 | ||||
| Six Months Ended August 4, 2001: | |||||||||||||||
| Direct Marketing Successories | $ | 13,940,000 | $ | 890,000 | $ | 7,685,000 | $ | 47,000 | $ | 134,000 | |||||
| Sales to Franchisees | 1,926,000 | 68,000 | 962,000 | — | 3,000 | ||||||||||
| Other segments | 1,695,000 | 269,000 | 954,000 | — | 28,000 | ||||||||||
| Corporate | — | (4,385,000 | ) | 10,077,000 | 101,000 | 974,000 | |||||||||
| CONTINUING OPERATIONS | $ | 17,561,000 | $ | (3,158,000 | ) | $ | 19,678,000 | $ | 148,000 | $ | 1,139,000 | ||||
| Retail 100% owned store | $ | 3,218,000 | $ | (1,237,000 | ) | $ | 2,136,000 | $ | 31,000 | $ | 513,000 | ||||
The Company utilizes its facilities and the majority of its assets interchangeably among each distribution channel. Assets that relate specifically to a reportable segment have been included in the above table. Assets identified to the reportable segments are primarily cash, receivables, inventory, prepaid catalogs, property and equipment, and intangibles. The assets of the discontinued operations of the retail 100% owned stores have been included in the accompanying consolidated balance sheet.
11
The following table presents the details for "Corporate":
| |
Three Months Ended |
Six Months Ended |
||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
August 3, 2002 |
August 4, 2001 |
August 3, 2002 |
August 4, 2001 |
||||||||
| Corporate administrative expenses | $ | 1,171,000 | $ | 1,166,000 | 2,253,000 | $ | 2,331,000 | |||||
| Unallocated depreciation and amortization expense | 437,000 | 478,000 | 879,000 | 974,000 | ||||||||
| Other expenses | 39,000 | 71,000 | 107,000 | 161,000 | ||||||||
| Income tax expense (benefit) | — | 700,000 | (106,000 | ) | 700,000 | |||||||
| Extraordinary loss on early debt extinguishment | — | — | — | 219,000 | ||||||||
| $ | 1,647,000 | $ | 2,415,000 | $ | 3,133,000 | $ | 4,385,000 | |||||
Corporate administrative expenses are primarily charges for those functions not specifically attributable to any specific segment; these functions include the product development, merchandising, information systems, accounting, legal, human resource and executive departments. Included in the expenses associated with these functions are payroll and related costs, professional fees, information system maintenance costs, office occupancy costs, and property, casualty and directors and officers insurance.
The Company's operations are principally in North America. No single foreign country or geographic area is significant to the consolidated operations. Long-lived assets are all located in North America.
The Company's products include distinctive lines of wall decor, desktop accessories, books and stationery, personalized gifts and awards. In addition, the Company sells other motivational products supplied by third parties.
For the six months ended August 3, 2002 and August 4, 2001, net product sales by product categories were as follows:
| |
Six Months Ended |
||||
|---|---|---|---|---|---|
| |
Augusts 3, 2002 |
Augusts 4, 2001 |
|||
| Wall décor | 43.2 | % | 42.8 | % | |
| Desktop accessories | 18.9 | % | 21.1 | % | |
| Books and stationery | 18.7 | % | 18.8 | % | |
| Personalized gifts and awards | 19.2 | % | 16.2 | % | |
| Other | — | 1.1 | % | ||
NOTE 9. NEW ACCOUNTING PRONOUNCEMENTS
During the second quarter ended August 3, 2002, the Company adopted FASB No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets." The provisions of FASB No. 144 were applied to the Company's plan to close all of its 100% owned retail stores. The operations of the Company's 100% owned retail stores can be distinguished from the rest of the entity and will be eliminated from the ongoing operations of the Company. Accordingly, the operations of the 100% owned retail stores, net of applicable income tax effect, have been presented as discontinued operations and prior period statements of operations have been reclassified accordingly. (See Note 3 for further information).
In May 2002, the Financial Accounting Standards Board issued FASB No. 145 "Recision of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13 and Technical Corrections,"
12
FASB No. 145 is effective for fiscal years beginning after May 14, 2002 unless adopted earlier. FASB 145 requires the stringent criteria of Accounting Principles Board No. 30 to be applied to debt extinguishments. Prior debt extinguishments that do not qualify will be reclassified as ordinary. FASB 145 also amends the requirements for certain lease modifications which result in a change in classification of the lease from a capital lease to an operating lease. In addition FASB 145 provides guidance regarding the trucking industry's deregulation that occurred in 1980. The Company has not yet adopted FASB 145 and adoption of it is not expected to have a material impact on the Company's results of operations or financial condition. The adoption of FASB 145 will result in increasing the loss from continuing operations by $219,000, which was previously classified as an extraordinary item for the six months ended August 4, 2001.
