<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------
FORM 10-KSB/A-1
(Mark One)
[ ] Annual Report to Section 13 or 15(d) of the Securities Exchange Act of
1934
[ X ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from January 1, 1996 to September 30, 1996
Commission File No. 0-22432
DIPLOMAT CORPORATION
(Exact name of registrant as specified in its character)
Delaware 13-3727399
(State or other jurisdiction of (I.R.S. Employer Identification No.
incorporation or organization)
25 Kay Fries Drive, Stony Point, New York 10980
(Address of principal executive offices) (Zipcode)
Registrant's telephone number, including area code: (914) 786-5552
Securities registered pursuant to Section 12(b) of the Act:
Title of each Class Name of each exchange on which
Applicable registered None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.0001 par value and Common Stock Purchase Warrants
(Title of Class)
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 prior that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of the
<PAGE>
Regulation S-K (s.229.405 of this chapter) is not contained herein, and will not
be contained, to the best of the registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K [X]
The issuer's net sales for the most recent fiscal year were
$19,222.801.
The aggregate market value of the voting stock held by non-affiliates
based upon the closing bid price on March 20, 1997 was approximately
$5,423,484.35.
As of March 15, 1997 there were 5,343,525 shares of Common Stock,
par value $.0001 per share, outstanding.
Certain exhibits listed in Part IV have been incorporated by reference.
The index to exhibits appears on Page 32.
<PAGE>
PART I
Item 1. Business
General
The term "the Company" shall include Diplomat Corporation and its
wholly-owned subsidiary, Biobottoms, Inc. ("Biobottoms") unless otherwise
indicated. The term "Diplomat" shall refer to the operations of the Diplomat
Corporation exclusive of the Biobottoms subsidiary.
On February 9, 1996, Diplomat Corporation completed the acquisition of
Biobottoms, a California corporation located in Petaluma, California. Biobottoms
is a childrens' mail order catalog company selling apparel and accessories in
the United States for newborns through preteens. Management of the Company
believes that this business combination will strengthen the Company's existing
business by joining the manufacturing strength and expertise of the Company with
the retailing expertise of Biobottoms.
The Company designs, develops, markets and distributes infantwear and
care products, nursery accessories and the products for infant and toddler
comfort and care. Through its wholly-owned subsidiary, Biobottoms, the Company
also sells apparel and accessories for newborns through preteens via direct mail
catalog. The Company sells primarily cloth diapers, diaper covers, furniture
covers, layette, infant and child travel products, such as infant car seat
covers, and other accessories marketed principally under the trademarks Ecology
KidsTM and BiobottomsTN. These products are marketed in the United States and
internationally. While international sales of Diplomat's products have not been
material, its products are sold in several Pacific Rim countries, (Japan,
Singapore, Taiwan and Malaysia). Biobottoms' products are sold domestically and
internationally. Biobottoms distributes a catalog in Japan and has an 800 number
which is answered in Japanese at the Petaluma office. Sales in Japan have
accounted for 20% of Biobottoms' sales since the Company acquired it.
In November 1996, the Board of Directors approved a plan to restructure
its Stony Point, New York operations by eliminating several of its unprofitable
retail lines and downsizing its distribution facility. The Company intends to
focus its Stony Point on its traditional core business under its Ecology KidsTM
brand name, which has historically generated the largest part of the Company's
revenue. The Company also announced that it has changed its fiscal year end to
September 30.
Marketing and Sales
The primary customers of Diplomat are major mass merchandisers,
including Toys 'R Us, Inc. ("Toys 'R Us") and Wal-Mart Stores, Inc.
(Wal-Mart"). The foregoing two customers represented a total of approximately
51% of the Diplomat operations total revenues during the fiscal year ended
September 30, 1996. Diplomat's products are presently carried by Wal-Mart,
<PAGE>
Toys 'R Us, Target Stores and Baby Superstores, all nationally known merchants.
Diplomat's products are also sold to drug store chains, catalog showrooms, mail
order catalogs and food and drug chains which include Publix, Winn-Dixie and
Walgreens.
Historically, Diplomat obtained substantially all of its raw materials
required for the manufacture of its products and shipped such materials to
contract manufacturers, who assembled the products in accordance with the
Company's specifications and under its supervision, either from facilities at
the Company's Rockland County, New York warehouse and distribution facilities,
or other locations in New York State.
Biobottoms is a leading childrens' catalog company in the United States
selling apparel and accessories primarily for newborns through preteens. The
majority of the products offered for sale sold by Biobottoms are made of natural
fibers and are designed by Biobottoms with an emphasis on comfort and ease of
care. Biobottoms mailed over 9 million catalogs to its existing and prospective
customers and delivered over $17 million of merchandise in the fiscal year ended
September 30, 1996. The catalog is redesigned four times a year and is mailed as
many as 13 times a year to a combination of customers and prospective customers.
The catalog is divided into product categories, generally by the age of the
child and the size of the products being offered. Biobottoms also operates a
retail store selling overstocks and out-of-season items.
Nearly 70% of Biobottoms' products are designed to its specifications
and marketed under Biobottoms' brand name. Established national brands, such as
CONVERSE and SARA'S PRINTS round out the product offering. Unlike other segments
of the apparel industry, the demand for children's clothing is driven by the
physical growth of the child, rather than changing fashions. As a result,
staples and basics account for much of the merchandise mix, with low return
rates and low markdowns.
Biobottoms' brand products allow the Company to distinguish itself from
other catalogs and retailers. The lower cost of these goods also give management
more pricing flexibility. Biobottoms has increased its average order size in
each of the past few years by increasing the number of items per order while
decreasing the average item price. Biobottoms has also significantly expanded
the age range of its merchandise, testifying to the appeal of the Biobottoms
brand.
The increase in the number of working women has provided a very
receptive environment for catalogers over the past two decades. The Company
understands that more than 70% of women aged 25 to 54 were working full time in
1993, versus 43% in 1965. The increasing number of dual income families and
single women in the workforce is expected to continue to fuel the growth of
direct marketing through the 1990's.
Even though the Company has shifted its emphasis to the Biobottoms'
division, it continues to market Diplomat's products. The Company's plan is to
evaluate Diplomat's business and determine which areas should be continued.
Diplomats was a party to an exclusive distribution agreement ("the Lamaze
Agreement") with Ambrose & Montgomery, doing business
4
<PAGE>
as "Lamaze from AMI". Pursuant to the Lamaze Agreement, Diplomat was granted the
right to utilize the Lamaze registered trademark in conjunction with the
manufacture, advertisement, promotion, distribution and sale of various products
for infants. The Lamaze Agreement expired in July 1996 and the Company currently
has no plans to extend it. Accordingly, the Company no longer uses the Lamaze
registered trademark.
New and Planned Products
The Company's success depends in part upon the development of strong
brand identification for its current and proposed products. The primary
direction of the Company's marketing plan is to promote certain of its existing
products and develop new products under the Fresh Air Wear trademark. Achieving
and maintaining market acceptance for its products will require significant
efforts and expenditures. There can be no assurance that the Company will be
successful in effecting this plan.
Product development and selection are based upon reliability of
vendors, visual appeal, perceived customer value, and uniqueness of design.
Biobottoms utilizes customers feedback on products' performance and their
reported preferences for new product designs, fabrications and category
expansion. Biobottoms' sales are generated from both house file customers
(persons who have either previously purchased from Biobottoms or requested a
catalog) and rented mailing lists (names of current customers from other catalog
companies). Analysis of this segmentation allows Biobottoms to mail frequently
and selectively to its most responsive customers.
Sourcing
Biobottoms provides for manufacturing and sourcing of products in a
number of ways. Private label vendors supply some high volume basics, such as
t-shirts, play pants and knit shorts, where price competitiveness is critical.
Other manufacturers, that may be more costly, compared to private label vendors,
may be used for products requiring shorter lead times or testing fashion trends.
This provides greater flexibility for inventory management. Biobottoms'
manufacturing group provides control of the manufacturing process by closely
supervising all phases of production with local consultants and contractors.
Biobottoms' manufacturing group is a convenient source for testing new private
label product concepts. Branded merchandise from a variety of manufacturers is
the further source of products for Biobottoms.
