Possible Dreams owns a 55,000 square feet building in Foxboro, Massachusetts where it maintains all its distribution, sales and administrative facilities. Possible Dreams currently utilizes approximately 48,000 square feet as distribution space and approximately 7,000 square feet as sales and administrative offices. Substantially all of the properties and other assets of Possible Dreams are pledged to Possible Dreams' principal lender as security for a line of credit and related loans.
Security Capital reported net income of $1,935,000 for the year ended December 31, 1999. This compares to a net income of $2,149,000 for the year end December 31, 1998. The Company reported basic net income per common share of $0.28 for the year ended December 31, 1999, as compared to basic net income per common share of $0.41 for the year ended December 31, 1998.
Depreciation and amortization increased by $998,000 for the year ended December 31, 1999. Without taking into consideration the educational segment acquisition, depreciation and amortization increased by $17,000 for the year ended December 31, 1999, as compared to the year ended December 31, 1998.
Security Capital reported net income of $2,149,000 for the year ended December 31, 1998 compared to net income of $3,360,000 for the year ended December 31, 1997. The net income per common share was $0.41 for the year ended December 31, 1998 compared to net income per common share (after accrual for Class A Preferred Stock dividends) of $0.66 for the twelve month period ended December 31, 1997. The decrease in net income and net income per share was primarily attributable to the sale of the Company's insurance agency affiliate, which resulted in a $1,149,000 non-recurring gain (net of tax) in the prior calendar year. The Company has recorded the disposal of its proprietary interest in its insurance operations as a discontinued operation.
Selling, general and administrative expenses increased by $1,858,000, or 21% to $10,579,000 for the year ended December 31, 1998 from $8,721,000 for the year ended December 31, 1997. The acquisition of Pumpkin occurred during June 1997 and therefore the Company's prior year selling, general and administrative expense was not representative of an entire twelve month period of the Company's SG&A expense.
The seasonal products segment consists of Possible Dreams and Pumpkin. This segment experiences a significant seasonal pattern in its working capital requirements and operating results. The seasonal segment historically received orders representing approximately 34% and 42% of its annual bookings during the first and second quarters, respectively. It ships products throughout the year, with a majority of the shipping from July through November. Temporary employees are hired to accommodate peak shipping periods. This segment provides extended payment terms to some of its customers for seasonal merchandise and, accordingly, collects a substantial portion of its accounts receivable in the fourth calendar quarter. Due to the seasonal pattern, the seasonal product segment has had greater working capital needs in its peak seasonality and has experienced greater cash availability in its fourth calendar quarter. As a result of this sales pattern, a substantial portion of its revenues is typically recorded in the third and fourth calendar quarters. The Company expects this seasonal pattern to continue for the foreseeable future. The seasonal products segment has historically financed its operations through internally generated cash flow and short term seasonal borrowings.
Cash and cash equivalents decreased by $7,320,000, from $9,133,000 at December 31, 1998 to $1,813,000 at December 31, 1999. Approximately $7,750,000 of the decrease in cash and cash equivalents was primarily attributable to the net effects of the common stock issuance and the Primrose acquisition. The remaining $430,000 decrease in cash was primarily attributable to the seasonal products segment for its working capital needs for the year ended December 31, 1999.
The Company's consolidated working capital decreased by $10,533,000, from $14,399,000 at December 31, 1998 to $3,866,000 at December 31, 1999. Approximately $10,650,000 of the decrease was primarily attributable to the Primrose acquisition and an additional $460,000 used for its normal operating expenses. The seasonal products segment's increase in working capital was approximately $841,000 for the year ended December 31, 1999, which was primarily due to its results from operations generated by its earnings in the third and fourth quarters due to its seasonal pattern. The remaining decrease of $264,000 was primarily attributable to changes in the deferred tax asset at the holding Company level.
Total term debt increased by $9,876,000 from $12,198,000 at December 31, 1998 to $22,074,000 at December 31, 1999. Term debt increased by $13,150,000 due to the Primrose acquisition and decreased by $3,272,000 due to payments on all term debt. Term debt in aggregate has an approximate 9.87% interest rate and current maturities of $3,617,000. Term debt also has certain covenants at the subsidiary operating Company level, the more significant of which requires the subsidiary operating Companies to maintain minimum earnings before interest, taxes, depreciation and amortization ("EBITDA"), leverage ratio, interest coverage ratio, fixed charge ratio and maximum lease expense. At December 31, 1999, Primrose and Possible Dreams were not in compliance with their respective minimum EBITDA and leverage and maximum lease expense covenants. Primrose and Possible Dreams received waivers and amendments to their credit agreement. Primrose and Possible Dreams estimate full compliance with their respective 2000 covenants.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Security Capital Corporation and subsidiaries at December 31, 1999 and 1998 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999 in conformity with accounting principles generally accepted in the United States of America.