In June 2002, FASB No. 146 "Accounting for Costs Associated with Exit or Disposal Activities," was issued. FASB No. 146 covers accounting for costs associated with exit or long-lived asset disposal activities, such as restructurings, consolidation or closing of facilities, lease termination cost, and employee relocation or severance cost. FASB No. 146 replaces Emerging Issues Task Force (EITF) 94-3, and is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. Early application is encouraged. One of the provisions of FASB No. 146 changes the timing of when companies recognize costs associated with exit or disposal activities, so that the costs would generally be recognized when they are incurred rather than at the date of a commitment to an exit or disposal plan. The Company adopted FASB No. 146 in the second quarter of fiscal 2002. See Note 3 for a discussion of the discontinuance of the Company's 100% owned retail operations.
NOTE 10. MANAGEMENT PLANS
Due to the continuing soft economic climate and the substantial loss before income taxes and extraordinary items of $5,712,000 sustained in fiscal 2001, the Company retained the professional services of Duff & Phelps, LLC, an investment banking and financial advisory firm. Duff & Phelps is currently assisting with the sale of the Company. No assurance can be given that the sale of the Company shall be effected. If the sale of the Company does not occur, the management of the Company shall take steps to restructure and further reduce its expenses, pursue an equity infusion and seek expanded lines of credit from the existing or new lenders. No assurance can be given that any restructuring plans undertaken by management will be successful, or that the Company will be able to secure additional capital or borrowings on terms acceptable to it, or at all.
The Company will continue its primary focus on sales growth in the direct marketing channel, support of its current franchisees and evaluating wholesale business opportunities. In the process of reviewing its strategic options, the Company decided on May 7, 2002 to take immediate steps to develop and implement a plan to close all of its 100% owned retail stores, (See Note 3 for further information). At the end of the first quarter in fiscal 2002, the Company discontinued contract-framing services for third party products. Any future contract framing services shall be limited primarily to large and multiple unit production runs. Net sales and operating results for contract framing were not material.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with, and is qualified in its entirety by, the Consolidated Financial Statements and Notes thereto included elsewhere in this Report.
Successories designs, manufactures and markets a diverse range of motivational and self-improvement products, most of which are the Company's own proprietary designs. The Company's products include distinctive lines of wall decor, desktop accessories, books and stationery, and personalized gifts and awards. In-house designers create proprietary art work and designs that can be used in conjunction with a wide variety of products. The Company will also customize products to fulfill customers' special needs.
The Company's products are marketed primarily under its Successories trade name through direct marketing (catalog, electronic commerce and telemarketing), retail channel (100% Company-owned stores), sales to franchisees and wholesale distribution. Although the Company utilizes multiple distribution channels for its products, the Company's products have similar purposes and uses in each channel of distribution. The profitability varies among products and distribution channels. The Company utilizes its facilities interchangeably for each distribution channel. Furthermore, the marketing channels are directed at a single customer base located primarily in North America. In addition, starting in fiscal 2000, the Company generated revenue from providing framing services to outside corporate businesses on a contract fee basis. At the end of the first quarter in fiscal 2002, the Company discontinued contract framing services for third party products. Any future contract framing services shall be limited primarily to large and multiple unit production runs. Net sales and operating results for contract framing were not material.
Due to the continuing soft economic climate and the substantial loss before income taxes and extraordinary items of $5,712,000 sustained in fiscal 2001, the Company retained the professional services of Duff & Phelps, LLC, an investment banking and financial advisory firm. Duff & Phelps is assisting with the sale of the Company. No assurance can be given that the sale of the Company shall be effected. If the sale of the Company does not occur, the management of the Company shall take steps to restructure and further reduce its expenses, pursue an equity infusion and seek expanded lines of credit from the existing or new lenders. No assurance can be given that any restructuring plans undertaken by management will be successful, or that the Company will be able to secure additional capital or borrowings on terms acceptable to it, or at all.
The Company will continue its primary focus on sales growth in the direct marketing channel, support of its current franchisees and evaluating wholesale business opportunities. In the process of reviewing its strategic options, the Company decided on May 7, 2002 to take immediate steps to develop and implement a plan to close all of its 100% owned retail stores (See Note 3 in the accompanying financial statements for further information). The results of operations and costs incurred to-date associated with the Company's plan to close the 100% owned retail stores have been reflected as discontinued operations in the accompanying consolidated financial statements.
For the three and six months ended August 3, 2002 and August 4, 2001, net product sales for the various distribution channels, as a percentage of total net product sales, were as follows:
| |
Three Months Ended |
Six Months Ended |
|||||||
|---|---|---|---|---|---|---|---|---|---|
| |
August 3, 2002 |
August 4, 2001 |
August 3, 2002 |
August 4, 2001 |
|||||
| Direct marketing—Successories | 72.2 | % | 64.7 | % | 72.5 | % | 67.1 | % | |
| Retail 100% Company-owned stores | 16.2 | % | 16.9 | % | 15.6 | % | 15.5 | % | |
| Sales to franchisees | 6.2 | % | 10.3 | % | 6.0 | % | 9.3 | % | |
| Other channels | 5.4 | % | 8.1 | % | 5.9 | % | 8.1 | % | |
The gross profit margins for direct marketing and retail channels vary due to differences in product mix and volume discounts based on order size. The gross profit margin for sales to the franchisees is lower than the direct marketing and retail channels since these sales are generally made at wholesale prices.