Major Customers
For the fiscal year ended December 31, 1995, two of the Company's
customers, Toys 'R Us and Wal-Mart individually accounted for approximately 23%
and 36% respectively, of the Diplomat net sales. For the nine month period ended
September 30, 1996, such customers
5
<PAGE>
individually accounted for 11% and 40%, respectively, of the Diplomat
operation's sales. Sales to such customers accounted for approximately 22% of
the Company's sales for the nine month period ended September 30, 1996. The
Company has no written contracts with such customers and there can be no
assurance that such customers will continue to purchase products from the
Company. The loss of either of these customers would have a materially adverse
effect on the Company's business.
In addition, the Company sold its products to approximately 500 retail
accounts consisting primarily of mass merchandisers and toy retailers, and, to a
lesser extent, drug store chains, catalog showrooms, mail order operations and
food store chains. In addition to Toys'R Us and Wal-Mart, the Company's
customers include Burlington Coat Factory, Kids 'R Us, Winn-Dixie Supermarkets,
American Drug Stores, Baby Superstores, Eckerd Drugs, Walgreens, Caldor, Target
Stores and Publix Supermarkets. A reduction in the number of retail accounts
from prior periods reflects a change in customer mix, with an increased emphasis
on mass merchandisers and chain stores. The decrease also reflects general
economic conditions which include a decrease generally in the number of
retailers.
Seasonality of product is generally not a factor affecting the
Company's sales. Sales fluctuations are, however, affected by special seasonal
promotional activities of the merchandise retailer.
Quality Assurance
Products developed for either Biobottoms or Fresh Air Wear and Ecology
Kids brands are chosen based upon the following criteria:
o Quality
o Price/Value
o Fabric
o Fit
o Testing
o Exclusivity
o Color/Print
o Styling
o Manufacturing Responsibility
o Merchandising
Additionally, a minimum of two additional features beyond the must have
requirements that add appropriate performance or styling benefits, and are
comparable to the benchmarks, must be added. These include, but are not limited
to:
Specialized fabrications
Premium construction details
6
<PAGE>
Appropriate decorative items, such as buttons
Logos, Patches and Graphics to enhance brand
identification
Governmental Regulation
As a seller of infant products, the Company is subject to laws and
regulations administered by various states and the Federal Trade Commission. As
a seller of bedding products, the Company is also required to maintain licenses
in the various states where it conducts business. These licenses subject the
Company to compliance with a variety of laws and regulations regarding the
labeling and cleanliness of its products. In addition, the Company has all of
its bedding products produced to the upholstered product specifications required
by the flammability laws of the State of California, which the Company believes
to be the most stringent in the United States. The Company believes that it
complies with the laws and regulations in all material respects.
Product Liability
The Company currently has an aggregate of $2,000,000 of product
liability insurance for its current products with an umbrella policy of up to
$3,000,000. The Company does not intend to increase such coverage upon
commercialization of any other product under development. There can be no
assurance that the Company's existing coverage will be sufficient to cover any
liability resulting from any product liability claims or that the Company would
have funds available to pay any claims over the limit of its insurance. Either
an underinsured or an uninsured claim could have a materially adverse effect on
the Company.
Employees
As of December 15, 1996, the Company had 35 full time employees in its
Stony Point facility. Of such employees, three act in executive capacities,
three are full time sales and marketing personnel, one is a customer service
representative and 28 are administrative and warehouse personnel. None of the
employees are covered by a collective bargaining agreement. The Company
considers its relations with the employees to be good.
Biobottoms employs permanent, full-time and part-time employees, part
time casual (not eligible for benefits), and temporary workers due to seasonal
increases in its sales volume. This allows for optimal employment levels during
peak and slack times. Also, it allows a portion of the work force the option of
flexible working hours. Biobottoms employed 131 employees at January 28, 1996
and 134 full time equivalents (total employee and temporary hours divided by an
annual 40 hour week) at January 15, 1997. None of the Biobottoms employees are
represented by any labor union.
7
<PAGE>
Trademarks, Patents and Proprietary Rights
The Company's success depends, in part, upon the development of strong
brand identification for its current and proposed products. Diplomat has federal
trademark protection for the name Ecology Kids(TM) and historically relied
heavily on its right to utilize the Lamaze name in accordance with its now
expired distribution agreement with AMI. The Company does not believe that the
inability to use the Lamaze name will have an adverse effect on the Company.
The Company has federal trademark protection to utilize the name "Fresh
Air Wear" in connection with the sale of Biobottoms' products and may apply for
other trademarks as it deems appropriate. There can be no assurance that the
registrations will be issued, or that any registration issued will not be
infringed upon by others or that the Company can successfully challenge any
alleged infringement. In the event that it became necessary to establish
recognition of alternative trademarks, the cost of such development could be
substantial, and, as a result, materially adversely affect the Company's
business and prospects.
In November, 1992 the Company acquired the four-year exclusive License
to a United States patented thermochromatic process that can be utilized with a
diaper cover to indicate wetness and soiling through heat generated color
changes. This License was entered into for the purpose of promoting an extension
of the Company's diaper cover business and for use in developing a disposable
diaper pad product combination, providing the convenience of disposable diapers,
while generating significantly less solid waste. Plans to develop the disposable
diaper pad product are not being actively pursued at this time.
The License required that the Company pay fixed annual minimum royalty
payments of $50,000 in 1993, $87,500 in 1994, and $100,000 in 1995 and 1996. All
minimum royalty payments required to be paid have been paid through 1995 and the
balance of the 1996 payments will be paid by March 31, 1997 . The Company did
not exercise its right to extend the License.
Competition
There are a wide range of catalogs selling infant and childrens'
apparel in competition with Biobottoms. These vary from general catalog
merchandisers, such as JC Penney to smaller specialty childrens' apparel
catalogs. Biobottoms believes it competes primarily with the latter, which group
includes: Hanna Anderson, Playclothes, Childrens Wear Digest, Storybook
Heirlooms, Wooden Soldier, and Lands End Kids. Companies in the catalog business
compete on price, product quality, features, benefits, brand name and customer
service. Biobottoms seeks to market a product line that is distinctive from its
competitors. Biobottoms also competes with non-mail order childrens' clothing
retailers, including specialty stores, department stores, major chains and
discount retailers. Gap Kids, Gymboree and other national retailers are also
competitors outside the direct mail industry. Although certain of these direct
competitors have greater financial and marketing resources, Biobottoms believes
that it has been able to be
8
<PAGE>
competitive because of its ability to offer quality products, reasonable prices
and outstanding customer service.
The infant and toddler products industries are extremely competitive in
the United States and Diplomat faces substantial competition in each of its
product lines. The Company competes in a variety of segments within these
product categories, including disposable diapers, infant and juvenile
furnishings and accessories. Competitive factors include quality, price, style,
name recognition and service. Although the Company believes that it can compete
favorably in these areas, there can be no assurance thereof.
Item 2. Properties
Properties and Facilities
In December 1992, Loshell Realty Corporation ("Loshell"), owner of the
real estate and buildings housing the Company's warehouse and distribution
facilities located at 25 Kay Fries Drive, Stony Point, New York (the
"Facilities"), transferred to the Company a fee interest in the Facilities,
subject to purchase money mortgage indebtedness. The Facilities consist of five
buildings aggregating approximately 40,000 square feet, located on approximately
seven acres. The Facilities had an adjusted basis of $1,984,857 when transferred
to the Company. Approximately 6,000 square feet of the Facilities are utilized
by the Company's contract manufacturers located at the premises. Sheldon R.
Rose, the Company's former President and Chief Executive Officer and his wife
are the sole shareholders of Loshell. In connection therewith, the Company
assumed purchase money mortgage indebtedness of Loshell aggregating
approximately $1,799,000 ($1,101,000 with respect to a first mortgage note due
August 2010, bearing interest at an initial rate of $11.75% adjusted every three
years, commencing July 1993 (currently 8.375%) and $698,000 with respect to a
subordinated mortgage note originally due July 1995 but (extended to January
1997), bearing interest at an initial rate of 11.5% per annum. Mr. Rose and his
wife have personally guaranteed payment of the first mortgage, and Mr. Rose and
Loshell are co-makers of the subordinated mortgage note. The Company pays
approximately $26,000 per month for both mortgage payments and real estate
taxes. The Company is currently negotiating the refinancing of the second
mortgage.