The accompanying notes to are an integral part of these consolidated financial statements.
CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share amounts)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Revenues from product sales are recognized in the period in which the merchandise is shipped. Customers who purchase certain minimum quantities receive extended payment terms.
Property and equipment are carried at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which range from 3 to 27 years.
Goodwill relates to the cost in excess of the fair value of the assets acquired in the purchase business combinations of Possible Dreams, Pumpkin, and Primrose. Goodwill is being amortized over periods of 20 to 25 years. Patent rights, acquired in such acquisitions, are being amortized over the 9 to 12 year remaining life of the patent. Deferred financing costs are amortized over the term of the related debt. Franchise agreements, curriculum, and non-compete agreements related to Primrose are being amortized over periods of 21, 10 and 3 years, respectively. All such assets are being amortized on a straight-line basis.
Basic earnings per common share amounts are based on the weighted average number of Common and Class A Common shares outstanding. The sum of Common Stock and Class A Common Stock is used because the two classes are identical except for certain transfer restrictions. Diluted earnings per common share are based on the weighted average shares outstanding and the dilutive effect, if any, of outstanding stock options, warrants and convertible securities.
In April 1999, the Company purchased a 98% interest in Primrose. The results of operations of Primrose have been included in the financial statements and results of operations from the date of acquisition. The Company paid $26,225 in cash, issued 500,000 shares of zero coupon redeemable convertible preferred stock valued at $2,000, and issued a warrant to a bank to purchase shares of Primrose. The acquisition has been accounted for as a purchase, with the purchase price, net of cash acquired of $838 allocated as follows:
YEAR ENDED YEAR ENDED DECEMBER 31, 1999 DECEMBER 31, 1998 Pro-forma: (unaudited) (unaudited)
In June 1997, the Company purchased an 80% interest in the assets and assumed liabilities of Pumpkin, Ltd. (Pumpkin). The results of operations of Pumpkin have been included in the consolidated financial statements from the date of acquisition. The purchase agreement contains earnout sections requiring additional purchase price to be paid if future operating results exceed certain defined formula-based thresholds. One such earnout section relates to average operating results from 1997 through 2000, and a second earnout section relates to annual operating results through 2001. The range of the possible additional purchase price payments under both sections at December 31, 1999 is from $-0- to $2,080. Based upon such formulas through December 31, 1999, and the expected operating results in the year 2000, management believes that it is probable that the full $2,080 amount of additional purchase price will become payable in 2002; payment may be extended under the agreement until 2004 if the payment of such amount could cause a default in Pumpkin's senior debt agreements. If extended to 2004, interest would be payable quarterly at an annual rate of 8%. If the thresholds are met, the Company would record additional goodwill related to the acquisition. In both 1999 and 1998, Pumpkin paid $40 in additional purchase price based on these formulas, which was recorded as additional goodwill.
The following unaudited pro forma financial information presents the combined results of the Company and Pumpkin as if the acquisition had taken place on January 1, 1997. The pro forma amounts give effect to certain adjustments including the amortization of goodwill and intangibles, increased interest expense and income tax effects. This pro forma information does not necessarily reflect the results of operations as they would have been if the business had been managed by the Company during these periods and is not indicative of results that may be obtained in the future.
Finished goods ........................... $ 782 $ 600 Raw materials ............................ 3,411 4,739 -------- --------
Pumpkin's agreement is a $3,500 line of credit, under which borrowing capacity is be limited to a defined borrowing base. Interest is calculated at the commercial paper rate plus 4.25% (9.77% at December 31, 1999). There were no borrowings outstanding at either balance sheet date. Borrowing capacity under the line was $1,742 at December 31, 1999. The agreement expires in 2003 or upon the repayment of the Pumpkin Tranche A and B term loans, if earlier.
Primrose' agreement is a $2,500 line of credit, under which $500 was borrowed at December 31, 1999 at the greater of the bank's prime rate or federal funds rates, plus 0.5% (10.5% at December 31, 1999). Additional borrowing capacity under the line was $2,000 at December 31, 1999. The agreement expires in 2005.
DECEMBER 31, 1999 1998 -------- -------- Possible Dreams Tranche A Term Loan, payable in twenty quarterly installments through July 1, 2001; interest payable monthly at the commercial paper rate plus 4% (9.52 % at December 31, 1999) ................................ $ 1,800 $ 3,363
Pumpkin Tranche A Term Loan, payable in 16 quarterly installments ranging from $150 to $225 through December 2001; interest payable monthly at the commercial paper rate plus 4.5% (10.52% at December 31, 1999) ... 817 1,117
Total long term debt ................................... $ 17,304 $ 10,196 ======== ========
Maturities of long-term debt and other obligations for the next five years are as follows: $ 3,617 - 2000; $ 4,158 -2001; $ 5,288 - 2002; $ 6,423 - 2003; and $ 2,113 - 2004.