14
RESULTS OF OPERATIONS
The following table sets forth the results of operations for the three months and six months ended August 3, 2002 and August 4, 2001:
| |
Three Months Ended |
|
|
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
August 3, 2002 |
August 4, 2001 |
Increase (Decrease) |
|||||||||||||
| |
Amount |
% |
Amount |
% |
Amount |
% |
||||||||||
| |
(Dollars in thousands) |
|
|
|||||||||||||
| Net product sales | $ | 7,163 | 100.0 | % | $ | 8,058 | 100.0 | % | $ | (895 | ) | (11.1 | ) | |||
| Cost of goods sold | 3,630 | 50.7 | 4,051 | 50.3 | (421 | ) | (10.4 | ) | ||||||||
| Gross profit on product sales | 3,533 | 49.3 | 4,007 | 49.7 | (474 | ) | (11.8 | ) | ||||||||
| Fees, royalties and other income | 228 | 3.2 | 283 | 3.5 | (55 | ) | (19.4 | ) | ||||||||
| Gross margin | 3,761 | 52.5 | 4,290 | 53.2 | (529 | ) | (12.3 | ) | ||||||||
| Operating expenses | 4,894 | 68.3 | 5,453 | 67.7 | (559 | ) | (10.3 | ) | ||||||||
| Loss from continuing operations before other expenses and taxes | (1,133 | ) | (15.8 | ) | (1,163 | ) | (14.5 | ) | 30 | 2.6 | ||||||
| Interest and other expenses | 39 | 0.5 | 71 | 0.9 | (32 | ) | (45.1 | ) | ||||||||
| Loss from continuing operations before income taxes | (1,172 | ) | (16.3 | ) | (1,234 | ) | 15.4 | 62 | 5.0 | |||||||
| Income tax expense (benefit) | — | — | 700 | 8.7 | (700 | ) | (100.0 | ) | ||||||||
| Loss from continuing operations | (1,172 | ) | (16.3 | ) | (1,934 | ) | (24.1 | ) | 762 | 39.4 | ||||||
| Loss from discontinued operations | (1,108 | ) | (15.5 | ) | (899 | ) | (11.1 | ) | 209 | (23.2 | ) | |||||
| Net loss | $ | (2,280 | ) | (31.8 | ) | $ | (2,833 | ) | (35.2 | ) | $ | 553 | 19.5 | |||
| |
Six Months Ended |
|
|
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
August 3, 2002 |
August 4, 2001 |
Increase (Decrease) |
|||||||||||||
| |
Amount |
% |
Amount |
% |
Amount |
% |
||||||||||
| Net product sales | $ | 15,688 | 100.0 | % | $ | 17,561 | 100.0 | % | $ | (1,873 | ) | (10.7 | ) | |||
| Cost of goods sold | 7,808 | 49.8 | 8,617 | 49.1 | (809 | ) | (9.4 | ) | ||||||||
| Gross profit on product sales | 7,880 | 50.2 | 8,944 | 50.9 | (1,064 | ) | (11.9 | ) | ||||||||
| Fees, royalties and other income | 416 | 2.7 | 509 | 2.9 | (93 | ) | (18.3 | ) | ||||||||
| Gross margin | 8,296 | 52.9 | 9,453 | 53.8 | (1,157 | ) | (12.2 | ) | ||||||||
| Operating expenses | 10,000 | 63.7 | 11,531 | 65.7 | (1,531 | ) | (13.3 | ) | ||||||||
| Loss from continuing operations before other expenses and taxes | (1,704 | ) | (10.8 | ) | (2,078 | ) | (11.9 | ) | 374 | 18.0 | ||||||
| Interest and other expenses | 107 | 0.7 | 161 | 0.9 | (54 | ) | 33.5 | ) | ||||||||
| Loss from continuing operations before income taxes | (1,811 | ) | (11.5 | ) | (2,239 | ) | (12.8 | ) | 428 | 19.1 | ||||||
| Income tax expense (benefit) | (106 | ) | (0.7 | ) | 700 | 3.9 | (806 | ) | (115.1 | ) | ||||||
| Loss from continuing operations | (1,705 | ) | (10.8 | ) | (2,939 | ) | (16.7 | ) | 1,234 | 41.9 | ||||||
| Loss from discontinued operations | (1,538 | ) | (6.7 | ) | (1,237 | ) | (7.1 | ) | (301 | ) | (24.3 | ) | ||||
| Loss before extraordinary item | (3,243 | ) | (17.5 | ) | (4,176 | ) | (23.8 | ) | 933 | 22.3 | ||||||
| Extraordinary loss | — | — | (219 | ) | (1.2 | ) | 219 | 100.0 | ||||||||
| Net loss | $ | (3,243 | ) | (17.5 | ) | $ | (4,395 | ) | (25.0 | ) | $ | 1,152 | 26.2 | |||
15
Three Months Ended August 3, 2002 (Second Quarter 2002), Compared To Three Months Ended August 4, 2001 (Second Quarter 2001)
Net product sales were $7,163,000 in the current year second quarter ended August 3, 2002, compared to $8,058,000 for the corresponding second quarter ended August 4, 2001. The $895,000 or 11.1% decrease in net sales was comprised of direct marketing Successories of $103,000 or 1.6%, sales to franchisees of $471,000 or 47.1%, and other channels of $321,000 or 40.6%. The net sales and operations of the retail 100% owned stores are reported separately as discontinued operations on the accompanying consolidated statements of operations and comprehensive loss.