Biobottoms leases approximately 17,600 square feet of office space and
15,600 square feet of warehouse space in Petaluma, California. In addition,
Biobottoms leases 1,700 square feet of retail space in Petaluma, California.
Total fixed monthly payments (exclusive of any applicable common area
maintenance charges) currently under these leases is $27,276 and the lease
agreements provide for fixed annual increases. The office lease and warehouse
leases expire on July 1, 1997. No determination has been made as to whether
either or both of these leases will be renewed. These properties are adequate
for current planned operations. Other suitable facilities are available at
competitive prices and terms. The retail lease for Petaluma renews bi-annually.
9
<PAGE>
Item 3. Legal Proceedings
On July 17, 1996, BDO Seidman, LLP commenced an action against Diplomat
in the Supreme Court of the State of New York, New York County, to recover
accounting fees allegedly due in the amount of approximately $180,000. The
Company disputes this claim and intends to defend vigorously this action. In
addition, the Company believes that it has a claim against BDO Seidman, LLP for
damages in an amount which has not yet been determined. However, should the
claimant prevail, the result may have a materially adverse impact on the
Company.
In September 1996, the Company was named as a defendant in an action
brought in the Supreme Court of the State of New York, County of Rockland
(Richard Tracy and Anne Tracy v. Insulx Product Corporation, Consolidated Rail
Corporation, Diplomat Corporation and Bruce M. Smith Contracting Corporation).
Mr. Tracy alleges that the defendants negligent maintenance of a railroad
crossing adjacent to the Company's property caused him to collide with a train.
Mr. Tracy is seeking $10,000,000 in damages for his injuries, and Mrs. Tracy is
seeking an additional $1,000,000 in damages for loss of Mr. Tracy's services.
The Company and its insurance carrier intend to vigorously defend against these
claims. The ultimate outcome of this litigation cannot presently be determined.
Accordingly, no provision for the liability has been made in the accompanying
financial statements. Additionally, the Company maintains $1,000,000 of
insurance coverage which could be applied to any liability posed by this matter.
On November 20, 1996, a charge of employment discrimination was filed
by former employee Marilyn L. Vitale with the Equal Employment Opportunity
Commission ("EEOC") (Charge No. 171970094) and the New Jersey Division on Civil
Rights alleging violations of Title VII of the Civil Rights Act of 1964 and the
Americans with Disabilities Act against Diplomat Corporation. Specifically,
Charging Party alleges that Diplomat and certain current and former officers
discriminated against her based on her sex, disability and in retaliation for
complaining of such discrimination. Charging Party seeks reinstatement and
backpay. Potential backpay liability for the period January 29, 1996 to date is
$70,000. It is not possible to anticipate a potential damages award. At this
time, the EEOC is in the investigatory stage and has yet to make a
determination. The Company intends to vigorously defend against Ms.Vitale's
claims.
Other than the above claims, the Company has no notice of any pending
or threatened litigation.
Item 4. Submission of Matters To A Vote Of Security Holders
During the fiscal year covered by this report, the Company did not
submit any matters to a vote of security holders.
10
<PAGE>
PART II
Item 5. Market for the Company's Common Stock and Warrants
As of the date hereof, the Company has outstanding its Common Stock
$.0001 par value ("Common Stock") and Warrants to purchase its Common Stock
("Warrants"). The principal market for the Common Stock and Warrants is the
NASDAQ Small Cap Market ("NASDAQ") under the symbols of DIPL and DIPLW,
respectively. The following table sets forth the closing high and low bid prices
for the Common Stock and Warrants for each calendar quarter. The prices
represent inter-dealer quotations without adjustment for retail markups,
markdowns or commissions and may not represent actual transactions. NASDAQ
quotations do not assume that the market for the Company's securities will be
sustained.
Common Stock
<TABLE>
<CAPTION>
Bid Warrants
--- --------
For Fiscal Year Ending
December 30, 1995 High Low High Low
- ----------------- ---- --- ---- ---
<S> <C> <C> <C> <C>
First Quarter 5 _ 2 _ 3 _ 3/4
Second Quarter 3 1/4 1 1/4 _ _
Third Quarter 3 3/4 1 3/16 1 _ 1/2
Fourth Quarter 3 11/16 1 _ 1 1/16 1/4
1996
- ----
First Quarter 2 1/16 1 _ 1/2 1/4
Second Quarter 1 _ 1 _ _ 3/16
Third Quarter 2 29/32 1/4 1/16
</TABLE>
The Common Stock and Warrants commenced trading on NASDAQ on November
4, 1993.
The Company believes that there are approximately 2,200 beneficial
owners of each of its securities.
DIVIDEND POLICY
The Company has not paid any dividends on its Common Stock and does not
anticipate paying cash dividends in the foreseeable future. The Company intends
to retain any earnings to finance the growth of the Company. There can be no
assurance that the Company will ever pay cash dividends pursuant to the
Company's credit agreement with its commercial lender and the terms of
indebtedness incurred in connection with the acquisition of Biobottoms.
11
<PAGE>
Item 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Nine Months Ended September 30, 1996 Compared to Twelve Months Ended December
30, 1995 (The Company has changed its fiscal period to September 30, 1996)
NET SALES
Consolidated net sales for the Nine Month Period ended September 30,
1996 ("1996 Period") increased approximately $7,921,000 or 70% from the year
ended December 30, 1995 ("1995 Period") primarily as a result of the Biobottoms
sales of $11,774,000 from the date of acquisition, February 9, 1996. Sales of
Diplomat decreased 33% for the period. The lower sales in 1996 were also
impacted significantly by an adverse retailing environment that has continued
from the last quarter of 1995.
Consolidated cost of sales were 69% of net sales in 1996 and 61% in
1995. The increase in cost of sales of $6,422,000 in 1996 included $5,942,000
from Biobottoms. Cost of sales of Diplomat increased 7% in 1996 although sales
decreased 33% primarily from a writedown of inventory from its restructuring.
For the 1996 Period, Toys 'R Us and Wal-Mart represented 11% and 40%
respectively, of the Diplomat sales as compared to 23% and 36% in 1995.
OPERATING EXPENSES
Consolidated operating expenses, which include selling, general,
administrative, warehouse and distribution expenses, increased approximately
$5,977,000 from 1995 to 1996 primarily from $6,917,000 of Biobottoms operating
expenses. Consolidated operating expenses were 55% of net sales in 1996 and 41%
in 1995. There was a reduction of licensing fees in 1996 because of lower sales.
Interest expense increased $302,000 in 1996 compared to 1995 as a
result of Diplomat's increased borrowing at higher interest rates which include
$245,000 of interest in connection with the acquisition of Biobottoms.
The Company restructured its Stony Point, New York operations by
eliminating several of its unprofitable retail lines and downsizing its
distribution facility. The Company intends to focus its Stony Point operations
on its traditional core business. The restructuring expenses total approximately
$1,739,000 for the period ended September 30, 1996.
12
<PAGE>
The net loss for the 1996 period was $7,225,000 as compared to a net
loss of $721,000 for the 1995 period. Significantly lower sales of Diplomat
during 1996, without corresponding reductions in operating expenses and
additional interest expenses from the acquisition were the principal components
for the loss in 1996, in addition to the restructuring expenses. Biobottoms had
a net loss of $1,150,000 from the date of acquisition.
The following summary combines the consolidated results of operations
of the Company and Biobottoms as if the acquisition had occurred at the
beginning of fiscal 1995, after giving effect to the amortization of goodwill
and increased interest expense on the acquisition debt.