Consistent with the bank lines of credit, most of the Company's long-term obligations carry restrictive covenants which prohibit or limit certain actions, including levels of capital expenditures, investments, incurrance of additional debt, and the maintenance of defined levels of profitability and tangible net worth. Most borrowings are secured by a pledge of substantially all assets at the subsidiary level, as well as by a pledge of the Company's share ownerships in the subsidiary.
The maturities of the Possible Dreams Tranche A and Tranche B term loans are subject to acceleration if defined cash flow thresholds are achieved. Such borrowings are also subject to prepayment penalties.
The Company has issued and outstanding 500,000 shares of zero coupon, redeemable, preferred stock, that have a stated liquidation value of $10 per share. Such preferred shares are convertible into Class A common stock on a 1:1 basis. The preferred shares are redeemable at their liquidation value upon the earlier of (1) the date of Primrose' earnings before interest, income taxes, depreciation and amortization ("EBITDA") exceeds $8,500 on a latest twelve month basis on or after April, 2002, or (2) on April 6, 2006.
The owners of the minority interests in Possible Dreams, Pumpkin and Primrose have each entered into agreements with the Company providing for restrictions on the transfer of the such shares, and other related share rights. The minority shareholders of Pumpkin have the right to put their shares of Pumpkin to the Company for cash and the Company has the right to call the shares for cash upon earlier of (1) June, 2003, (2) payment in full of the acquisition indebtedness or (3) anytime after Pumpkin's average EBITDA exceeds $2,500 for a four year period commencing in 1997. The put and call price is determined by using a formula of EBITDA. At the mutual agreement of the parties settlement can occur in Security Capital Common Stock. If the lender objects to settlement in cash the Company may issue a subordinate note. Future cash settlement of such puts and calls would result in additional purchase price consideration payable to the former owners of Pumpkin and would result in the recording of additional goodwill relating to the acquisition.
Interest income ............ $ 33 $ 347 $ 368 Warrant expense ............ (290) (180) (149) Other ...................... 21 32 19 ----- ----- -----
1999 1998 1997 ----- ----- ----- Current: Federal ................. $ 17 $ 57 $ 74 State ................... 106 167 339 ----- ----- -----
The items comprising the Company's net deferred tax assets, are as follows:
At December 31, 1999, 500,000 shares of zero coupon redeemable convertible preferred shares, which were convertible to 500,000 common shares, were excluded from the computation of diluted earnings per share ("EPS") because their inclusion would have had an antidilutive effect on EPS. In addition, subsidiary options and warrants were also excluded from the computation of diluted EPS for the years 1999, 1998 and 1997, because their inclusion would have had an antidilutive effect on consolidated EPS.
The Company has an agreement with Capital Partners, Inc. ("CPI"), a shareholder of the Company. CPI and its affiliates and principals owned 83%, and 79% of the Company's common shares at December 31, 1999 and 1998, respectively. Under the agreement, CPI provides certain advisory services and management services related to investments, general administration, corporate development, strategic planning, stockholder relations, financial matters and general business policy. Fees paid by the Company to CPI are based upon the greater of either a fixed dollar amount or 5% of earnings before income taxes, depreciation and amortization, as defined. Subsequent to the acquisition of Primrose, the minimum annual fixed dollar amount is $375. Fees paid to CPI are generally subordinate to the rights of the lenders to the Company. In addition, the Company has agreed to pay fees to CPI for acquisition opportunities presented to the Company by CPI at a usual and customary rates for investment banking fees for transactions of similar size and complexity. The agreement is renewable annually. Fees paid by the Company to CPI were $ 1,092, $500, and $620 in the years ended December 31, 1999, 1998 and 1997, respectively.
The Company rents showrooms, office space and certain equipment under operating lease agreements. Certain office space and equipment, included in the following table, is rented from the minority shareholders of Pumpkin for which the annual rent is $45. Certain office space, also included in the following table, is rented from Security Capitals redeemable preferred stockholder for which the annual rent will be $174, $125 and $27 for 2000, 2001 and 2002, respectively.
Following the 1999 acquisition of Primrose, the Company has two segments. The educational segment consists of Primrose and the seasonal products segment consists of the Company's activities principally in the design importing and manufacturing of Halloween and Christmas products. Management evaluates performance of its segments based upon adjusted EBITDA, defined for the purposes of the segment disclosures as earnings before interest, taxes, depreciation, amortization, minority interest expense and non-recurring charges or gains. The accounting policies of the segments are the same as those described in Note 1.