The Company's direct marketing Successories sales in the second quarter 2002 were comparable to prior year second quarter 2001. The Company continues to evaluate the most effective prospect catalog circulation strategy in the current business environment, aggressively target opportunities in niche markets and focus on increasing customer re-buy rates. The Company increased it's overall circulation in the current year second quarter 2002 by 10%, which was primarily in the customer catalog circulation. The refined catalog circulation strategy undertaken by the Company has positively impacted the operating results of the direct marketing Successories channel. The decrease in sales to franchisees can be primarily attributed to 16 fewer stores in operation in the current year in comparison to prior year. The decrease in net sales in the other channels from year to year can be primarily attributed to the Company's decision made in first quarter 2002 to discontinue contract framing services for third party products, and one fewer joint venture retail store in operation in the current year.
Gross margin decreased in the current year second quarter 2002 to $3,761,000 from $4,290,000 in the prior year second quarter 2001. The decrease in gross margin can be attributed to a decline in net sales from year to year. In addition, the gross profit, as a percentage of net sales, decreased as a result of a permanent price reduction for wall décor and various other products initiated in the second quarter 2002 to encourage consumer spending in light of the current business environment. The lower sales volume in the current year has not significantly impacted the product costs per unit due to various manufacturing cost reduction efforts undertaken by the Company.
Operating expenses decreased in the current year second quarter 2002 to $4,894,000 from $5,453,000 in the prior year second quarter 2001. The decrease in operating expenses from year to year of $559,000 is primarily in catalog advertising costs due to refined catalog circulation, corporate payroll expenses related to workforce reductions initiated in the third quarter 2001 and the second quarter 2002, and variable operating expenses as a result of lower sales volume. In the second quarter 2002, the Company instituted a workforce reduction which is expected to provide annualized payroll expense savings of approximately $1,000,000. The severance costs associated with the above mentioned workforce reduction of approximately $93,000 has been recorded in the second quarter 2002.
In the prior year second quarter 2001, the Company recorded an income tax expense of $700,000 to increase the valuation allowance associated with the deferred tax asset balance. As a result of the challenging economic environment, the Company's management determined that the valuation allowance should be increased due to reduced likelihood of whether all the benefits of the deferred tax asset related to the net operating loss (NOL) carryforwards would be fully utilized before they expire.
In the second quarter 2002, the Company decided to take immediate steps to close all of its 100% owned retail stores and as a result has started to negotiate early lease terminations with the various landlords. In accordance with FASB No. 144, the Company has reflected separately the results of operations of the 100% owned retail stores as discontinued operations. During the second quarter 2002, the Company recorded $722,000 in disposal costs related to lease termination contracts entered to-date for four stores and asset impairment charges for certain stores with negative cash flow projections anticipated through store closing date. The Company is currently in the process of pursuing early lease terminations at the remaining ten stores whose leases extend beyond the current fiscal year. Actual lease termination costs will be determined by the lease termination agreements negotiated with
16
the landlords and could vary significantly if the Company cannot terminate lease agreements before their scheduled maturity.
The net loss was $2,280,000 in the current year second quarter 2002, compared to $2,833,000 in the corresponding prior year second quarter 2001. The loss from continuing operations improved from the prior year, in spite of lower sales volume, as a result of streamlining operating expenses.
Six Months Ended August 3, 2002 (Year-To-Date 2002), Compared To Six Months Ended August 4, 2001 (Year-To-Date 2001)
Net product sales were $15,688,000 year-to-date for the six months ended August 3, 2002, compared to $17,561,000 for the corresponding six months ended August 2, 2001. The $1,873,000 or 10.7% decrease in net sales was comprised of direct marketing Successories of $447,000 or 3.2%, sales to franchisees of $812,000 or 42.1%, and other channels of $614,000 or 36.2%. The net sales and operations of the 100% owned retail stores are reported separately as discontinued operations on the accompanying consolidated statements of operations and comprehensive loss.