<TABLE>
<CAPTION>
Nine Months Pro-Forma
Ended Nine Months Ended
September 30, 1996 September 30, 1995
------------------- ------------------
<S> <C> <C>
Net Sales $19,222,801 $20,180,355
Cost of Goods Sold 13,334,588 10,569,150
----------- -----------
Gross Profit 5,888,213 9,611,205
----------- -----------
Selling, General & Administrative Expenses 10,589,561 9,179,201
Restructuring Expense 1,738,975
----------- -----------
Operating Income(Loss) (6,440,323) 432,004
Interest Expense 784,577 933,895
-----------
Loss before Income Taxes (7,224,900) (501,891)
Income Taxes (benefit) -0- (173,072)
------------- ---------
Net Loss $ (7,224,900) $(328,819)
</TABLE>
Nine Months Ended September 30, 1996 Compared to Nine Months Ended September 30,
1995
NET SALES
Consolidated Net Sales for the Nine Month Period ended September 30,
1996 ("1996 Period") decreased approximately $958,000 from the Nine Month Period
ended September 30, 1995 ("1995 Period") primarily as a result of lower sales of
Diplomat for the period. The lower sales in 1996 were impacted significantly by
an adverse retailing environment that has continued from the last quarter of
1995. The sales of Diplomat decreased 24% and the sales of Biobottoms increased
16% from 1995 to 1996.
Consolidated cost of sales were 69% of net sales in 1996 and 52% in
1995. Cost of sales of Diplomat increased 32% primarily from a writedown of
inventory from its restructuring.
13
<PAGE>
Cost of sales of Biobottoms increased 16% as a result of an increase in sales.
For the 1996 period, Toys "R" Us and Wal-Mart represented 11% and 40%
respectively of the Diplomat sales as compared to 32% and 22% in 1995.
OPERATING EXPENSES
Consolidated operating expenses, which include selling, general,
administrative, warehouse and distribution expenses, increased $1,410,000 from
1995 to 1996. The increase resulted primarily from increased catalog expenses of
Biobottoms. The operating expenses of Diplomat increased by a minor amount from
1995 to 1996. Consolidated operating expenses were 55% of net sales in 1996 and
45% in 1995.
The Company restructured its Stony Point, New York operations by
eliminating several of its unprofitable retail lines and downsizing its
distribution facility. The Company intends to focus its Stony Point operations
on its traditional core business. The restructuring expenses total approximately
$1,739,000 for the period ended September 30, 1996.
Interest expenses decreased $141,000 in 1996 as a result of Biobottoms
decreased borrowing at lower rates.
The net loss for the 1996 period was $7,225,000 as compared to a net
loss of $329,000 for the 1995 period. Significantly lower sales of Diplomat
during 1996, without corresponding reductions in operating expenses and
additional interest expenses from the acquisition were the principal components
for the loss in 1996, in addition to the restructuring expenses.
Results of Operations
Fiscal Year Ended December 30, 1995 Compared to Fiscal Year Ended December 31,
1994
Net Sales
Net Sales for the year ended December 30, 1995 ("Fiscal 1995" or
"1995") increased approximately $1,023,000 or 10% from year ended December 31,
1994 ("Fiscal 1994" or "1994").
The 1995 period was favorably impacted by the market acceptance and
resulting sales of the Lamaze Layette Program.
Cost of sales were 61% of net sales in 1995 and 57% in 1994. During the
fourth quarter of 1995, the Company reserved $160,000 for slow moving inventory
of layette products.
14
<PAGE>
Form the year 1995, Toys 'R Us and Wal-Mart represented 23% and 36%,
respectively, of the Company's sales compared to 28% and 34% in 1994.
Operating Expenses
Operating expenses as a percentage of sales decreased from 45% in 1994
to 41% in 1995.
Operating expenses, which include selling, general, administrative
warehouse and distribution expenses, increased by approximately 1% from 1994 to
1995. With the introduction of the new product line in 1994, there was an
increase of approximately $322,000 for license fees associated with these
products. Payroll and consulting fees increased approximately $178,000 from 1994
to 1995. There was a reduction of travel and entertainment of approximately
$39,000, advertising and promotion of approximately $331,000, and commissions of
$36,000. A reserve of $100,000 was established in the fourth quarter in
connection with a barter transaction entered into in 1993.
Interest expenses increased $79,000 as a result of increased borrowing
at higher interest rates in 1995 compared to 1994.
The Company has net operating loss carry forwards which are available
to offset future taxable income.
Net loss for Fiscal 1995 was $720,878 as compared to $439,459 for the
comparable period in 1994. Significantly lower sales during the fourth quarter
of the fiscal years 1995 and 1994, with lower reductions in operating expenses
were the principal components for the loss reported for such periods. Sales
during the fourth quarter have historically been lower than other periods. The
lower sales in the fourth quarter of Fiscal 1995 (approximately $1,353,000) as
compared to Fiscal 1994 (approximately $1,766,000) were also impacted
significantly by an adverse retailing environment that has continued in 1996.
The resulting net loss for the fourth quarter of 1995 increased approximately
$496,000, from $730,000 in 1994 to $1,226,000 in 1995, an increase of
approximately 68%.
Liquidity and Capital Resources
The Company completed an initial public offering on November 13, 1993
and received net proceeds of approximately $4,454,000. Proceeds of the offering
were used for purchases of inventory, marketing and promotion, product
development, reduction of accounts payable and repayment of loans from a
principal stockholder and executive officer. The Company has relied upon the
proceeds of its initial public offering, borrowings from an institutional
lender, a principal stockholder and director of the Company, and proceeds from
the exercise of warrants in 1995 in order to fund its operation.
15
<PAGE>
The Company's principal working capital credit facility is provided by
Congress Financial Corporation ("Congress").
In April 1994, the Company entered into an agreement with Congress
providing the Company with a maximum $3,000,000 secured line of credit to be
used for loans and trade letters of credit. The loan are secured by
substantially all of the Company's personal property, including without
limitation, accounts receivable, inventory and trademarks. The interest rate on
loans is two (2%) above the prime rate announced by Core States Bank. The credit
agreement contains restrictions relating to the payment of dividends.
Additionally, the Company is required to maintain a minimum of $3,500,000 in
stockholders' equity and a minimum of $4,500,000 of working capital (excluding
the Congress loan and certain subordinated debt). At September 30, 1997, the
Company was not in compliance with these financial covenants, however Congress
continued to extend the Company credit the under the terms of the original
agreement. On February 25, 1997, the violations were waived by Congress, and the
Company and Congress agreed on revised financial covenants. Under the revised
agreement, the stockholders' equity and working capital minimums (excluding the
Congress loan and certain subordinated debt) were reduced to (750,000) and
500,000, respectively. Under the agreement the minimums shall be increased
during the fiscal year ending September 30, 1997 to (250,000) and 1,500,000,
respectively. The Company expects to be in compliance with the revised
financial covenants at each measurement date.
Under the terms of the credit agreement, the Company could borrow up to
85% of the amount of eligible accounts receivable (as defined in the agreement),
not to exceed the maximum credit. In February 1995 the Agreement was amended to
adjust the formula used to determine the amount available for revolving loans by
including therein an amount based upon eligible inventory not to exceed
$750,000.
In connection with that amendment, Robert Rubin, a director and
principal stockholder of the Company, furnished the lender with a personal
limited guarantee up to a maximum liability of $375,000, pertaining to loans
made based upon eligible inventory. In connection with the initial Congress
transaction, the Company borrowed from Robert Rubin $590,000 on a secured term
loan basis, subordinated to Congress Financial, in order to repay in full its
then existing outstanding principal indebtedness to Citibank, N.A. Such Citibank
facility in the initial principal amount of $650,000, was established in June,
1993, secured by certain assets of the Company and a shareholder guaranty from
Mr. Rubin. The loan from Mr. Rubin is repayable with interest at the prime rate
plus 1 1/2%, with required principal payment amortization identical to the terms
applicable to the Citibank loan terms. Accordingly, the Company made principal
payments of $120,000 in 1994, $120,000 in 1995, $175,000 in 1996 and will be
required to make payments of $174,800 in 1997. The balance of this debt was
converted into Preferred Stock in September, 1996.
16
<PAGE>
In connection with the Biobottoms acquisition, the Company incurred
debt of $4,303,100 consisting of Deferred Payment Notes, payable to (i) the
former Biobottoms stockholders in the amount of $1,500,000, (ii) Mr. Rubin in
the amount of $2,353,100, and (iii) American United Global in the amount of
$450,000. The American United Global loan was paid in May, 1996. Under the
Deferred Payment Note, $750,000 was due August 9, 1996, $375,000 was due
November 9, 1996 and $375,000 is due August 9, 1997 together with interest. The
August and November 1996 payments have not been made. On December 9, 1996, the
holders of these notes gave notice of default in accordance with the acquisition
agreement. Under this agreement, the holders of the notes must wait 270 days
after giving notice before taking notice before taking further action in the
collection of these notes. On February 25, 1997, the holders of these notes
agreed not to initiate an enforcement action prior to December 31, 1997. In
connection with obtaining this agreement, Diplomat agreed to pay the holders of
the Deferred Payment Notes ten installments of $5,000 to be applied against the
Deferred Payment Notes commencing on February 21, 1997 and to undertake to
conduct a private placement of its securities to raise funds for repayment of
the remaining balance due on the Deferred Payment Notes. Should the Company fail
to raise enough funds for repayment, it has agreed to repay the Biobottoms
shareholders additional payments of $50,000 on July 1, 1997 and $100,000 on
December 15, 1997 to be applied against the Deferred Payment Notes. Mr. Rubin
furnished the former Biobottoms stockholders with a limited guarantee up to a
maximum liability of $100,000 pertaining to the payments due July 1, 1997 and
December 15, 1997.
Effective September 30, 1996, Robert Rubin, a director and principal
stockholder of the Company, agreed to convert an aggregate of $2,900,000 in
outstanding debt into an aggregate of 290,000 Shares of Series B Preferred
Stock, which pay an annual dividend of 9% based on per share liquidation value.
The Company has approved the issuance to Mr. Rubin an aggregate of
550,000 shares of Common Stock in consideration of Mr. Rubin's waiver of certain
compensation owed to him and for restructuring certain debt owed to him, waiving
certain defaults and making additional loans to the Company in the aggregate
amount of $600,000. As of September 30, 1996, the 600,000 loan was converted
into 60,000 shares of Series C Preferred Stock, which pay an annual dividend of
9% based on per share liquidation value.
In connection with the February 9, 1996 closing or the Biobottoms
acquisition (the "Closing"), Biobottoms established an inventory based credit
facility with Congress Financial Corporation, the Company's principal lender,
secured by a first priority security interest in substantially all of the assets
of Biobottoms and a guaranty of such obligations by the Company (the Biobottoms
Congress Loan Facility"). The maximum credit available under the facility is
$2,000,000 and on the date of Closing $848,531 was available and borrowed.
The Biobottoms/Congress Loan Facility is guaranteed by the Company and
a default thereunder constitutes a default under the Company's Loan and Security
Agreement with Congress. The interest rate charged on the loan is the prime rate
as announced by Core States Bank, N.A. (the "Prime Rate") plus 2%. At September
30, 1997, the Biobottoms was not in compliance with certain covenants of the
loan agreement, however Congress continued to extend Biobottoms credit under the
terms of the original agreement. On February 24, the violations were waived by
Congress, and Congress and the Company agreed on revised financial covenants for
the remainder of the Company's fiscal year ending September 30, 1997. The
Company expects to be in compliance with the revised financial covenants at each
measurement date.
In February 1997, Mr. Rubin made an additional loan to the Company in
the amount of $200,000. This loan, and Series B and C Preferred Stock are
referred to hereafter as the "Rubin Obligations."
17
<PAGE>
The Deferred Payment notes and the Rubin/American United loans are
subject to an Intercreditor Agreement with Congress Financial Corporation (the
"Intercreditor Agreement") which has the effect of restricting or limiting
enforcement remedies under the promissory notes evidencing the Deferred Payment
and the Rubin American United Loans prior to repayment of the senior debt
payable to Congress Financial Corporation and restricting the repayment of
principal payable thereon based upon certain minimum excess loan availability
requirements.
The Intercreditor Agreement also provides that irrespective of the
relative priority status between the holders of the Deferred Payment obligations
and the Rubin/American United loans, repayment of the Deferred Payment is
permitted to be paid provided that there has been no default of senior debt
payable by the Company or Biobottoms to Congress, minimum excess availability
requirements under the Company's loan facility with Congress are satisfied and
such payments are made with proceeds from a subsequent sale of its capital
stock. Subject to the Intercreditor Agreement, the Deferred Payment and the
Rubin/American United loans will be payable from the proceeds from any sale of
capital stock by the Company in the proportions of 40% on account of the
Deferred Payment and 60% on account of the Rubin/American United Loans, except
that before any such distributions are made, the Company will be required to
reduce the outstanding principal amount of the Deferred Payment by $150,000.
These provisions were amended on February 25, 1997, such that the proceeds of a
private placement of the Company's Common Stock shall be applied first to repay
in full the principal of, and all accrued interests on, the Deferred Payment
notes. The Company does not presently have any commitment for any such
financing.
The Intercreditor Agreement contains provisions to the effect that
prior to March 1, 1998, no principal amount of the Rubin Obligations may be
repaid, except from proceeds from the sale of capital stock by the Company,
subject in all respects to the Intercreditor Agreement. Commencing March 1, 1998
and subject to the provisions of the Intercreditor Agreement, including without
limitation the requirement that the Company have certain minimum levels of
excess loan availability at the time of the making of any such principal
payment, the Rubin Obligations are subject to principal payments monthly of the
amount equal to 25% of the Company's net profit for the second preceding month,
plus depreciation and amortization expenses for said month, with the unpaid
principal amount of the Rubin Obligations and unpaid interest accrued thereon
payable in full on February 9, 1999.
18
<PAGE>
In connection with the Biobottoms Congress Loan Facility, Mr. Rubin
also issued to Congress his written commitment to provide additional term loans
to the Company, not to exceed in the aggregate the principal amount of $300,000,
such loans to be made solely at the discretion of Congress. Proceeds from any
such loans may only be used by the Company to provide working capital for
Biobottoms.
Proceeds from the Congress loan and the Rubin/American United Loans
were used on February 9, 1996 or remained otherwise available as of that date as
follows:
Payment at Closing of Biobottoms'
Institutional Secured Lender.......................$1,448,025
Cash portion of Biobottoms Purchase
Price...............................................1,000,000
Loan Costs and Legal Fees..............................96,690
Available Working Capital...........................1,103,816
At the time that the Biobottoms acquisition was completed, additional
equity financing was contemplated to fund the scheduled payments of the
acquisition debt and working capital requirements for the Diplomat and
Biobottoms businesses. Such financing was not secured within the time
constraints contemplated by the management of the Company. As a result, the
acquisition debt was not paid when due. In addition, the Company is experiencing
severe working capital shortages and requires additional capital resources to
fund its existing operations. Under Diplomat's and Biobottoms' lending
facilities with Congress Financial, the Company has borrowed the maximum amounts
available under the loan formula as of the date hereof and there is no unused
loan availability. The Company is pursuing a number of financing alternatives,
although there can be no assurance that such efforts will result in necessary
financing or that the terms of such financing will be on terms favorable to
existing stockholders. The failure to secure additional working capital and
funds to pay the Biobottoms acquisition debt will materially adversely affect
the business and financial condition of the Company. Insufficient working
capital may require the Company to reduce operations significantly.
In July 1995, the Company, in connection with a financial consulting
agreement, issued to Boulder Enterprises, Inc., Class B, Class C and Class D
Warrants, each exercisable for 500,000 shares of common stock, at $1.37, $1.00
and $3.00 per share, respectively. All of the Class B Warrants were exercised
during 1995 providing the Company with net proceeds of $628,000. The Class D
Warrants expired in July, 1996.
19
<PAGE>
In August 1996, the Company, in connection with a Non-Qualified Stock
Option Plan, issued 500,000 options which were exercised at a price of $.95 per
share.
There can be no assurance that the Company will operate profitably in
the future or that cash from operations will become the principal source of
funds for operations.