The decrease in direct marketing Successories channel net sales in the current year were in part due to the refined catalog circulation strategy undertaken by the Company. In comparison to prior year, the company to-date in the current year reduced the prospect catalog circulation due to lower response rates experienced in 2001 and increased customer catalog circulation as a result of targeting opportunities in niche markets. The refined catalog circulation strategy resulted in an overall catalog circulation decrease of 16% in the current year, but a positive impact to the operating profit of the direct market Successories channel as a result of improved return on catalog advertising costs. The Company has started to experience better response rates than prior year for prospect catalogs and as a result plans to increase circulation for the remainder of the current fiscal year 2002 in comparison to the prior year. Internet sales, which are included in the direct marketing Successories channel, increased by 20.2% from year to year. Internet sales represented 26.4% of the total direct marketing sales in the current year and were 21.3% in the prior year. Internet continues to be a significant marketing and sales opportunity for the Company. The decrease in sales to franchisees can be primarily attributed to 16 fewer stores in operation in the current year in comparison to prior year. The decrease in net sales in the other channels from year to year can be primarily attributed to the Company's decision made in the first quarter 2002 to discontinue contract framing services for third party products, and two fewer joint venture retail stores in operation in the current year.
Gross margin decreased in the current year to $8,296,000 from $9,453,000 in prior year. The decrease in gross margin can be primarily attributed to a decline in net sales from year to year. To encourage consumer spending, the Company continues to provide promotional and permanent discounting of various products. The gross profit, as a percentage of net sales, in the current year in comparison to the prior year was negatively impacted by additional discounting provided to customers. The lower sales volume in the current year has not significantly impacted the product costs per unit due to various manufacturing cost reduction efforts undertaken by the Company.
Operating expenses decreased in the current year to $10,000,000 from $11,531,000 in the prior year. The decrease in operating expenses from year to year of $1,531,000 is primarily in catalog advertising costs due to reduced and refined catalog circulation, variable operating expenses as a result of lower sales volume, and corporate payroll expenses related to workforce reductions instituted in the third quarter 2001 and the second quarter 2002.
In the current year first quarter 2002, the Company recorded an income tax benefit of $106,000 related to income tax refund claims approved and received from amended state returns. In the prior year second quarter 2001, the Company recorded an income tax expense of $700,000 to increase the valuation allowance associated with the deferred tax asset balance. As a result of the challenging
17
economic environment, the Company's management determined that the valuation allowance should be increased due to the reduced likelihood of whether all the benefits of the deferred tax asset related to the net operating loss (NOL) carryforwards would be fully utilized before they expire.
In the second quarter 2002, the Company decided to take immediate steps to close all of its 100% owned retail stores and as a result has started to negotiate early lease terminations with the various landlords. In accordance with FASB No. 144, the Company has reflected separately the results of operations of the 100% owned retail stores as discontinued operations. During the second quarter 2002, the Company recorded $722,000 in disposal costs related to lease termination contracts entered to-date for four stores and asset impairment charges for certain stores with negative cash flow projections anticipated through store closing date.
In the prior year first quarter 2001, the Company recorded an extraordinary loss of $219,000 related to early debt extinguishment. As a result of pre-payment of the term loan and fixed rate loan with the Company's bank, the Company recorded an additional expense to write-off the unamortized debt discount associated with the term loan and fixed rate loan.
In the current year the Company had a net loss of $3,243,000, in comparison to a net loss of $4,395,000 in the prior year. The improved operating results, in spite of lower sales volume, can be attributed to the Company's efforts to streamline operating expenses and utilization of cost-effective marketing strategies to improve the operating results of the Company. The Company's operating results from continuing operations improved 19.1%, even though, net sales declined by 10.7%.
LIQUIDITY AND CAPITAL RESOURCES
The Company's ongoing cash requirements are for working capital, capital expenditures and debt service. The Company expects to rely on cash generated from its operations, supplemented by borrowings available on the revolving credit loan, to fund its cash requirements.
Operating activities provided cash of $1,002,000 for the six months ended August 3, 2002, compared to $683,000 for the six months ended August 4, 2001. The improvement in cash flows from operating activities can be attributed primarily to a decrease in net loss from continuing operations, net of the change in asset and liability balances.
Investing activities provided cash of $3,000 for the six months ended August 3, 2002, compared to used cash of $108,000 for the six months ended August 2, 2001. The principal use of cash in investing activities is capital expenditures and the source of cash is proceeds from sales of property and equipment. The Company's current credit facility limits capital expenditures to $1 million for the fiscal year.
Financing activities used cash of $523,000 for the six months ended August 3, 2002, compared to $2,182,000 for the six months ended August 2, 2001. Planned debt repayments on the term note and net repayments on the revolving credit loan were the principal uses of cash. Proceeds from net borrowings on the revolving credit loan were the primary source of cash. In the prior year first quarter 2001, the Company prepaid its term loan and fixed rate loan with the bank as planned in an effort to strengthen the Company's balance sheet and debt to equity position. The above noted loans had payment terms through June 2003.
On June 13, 2002, the Company obtained an amendment to the credit facility to adjust and modify certain financial covenants which were retroactive to the first quarter ended May 4, 2002. In addition, the amendment adjusted the borrowing base and the revolver limits, prospectively. In connection with the above mentioned amendment, the Company agrees to provide the bank the option to exchange the stock warrants previously issued to the bank in exchange for a success fee equal to 2% of the gross sales price, in the event that the Company is sold. At August 3, 2002, the Company was in compliance with the debt covenants of the credit facility agreement.