PART III
Item 9. Directors and Executive Officers, Promoters and Control Persons
Compliance with Section 16(a) of the Exchange Act
Directors, Executive Officers and Key Employees
The Directors, Executive Officers and Key Employees of the Company are as
follows:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Robert M. Rubin 56 Chairman of the Board
and Director
Jonathan Rosenberg 36 President, Chief Executive
Officer and Director
Stuart A. Leiderman 52 Executive Vice President of
Sales & Marketing and
Director
Edward E. Hinds 69 Director
Irwin Oringer 60 Chief Accounting Officer
and Controller
Howard Katz 55 Director
</TABLE>
Jonathan Rosenberg was appointed to the Board of Directors in July
1995, to fill the vacancy created by the resignation of Felice F. Mischel. Since
1993, Mr. Rosenberg served as an independent consultant to the Company,
providing advice in the operations and finance areas and in long-term strategic
planning. From 1987 until 1993, he was President and Chief Operating Officer of
Servtex International, Inc., a New York based company engaged in
20
<PAGE>
international sourcing of imports and manufacturing activities on an agency
basis for textile related products.
Stuart A. Leiderman has served as Executive Vice President of Sales and
Marketing since July 1989, and has been a Director of the Company since June,
1992. From 1985 to 1989, Mr. Leiderman was a Divisional Vice President for
Hasbro, Inc., Playskool Baby Division, a company engaged primarily in the
development, sales and marketing of toys.
Robert M. Rubin has served as a Director of the Company since June,
1992. Since December 5, 1995, Mr. Rubin has been a Director of Help at Home,
Inc., a public company engaged in the business of providing homemaker and
general housekeeping services to elderly and disabled persons at home. Since
June 1994, Mr. Rubin has been a Director of Kaye Kotts Associates, Inc., a
public company that provides representation for delinquent tax payers before tax
authorities. In October 1996, Mr. Rubin became a director of Med-Emerg
International Inc., an operator of nursing homes and related healthcare
services. Currently, Mr. Rubin is also a director of Arzan International, an
Israeli food distributor.
Mr. Rubin has served as the Chairman of the Board of Directors of
Western Power and Equipment Corporation ("WPEC"), a construction equipment
distributor, since November 20, 1992. Between November 20, 1992 and March 7
1993, Mr. Rubin served as Chief Executive Officer of WPEC. Between October, 1990
and January 1, 1994 Mr. Rubin served as the Chairman of the Board and Chief
Executive Officer of American United Global Inc., a telecommunications and
software company ("AUGI") and since January 1, 1994, solely as Chairman of the
Board of AUGI. Mr. Rubin was the founder, President, Chief Executive Officer and
a Director of Superior Care, Inc. ("SCI") from its inception in 1976 until May,
1986 and continued as a Director of SCI (now known as Olsten Corporation
("Olsten") until the latter part of 1987. Olsten, a New York Stock Exchange
listed company is engaged in providing home care and institutional staffing
services and health care management services. Mr. Rubin was formerly a Director
and Vice Chairman, and is a minority stockholder of American Complex Care,
Incorporated ("ACCI"), a public company which provided on-site health care
services, including intradermal infusion therapies. In April 1995, the principal
operating subsidiaries of ACCI petitioned in the Circuit Court of Broward
County, Florida for an assignment for the benefit of creditors. Mr. Rubin is
also a Director, Chairman and minority stockholder of Universal Self Care, Inc.,
a public company engaged in the sale of products used by diabetics, and Response
USA, Inc., a public company engaged in the sale and distribution of personal
emergency response systems. Mr. Rubin is also Chairman, Chief Executive Officer
and a Director and a principal stockholder of ERD Waste Corp., a public company
specializing in the management and disposal of municipal solid waste, industrial
and commercial nonhazardous solid waste and hazardous waste.
Edward E. Hinds was appointed to the Board of Directors in March, 1994.
He is the retired Executive Vice President, Chief Operating Officer of Gerber
Childrens Wear, a division of Gerber Products, Inc., having served in that
capacity from 1986 - 1987.
21
<PAGE>
Irwin Oringer, a Certified Public Accountant, has been Chief Accounting
Officer and Controller of the Company since September, 1992. From October 1991,
until he joined the Company in September 1992, Mr. Oringer was Corporate
Controller of Trans-National Trade Development Corporation, a company engaged in
the business of importing diversified consumer products.
From 1988 to October, 1991 he held a variety of financial management
positions with subsidiaries of Kenrich, Inc., a holding company for its business
engaged in the wire and cable business. In February, 1991 Kenrich and its
subsidiaries filed a petition under Chapter 11 of the Federal bankruptcy laws
and was subsequently liquidated.
Howard Katz has been a Director of the Company since October, 1996.
Mr. Katz has been Executive Vice President of American United Global,
Incorporated since April 15, 1996. From December, 1995 through April 15, 1996
Mr. Katz was a consultant for, and from January, 1994 through December, 1995 he
held various executive positions, including Chief Financial Officer from
December, 1994 through December, 1995 with National Fiber Network (a fiber
optics telecommunications company). From January, 1991 through December, 1993
Mr. Katz was the President of Katlaw Construction Corporation, a company that
provides general contractor services to foreign embassies and foreign missions
located in the United States. Prior to joining Katlaw Construction Corp., Mr.
Katz was employed as a management consultant by Coopers and Lybrand, LLP and as
a divisional controller for several large public companies.
Directors of the Company are elected for one year terms or until their
successors are elected, and officers serve at the pleasure of the Board of
Directors.
Item 10. Executive Compensation
The following table sets forth a summary of the compensation paid to or
accrued by the Company during the fiscal period ended September 30, 1996 to the
Company's Chief Executive Officer and each of the other most highly compensated
executive officers of the Company.
determined as of the end of the last fiscal year.
<TABLE>
<CAPTION>
Name Annual
and Compensation(1) Restricted
Principal Position Year Salary Stock Award
------------------ ---- ------ -----------
<S> <C> <C> <C>
Sheldon R. Rose 9/30/96 $159,375
Chief Executive Officer 1995 191,047
(Resigned 11/96) 1994 193,370(2)
Jonathan Rosenberg 9/30/96 $130,804
Chief Executive Officer
(Elected 11/96)
</TABLE>
22
<PAGE>
<TABLE>
<S> <C> <C> <C>
Stuart Leiderman 9/30/96 $ 112,500
Executive Vice President 1995 139,334 68,000(3)
1994 143,654
Robert M. Rubin 9/30/96 $ 87,791
Consultant 1995 109,708
1994 119,712
</TABLE>
(1) The Company did not issue any bonuses, other annual compensation, stock
appreciation rights or long term incentive plan payouts to any of the
named individuals in the Summary Compensation Table.
(2) The $193,370 represents approximately four months of Mr. Rose being
paid at the rate of $175,000 per annum and eight months of being paid
at $212,500 per annum.
(3) In April 1993, Sheldon Rose and Lola Rose transferred 40,733 shares of
Common Stock to Stuart Leiderman. Because Sheldon Rose and Lola Rose
are controlling shareholders of the Company, such stock is deemed
returned to the Company and issued from the Company to Stuart
Leiderman.
The value given this stock was $1.66 per share which was derived from
taking 50% of the effective IPO price of the Common Stock. Based upon the last
reported bid price for the Company's Common Stock on December 31, 1996 and
without consideration of any discount to market based upon applicable
restrictions applicable to these "restricted shares" of Common Stock, the fair
market value of such shares is approximately $20,360. The last reported bid
price for the Company's Common Stock was $1.00.
In January 1996, Jonathan Rosenberg, a director of the Company, became
a full time employee of the Company, serving with the title of chief operating
officer. His compensation on an annualized basis is $175,000. In addition to
benefits generally available to senior level employees of the Company, he
receives an automobile allowance of $750 per month. In connection with his
employment, he was granted 75,000 incentive stock options , having an exercise
price of $1.50 per share, exercisable over a five (5) year period, 15,000 shares
per year.
OPTIONS/SAR GRANTS IN LAST FISCAL YEAR
23
<TABLE>
<CAPTION>
Potential
Realizable
Value at
Assumed
Annual Rates of Alternative (f)
Stock Price and (g); Grant
Individual Grants Appreciation for Date Value
Option Term
Percent of
Number of Total
Securities Options/SARS
underlying Granted to Exercise of Grant Date
option/SARs Employees in Base Price Expiration Present Value$
Name Granted (#) Fiscal Year ($/Sh) Date 5% 10% ($) (h)
(a) (b) (c) (d) (e) (f) (g)
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Jonathan 75,000 100% $1.50 2001
Rosenberg
- -------------------------------------------------------------------------------------------------------------------------------
===============================================================================================================================
</TABLE>
In September 1996, the Company entered into an arrangement with
Gersten, Savage, Kaplowitz & Curtin,LLP ("GSK&C") which provided the GSK&C will
provide certain legal and consulting services to the Company over an extended
period of time. As compensation for its services, certain individual members of
the firm received an aggregate of 350,000 shares of Common Stock and options to
purchase an aggregate of 150,000 shares of Common Stock at $2.50 per share.