18
On September 11, 2002, the Company obtained approval to extend the step down in maximum borrowings from $3,500,000 to $3,000,000 on the revolving credit loan from October 31, 2002 to January 1, 2003. The Company requested the above extension to provide for adequate revolving credit loan availability for the payout of projected lease termination costs related to the 100% Company-owned retail stores, See Note 3 in the accompanying financial statements for further information.
The Company believes that internally generated funds and the credit facility will be sufficient to meet its current operating needs, including funds required to close all of the 100% owned retail stores, fund debt service and make anticipated capital expenditures.
Subsequent to the current fiscal year-end and in the absence of a sale of the Company, the Company shall take steps to meet its liquidity needs through restructuring and further reduction of its expenses, pursuit of a cash equity infusion, looking into expanded lines of credit from existing or new lenders. The current revolving credit facility expires June 2003. No assurance can be given that any restructuring plans undertaken by management, in the event the Company is not sold, will be successful, or that the Company will be able to secure additional capital or borrowings on terms acceptable to it, or at all.
SEASONALITY
The Company's business is subject to seasonal variations in demand. Historically, a significant portion of the Company's sales and net income have been realized during the period from October through January. The effects of seasonality are greater in the Company's retail operations and sales to franchisees than the other segments of its business, the impact of which will diminish going-forward as the Company closes all of its 100% owned retail stores and with fewer franchisee stores in operation. Most operating expenses are incurred evenly throughout the year, although some selling and administrative expenses are variable depending on sales, and direct marketing catalog advertising expenses as a percentage of sales are generally higher in the first calendar quarter due to more prospecting. The Company's quarterly operating results may also vary depending upon such factors as catalog mailings and the timing of new product introductions and promotions by the Company. The Company's cash requirements generally reach a seasonal peak in the second half of the fiscal year to finance increased inventory levels needed to meet the third and fourth quarter sales demand.
INFLATION
The Company does not believe that inflation has had a material impact on its operations.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This Form 10-Q report contains forward-looking statements which the Company believes are within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such forward-looking statements may be deemed to include, among other things, statements relating to anticipated financial performance, the management team, management's long-term performance goals, channels, programs to reduce costs and enhance asset utilization, banking arrangement and terms, realization of deferred tax assets, as well as statements relating to the Company's operational and growth strategies. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to be accurate, and actual results could differ materially from those addressed in forward-looking statements contained in this Form 10-Q report. Potential risks and uncertainties include such factors as the financial strength of the economy, and the retail and catalog industries in general, changes in consumer confidence, the level of consumer spending on motivational-type products, the competitive pricing environment within the markets that the Company distributes its products, the level of the Company's success in continuing to control costs and the Company's ability to
19
increase certain margins through economies of scale. Additional risks and uncertainties include the Company's ability to develop and introduce successful new products, generate funds sufficient to meet its current operating and capital needs, sale of the Company, and successfully exit the retail channel (100% Company-owned stores). Investors are also directed to consider other risks and uncertainties discussed in the Company's public announcements, reports to shareholders and documents filed by the Company with the Securities and Exchange Commission, including but not limited to Reports on Forms 10-K, 8-K and 10-Q. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. The Company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date on this report.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is subject to market risk associated with adverse changes in interest rates and foreign currency exchange rates, but does not hold any market risk sensitive instruments for trading purposes. The Company uses variable rate debt, as described in Note 5 of the Notes to Consolidated Financial Statements. At August 3, 2002, principal exposed to interest rate risk is limited to $1,055,000 in variable rate debt. The variable rate debt level varies periodically and the maximum borrowing allowed at August 3, 2002 was $3,308,000. The impact of a 1% change in interest rates on the variable rate debt is approximately $10,000. The Company's exposure to foreign currency exchange rate risk relates primarily to the financial position and results of operations in Canada. The Company's exposure to foreign currency exchange rate risk is difficult to estimate due to factors such as balance sheet accounts, and the existing economic uncertainty and future economic conditions in the international marketplace. The Company does not expect significant impact from foreign currency exchange rate risk. The Company's Canadian operations annual sales are approximately $2,000,000.
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The Company was named as a defendant in a case filed by Brandon Shopping Center Partners, LTD ("Plaintiff"). Brandon Shopping Center Partners, LTD v Celex Group, Inc. (now Successories, Inc.) (Case No. 02 06414) was filed in the Circuit Court of the Thirteenth Judicial Circuit in and for Hillsborough County, Florida on July 11, 2002. Plaintiff alleged that the Company entered into a lease agreement with Plaintiff and was in default under the lease agreement due to failure to pay rent. Plaintiff sought (i) eviction of Company; (ii) compensatory damages, including unpaid rent of $17,201.95 and accelerated rent, and prejudgment interest (iii) costs; (iv) attorney's fees; and (v) all other charges owed. The parties settled the matter by entering into a Termination of Lease Agreement dated August 21, 2002.
The Company was named as a defendant in a case filed by Pyramid Company of Buffalo ("Plaintiff"). Pyramid Company of Buffalo v Successories, Inc. (Index No. 2002-8509) was filed in the State of New York Supreme Court in the County of Erie on August 15, 2002. Plaintiff alleges that the Company entered into a lease agreement with Plaintiff and was in default under the lease agreement due to failure to pay rent. Plaintiff seeks the sum of $9,415.27 as and for past due rents; all rents that may accrue; and such other and further relief as seems just and proper to the Court. The Company has since paid all past due rents and the parties are involved in settlement negotiations.
The Company was named as a defendant in a case filed by EKLECCO L.L.C. ("Plaintiff"). EKLECCO L.L.C. v Successories, Inc. (Index No. 2002-5591) was filed in the State of New York Supreme Court in the County of Erie on August 14, 2002. Plaintiff alleges that the Company entered into a lease agreement with Plaintiff and was in default under the lease agreement due to failure to pay rent. Plaintiff seeks the sum of $11,513.47 as and for past due rents; all rents that may accrue; and such other and further relief as seems just and proper to the Court. The Company has since paid all past due rents and the parties are involved in settlement negotiations.
The Company was named as a defendant in a case filed by Pyramid Crossgates Company ("Plaintiff"). Pyramid Crossgates Company v Successories, Inc. (Index No. 2002-5653) was filed in the State of New York Supreme Court in the County of Erie on August 14, 2002. Plaintiff alleges that the Company entered into a lese agreement with Plaintiff and was in default under the lease agreement due to failure to pay rent. Plaintiff seeks the sum of $10,992.96 as and for past due rents; all rents that may accrue; and such other and further relief as seems just and proper to the Court. The Company has since paid all past due rents and the parties are involved in settlement negotiations.
The Company was named as a defendant in a case filed by Scottsdale Fashion Square Partnership ("Plaintiff"). Scottsdale Fashion Square Partnership v Celex Group, Inc. (now Successories, Inc.) (No. CV2002-016540) was filed in the Superior Court of the State of Arizona in the County of Maricopa. Plaintiff alleges that the Company entered into a lease agreement with Plaintiff and is in default under the lease agreement due to failure to pay rent. Plaintiff seeks an order for immediate possession of the premises and all fixtures, trade fixtures, and tenant improvements; a writ of restitution; the sum of $17,231.46 for unpaid rent, accrued interest and late charges; interest on unpaid rent and late charges at the rate of 18% per annum; all rents that accrue with interest at the rate of 18% per annum, late charges at the rate of 5%, plus applicable rental tax thereon at the rate of 1.9%, court costs with interest thereon at the rate of 10% per annum; and such other further relief as the Court deems just and proper.
Except as noted above, there are no other material pending legal proceedings against the Company. The Company is, however, at times involved in routine litigation arising in the ordinary course of its business and, while the results of such proceedings cannot be predicted with certainty, the
21
Company believes that the final outcome of such matters will not have a material adverse effect on the Company's consolidated financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its annual meeting of shareholders on July 25, 2002, and the following matters were voted on at the meeting.
| |
For |
Abstain |
||
|---|---|---|---|---|
| Howard I. Berstein | 8,298,624 | 293,280 | ||
| Larry A. Hodges | 8,381,969 | 209,935 |
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
22
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| SUCCESSORIES, INC. (Registrant) |
||
Date: September 16, 2002 |
By: |
/s/ Gary J. Rovansek Gary J. Rovansek President, Chief Executive Officer and Director (Principal Executive Officer) |
Date: September 16, 2002 |
By: |
/s/ John C. Carroll John C. Carroll Senior Vice President, Chief Financial Officer and Chief Operating Officer (Principal Financial and Accounting Officer) |
23
I, Gary J. Rovansek, certify that:
| Date: September 16, 2002 | ||||
/s/ GARY J. ROVANSEK |
||||
Gary J. Rovansek Director, President and Chief Executive Officer |
||||
I, John C. Carroll, certify that:
| Date: September 16, 2002 | ||||
/s/ JOHN C. CARROLL John C. Carroll Senior Vice President, Chief Operating and Financial Officer |
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| Exhibit No. |
Description |
|
|---|---|---|
| 3.1 | Articles of Incorporation of Registrant—Amended and Restated as of October 28, 1999 (14) | |
3.3 |
By-laws of Registrant(11) |
|
3.4 |
Amended and Restated Certificate of Designation of Series A and Series B Convertible Preferred Stock(12) |
|
4.1 |