Employment and Related Agreements
Sheldon R. Rose was employed under a three-year employment agreement
commencing on or about November 4, 1993, pursuant to which he was paid a base
salary of $175,000 per annum and was entitled to an annual cash bonus, based
upon the Company's reported pre-tax income from operations. In April 1994 the
Board of Directors approved a $37,500 increase to Mr. Rose's employment
agreement. No bonuses have been paid to Mr. Rose in the preceding three years.
In November 1996, the Company entered into a termination agreement with Mr.
Rose. The termination agreement provides for the cancellation of Mr. Rose's
agreement with the Company and his resignation as a Director of the Company.
The agreement provides that the Company will pay Mr. Rose an aggregate
of $70,833.33 over a four month period as severance pay. As part of the
agreement, the Company and certain of its affiliates will either purchase or
cause to be purchased an aggregate of 1,019,000 shares
24
<PAGE>
of the Company's Common Stock for an aggregate of $475,000.
Stuart A Leiderman was employed under a three-year employment agreement
commencing on or about November 4, 1993, pursuant to which he is paid a base
salary of $150,000 per annum and is entitled to an annual bonus as determined by
the Board of Directors. No bonuses have been paid to Mr. Leiderman in the three
preceding fiscal years. The Company also provides and maintains an automobile
for Mr. Leiderman. Although the employment agreement has expired, Mr. Leiderman
is currently employed under the same terms.
In January 1994, the Company entered into a three year financial
consulting agreement with Robert M. Rubin, a director and principal stockholder
of the Company, pursuant to which he is paid $125,000 per annum. In September
1996, this agreement was extended until December 31, 1998.
In March 1994, the Company entered into a consulting agreement with
Francine H. Nichols to render consulting services pertaining to the development
and promotion of new products to be manufactured, marketed or distributed by the
Company, which may include the development of educational and developmental toy
products not presently developed by the Company. In order to assist the Company
in the implementation of its marketing and product promotion strategies, she
will prepare written educational editorial material relating to infant and child
care to be included with or printed on packaging of Company products, and for
pamphlets and similar materials to be distributed by the Company with its
products. The agreement provides for a term expiring December 31, 1996 and
provides that the Company will pay Ms. Nichols a consulting fee in the amount of
1% of net sales (as defined in the agreement) of products sold, marketed or
distributed by the Company with the trademark "Lamaze From AMI" or any variation
thereof. The maximum consulting fee in any year may not exceed $200,000.
The contract was not extended beyond its expiration date.
In September 1996, the Company entered into an arrangement with
Gersten, Savage, Kaplowitz & Curtin,LLP ("GSK&C) which provided that GSK&C will
provide certain legal and consulting services to the Company over an extended
period of time.
As compensation for its services, certain individual members of GSK&C
received an aggregate of 350,000 shares of Common Stock and options to purchase
an aggregate of 150,000 shares of Common Stock at $2.50 per share.
Stock Option Plan
The Diplomat Corporation Stock Option Plan("Stock Option Plan")
provides for the issuance of up to 200,000 shares of Common Stock upon exercise
of incentive stock options and is intended to qualify under Section 422 of the
Internal Revenue Service Code of 1986, as amended ("Code").
25
<PAGE>
The Stock Option Plan may be administered by the Board of Directors or
by a stock option committee of the Board of Directors (the "Committee').
Incentive stock options are granted under the Stock Option Plan to employees
generally on the basis of the recipient's responsibilities and the achievement
of performance objectives. Subject to the limitations set forth in the Stock
Option Plan, the Board or the Committee has the authority to determine when the
options may be exercised and vest. Under the Plan, the per share exercise price
may not be less than the greater of 100% of the fair market value of the shares
on the date of grant. With respect to any participant who owns stock possessing
more than 10% of the voting rights of the Company's outstanding capital stock,
the per share exercise price must be at least 110% of the fair market value on
the date of grant and the term may not be longer than five years. As of this
date, the Company has issued an aggregate of 150,000 Stock Options, exercisable
at $1.50 per share, to four persons, two of whom is an officers and directors of
the Company.
The Company also established in August 1996, a non-qualified stock
option plan providing for the issuance of up to 1,500,000 shares of Common Stock
to its directors, officers, key employees and consultants.
To date, the Company has granted directors, officers and key employees
an aggregate of 150,000 incentive and non-qualified stock options, at an
exercise price of $1.50 per share, and 500,000 non-qualified stock options to
consultants of the Company, at an exercise price of $.95 per share. Future
grants could have an adverse affect on the market price of the Company's
securities.
In November 1996, the Company adopted an Incentive Stock Option Plan
(the "1996 Plan") pursuant to which options to purchase a maximum of 1,500,000
shares of Common Stock of the Company (subject to adjustments in the event of
stock splits, stock dividends, recapitalizations and other capital adjustments)
may be granted to employees, officers and directors of the Company and other
persons who provide services to the Company. As of the date hereof, 1,060,000 of
such options have been granted at an exercise price of $1.00. The options to be
granted under the 1996 Plan are designated as incentive stock options or
non-incentive stock options by the Board of Directors which also has discretion
as to the persons to be granted options, the number of shares subject to the
options and the terms of the option agreements. Only employees, including
officers and part time employees of the Company, and non-employee directors,
consultants and advisors and other persons who perform significant service for
or on behalf of the Company, may be granted incentive stock options. Officers
and directors who currently own more than 5% of the issued and outstanding stock
are not eligible to participate in the plan.
The 1996 Plan provides that options granted thereunder shall be
exercisable during a period of no more than ten years from the date of grant,
depending upon the specific option agreement, and that, with respect to
incentive stock options, the option exercise price shall be at least equal to
100% of the fair market value of the Common Stock at the time of the grant.
26
<PAGE>
Employee Pension Plan
In 1985, the Company instituted a pension plan (the "Pension Plan"),
which is a defined benefit pension plan maintained for all employees. Benefits
are payable based on 60% of average compensation for the three highest paid
consecutive years of service, reduced for less than 29 years of service
retirement. The Pension Plan is funded as required by the Employee Retirement
Income Security Act of 1974 ("ERISA") and does not require employee
contributions. Full vesting occurs immediately upon joining the Plan. As of the
date of this Prospectus, Sheldon R. Rose and Stuart A. Leiderman have accrued 22
and 5 years, respectively, of service under the Pension Plan. As of February
1993, the plan was curtailed and no additional pension benefits will accrue.
The following table represents the benefits payable to an employee at
age 62, based on renumeration and years of service.
27
<PAGE>
<TABLE>
<CAPTION>
=======================================================================================================================
Remuneration Years of Service
=======================================================================================================================
15 20 25 30 35
-- -- -- -- --
<S> <C> <C> <C> <C> <C>
$25,000 $7,759 $10,345 $12,931 $15,000 $15,000
$50,000 15,517 20,690 25,862 30,000 30,000
$75,000 23,276 31,034 38,793 45,000 45,000
$100,000 31,034 41,379 51,724 60,000 60,000
$125,000 38,793 51,724 64,655 75,000 75,000
$150,000 46,552 62,069 66,586 90,000 90,000
$175,000 54,310 72,414 90,517 105,000 105,000
$200,000 62,069 62,759 103,448 120,000 120,000
and above
=======================================================================================================================
</TABLE>
Limitation on Liability of Director
As permitted by Delaware law, the Company's Certificate of
Incorporation contains an article limiting the personal liability of directors.