Specimen Common Stock Certificate(11) |
|
4.2 |
Specimen Series A Convertible Preferred Stock Certificate(13) |
|
4.3 |
Specimen Series B Convertible Preferred Stock Certificate(13) |
|
10.1 |
Form of Franchising Agreement(11) |
|
10.2 |
Stock Option Instrument for Arnold M. Anderson dated November 19, 1991(1) |
|
10.3 |
Successories, Inc. Amended and Restated Stock Option Plan(17) |
|
10.4 |
Joint Venture Agreement with Morrison DFW, Inc. and related documents(3) |
|
10.5 |
Indemnification Agreement dated April 7, 1999 between the Company and Arnold M. Anderson(10) |
|
Indemnification Agreements in the form filed were also entered into by the Messrs. Seamas T. Coyle, Timothy C. Dillon, C. Joseph LaBonte, Steven B. Larrick, Michael H. McKee, Mervyn C. Phillips, Jr., Guy E. Snyder, Gary J. Rovansek, R. Scott Morrison, Jr., Jack Miller, Howard I. Bernstein, Larry A. Hodges, and Leslie Nathanson Juris. |
||
10.6 |
Form of Subordinated Note, Common Stock Purchase Warrant and Subordination Agreement relating to issuance of $1,500,000 Subordinated Notes and Warrants to purchase 120,000 shares of the Company's Common Stock(4) |
|
10.7 |
Common Stock Option Agreement granted to Arnold M. Anderson and Incentive Stock Option Agreement granted to Arnold M. Anderson(4)* |
|
10.8(a |
) |
Employment Agreement with Arnold M. Anderson dated March 1, 1996(5)* |
10.8(b |
) |
Amendment to Employment Agreement with Arnold M. Anderson dated March 1, 1996(14)* |
10.8(c |
) |
Amendment to Employment Agreement with Arnold M. Anderson dated January 14, 1997(14)* |
10.8(d |
) |
Addendum to Employment Agreement with Arnold M. Anderson dated February 16, 2000(14)* |
10.8(e |
) |
Amendment to Employment Agreement with Arnold M. Anderson dated October 1, 2001(20)* |
10.9 |
Employment Agreement with Michael H. McKee dated June 1, 1999(11)* |
|
10.10 |
Form of Subordinated Note Extensions, Stock Options and Subordination Agreement relating to the extension of $100,000 of Subordinated Notes, and options to purchase 10,000 shares of the Company's Common Stock(2) |
|
10.11 |
Credit Agreement between the Company and The Provident Bank dated as of June 20, 1997(6) |
|
10.12 |
First Amendment to Credit Agreement between the Company and The Provident Bank dated as of July 16, 1997(6) |
|
10.13 |
Lease Agreement between LaSalle National Trust, N.A. as Trustee under Trust No. 120358 and Celex Group, Inc.(7) |
|
10.14 |
Second Amendment to Credit Agreement between the Company and The Provident Bank dated as of May 14, 1998(7) |
|
10.15 |
Third Amendment to Credit Agreement between the Company and The Provident Bank dated as of September 1, 1998(8) |
|
10.16 |
Employment Agreement with Gary Rovansek dated October 29, 1998(8) |
|
10.17 |
Fourth Amendment to Credit Agreement between the Company and The Provident Bank dated as of April 28, 1999(10) |
|
10.18 |
Warrants to Purchase Common Stock of the Company granted to Provident Financial Group, Inc. dated as of April 29, 1999(10) |
|
10.19 |
Preferred Stock Purchase Agreement, dated as of May 28, 1999, by and among the Company and the investors(9) |
|
10.20 |
Registration Rights Agreement, dated as of May 28, 1999, by and among the Company and the investors(9) |
|
10.21 |
Preferred Stock Purchase Agreement, dated as of October 18, 1999, by and among the Company and the investors(12) |
|
10.22 |
Amendment No. 1 to the Registration Rights Agreement, dated as of October 18, 1999, by and among the Company and the investors(12) |
|
10.23 |
Fifth Amendment to Credit Agreement between the Company and The Provident Bank dated as of April 6, 2000(15) |
|
10.24 |
Sixth Amendment to Credit Agreement between the Company and The Provident Bank dated as of August 28, 2000(16) |
|
10.25 |
Joint Venture Agreement with Celebrating Excellence of Minnesota, Inc. and related documents(18) |
|
10.26 |
Seventh Amendment to Credit Agreement between the Company and The Provident Bank dated as of September 4, 2001(19) |
|
10.27 |
Retainer Agreement between the Company and Jack Miller dated April 17, 2001 (19) |
|
10.28 |
Eighth Amendment to Credit Agreement between the Company and The Provident Bank dated as of December 3, 2001(20) |
|
10.29 |
Ninth Amendment to Credit Agreement between the Company and the Provident Bank dated as of June 13, 2002 (filed herewith) |
|
10.30 |
Retention Agreement with Gary J. Rovansek dated August 20, 2002 (filed herewith) |
|
10.31 |
Retention Agreement with John C. Carroll dated August 20, 2002 (filed herewith) |
|
10.32 |
Retention Agreement with John F. Halpin dated August 20, 2002 (filed herewith) |
|
10.33 |
Retention Agreement with Michael McKee dated August 20, 2002 (filed herewith) |
|
10.34 |
Retention Agreement with Gregory J. Nowak dated August 20, 2002 (filed herewith) |
|
21.1 |
Subsidiaries of the Registrant (filed herewith) |
|
99.1 |
Certification of Chief Executive Officer (filed herewith) |
|
99.2 |
Certification of Chief Financial Officer (filed herewith) |