The Certificate of Incorporation provides that a director of the Company shall
not be personally liable for any damages from any breach of fiduciary duty as a
director, except for liability based on a judgement or other final adjudication
adverse to him establishing that his acts or omissions were committed in bad
faith, or the result of active or deliberate dishonesty and were material to the
cause of action so adjudicated, or that he personally gained a financial profit
or other advantage to which he was not legally entitled. This article is
intended to afford directors additional protection and limit their potential
liability from suits alleging breach of the duty of care. The Company believes
this article may assist it in securing services of directors who are not
employees of the Company. As a result of the inclusion of such a provision,
holders of the Common Stock may be unable to recover monetary damages against
directors for actions taken by them which constitute negligence or gross
negligence in violation of their fiduciary duties, although it may be possible
to obtain injunctive or other equitable relief with respect to such actions. If
equitable remedies are found not to be available for any particular use, holders
of the Common Stock may not have an effective remedy against the challenged
conduct.
The Company's Certificate of Incorporation and Bylaws also provide for
indemnification of all officers and directors of the Company to the fullest
extent permitted by law. In addition, Messrs. Rose and Leiderman have been
entitled to such indemnification pursuant to their respective employment
agreements with the Company.
Insofar as indemnification for liabilities arising under the
Securities Act of 1933 (the
27
<PAGE>
"Act") may be permitted to directors, officers and controlling persons of the
Company pursuant to the foregoing provisions, or otherwise, the Company has been
advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable.
Item 11. Security Ownership of Certain Beneficial Owners and Management
<TABLE>
<CAPTION>
Percentage
Number of Shares (1) Beneficially Owned
<S> <C> <C>
Boulder Enterprises, Inc.(2) 500,000 8.56%
Robert M. Rubin (3)(6) 5,983,000 57.45%
Sheldon R. Rose (4) 1,039,000 19.37%
Lola Rose (4) 1,039,000 19.37%
Stuart A. Leiderman(3)(9) 188,000 3.51%
Jonathan Rosenberg(3)(5) 95,000 1.78%
Edward E. Hinds(3) 1,000 *
Gersten, Savage, Kaplowitz
& Curtin, LLP(7) 500,000 9.10%
Howard Katz(8) 0 0
All officer and directors
as a group (5 persons) 6,317,000 59.72%
</TABLE>
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Shares of Common Stock
issuable upon conversion of outstanding preferred stock, or subject to
options, or warrants currently exercisable or convertible, or
exercisable or convertible within 60 days, are deemed outstanding for
computing the percentage of any other person.
(2) Represents 500,000 shares of Common Stock, issuable upon conversion of
Class C Warrants, entitling the holders of each class to acquire
500,000 shares of Common Stock exercisable at $2.50 per share. Boulder
Enterprises, Inc. maintains a
28
<PAGE>
business address at 140 Euclid Avenue, Suite 4E, Hackensack, New Jersey
and its sole officer, director and stockholder is Stuart Jacobson.
(3) The business address of such person is c/o Diplomat Corporation, 25 Kay
Fries Drive, Stony Point, New York 10980.
(4) Lola Rose is the wife of Sheldon Rose. Includes (1) 487,000 shares of
common stock owned by Sheldon Rose, (ii) 532,000 shares of common stock
owned by Lola Rose, and (iii) 20,000 shares issuable upon the exercise
of 20,000 options issued to Sheldon Rose pursuant to the 1992 Option
Plan. Each of them disclaim beneficial ownership in shares owned by the
other. Their address is 70 Tranquility Road, Wesley Hills, NY 10901.
(5) 145,000 shares are issuable upon exercise of currently exercisable
options. Does not include shares issuable upon exercise of 200,000
options, which are not yet exercisable, issued to Mr. Rosenberg
pursuant to the 1996 Option Plan.
(6) Represents (i) 913,000 shares of Common Stock currently owned, (ii)
1,000,000 shares of Common Stock issuable upon conversion of 100,000
shares of the Company's Series A Preferred Stock, (iii) 290,000 shares
of Series B Preferred Stock which provide for certain conversion rights
and entitle him to 2,900,000 votes, (iv) 60,000 shares of Series C
Preferred Stock which provide for certain conversion rights and
entitle him to 600,000 votes, (v) 20,000 shares of Common Stock
issuable upon exercise of currently exercisable options issued pursuant
to the 1992 Stock Option Plan, and (vi) 550,000 shares of Common Stock
approved for issuance but not yet issued. See "Management" and
"Description of Securities - Preferred Stock."
(7) The shares are owned by three individual partners of the law firm who
may be deemed to be acting as a group. Includes (i) 350,000 shares of
Common Stock currently owned and (ii) an aggregate of 150,000 shares
which may be issued upon exercise of currently exercisable options
issued pursuant to the August 1996 Stock Option Plan. The business
address of the firm is 101 East 52nd Street, New York, New
York 10022.
(8) Does not include shares issuable upon exercise of 75,000 options,
which are not yet exercisable, issued to Mr. Katz pursuant to the 1996
Stock Option Plan.
(9) Includes shares issuable upon exercise of 20,000 options which
are currently exercisable. Does not include shares issuable upon
exercise of 80,000 options, which are not yet exercisable, issued to
Mr. Liederman pursuant to the 1996 Option Plan.
Item 12. Certain Relationships and Related Transactions
In April 1994, the Company entered into an agreement with Congress
Financial Corporation providing the Company with a $3.0 million secured line of
credit to be used for loans and trade letters of credit (the "Agreement"). The
loans are secured by substantially all of the Company's personal property,
including without limitation, accounts receivable, inventory and trademarks. The
interest rate on loans is two percent above the prime rate announced by
Philadelphia National Bank.
Under the terms of the Agreement, the Company may borrow up to 85% of
the amount of eligible accounts receivable(as defined in the Agreement), not to
exceed the maximum credit. In February 1995, the Agreement was amended to
adjust the formula used to determine the amount available for revolving loans by
including therein an amount based upon eligible inventory not to exceed
$750,000. At the present time, the company is fully utilizing its line of
credit. On February 9, 1996, the date of closing of the purchase of Biobottoms
by Diplomat, Congress entered into a loan and
30
<PAGE>
security agreement with Biobottoms providing for a line of credit of $2.0
million limited to 45% of eligible inventory (as defined in the Agreement).
In April 1994 and in connection with the Congress agreement, the
Company borrowed from Mr. Rubin, $590,000 on a secured term loan basis,
subordinated to Congress, in order to repay in full its then existing
outstanding principal indebtedness to Citibank, N.A. Such Citibank facility in
the initial principal amount of $650,000 was established in June, 1993, secured
by certain assets of the Company and a shareholder guaranty by Mr. Rubin. The
loan from Mr. Rubin was repayable with interest at the prime rate plus 1%, with
required principal payment amortization identical to the terms applicable to the
Citibank loan terms. Accordingly, the Company was required to make principal
payments on the loan from Mr. Rubin of $120,000 in 1994, $120,000 in 1995,
$120,000 in 1996 and the balance in 1997.
At September 30, 1996 the currently outstanding balance of $310,000 was
converted into preferred stock. Initial borrowings from Congress in the amount
of $1,065,192 were used to repay indebtedness to the American Insured
Receivables Fund, the Company's former asset based lender. In February 1995, the
Agreement was amended to adjust the formula used to determine the amount
available for revolving loans by including therein an amount based upon eligible
inventory not to exceed $750,000. In connection with this amendment, Robert
Rubin, a director and principal stockholder of the Company, furnished the lender
with a personal limited guaranty up to a maximum liability of $375,000,
pertaining to loans made based upon eligible inventory.
The Company employed Mr. Rose's brother-in-law as director of
purchasing and human resources with an annual salary of $75,000 until February
1995. Subsequent to that date and until his termination in October 1996, he has
been employed as a consultant at the rate of $19,365 for the 1996 period. The
Company also employed five (5) other members of Mr. Rose's immediate family and
during the nine months ended September 30, 1996 they were paid aggregate
salaries of approximately $135,000. Such persons include Lola Rose, Mr. Rose's
wife, a principal stockholder of the Company. The Company believes that the
terms of such employment were no less favorable than would have been obtained
from unrelated parties. At the present time, only one family member remains
employed.
In January 1994, the Company entered into a three year financial
consulting agreement with Robert M. Rubin, a director and principal stockholder
of the Company, providing for the payment to him of $125,000 per annum. Mr.
Rubin consults with the Company on financial management and long term planning
matters, including consideration of acquisitions. The term of the agreement was
extended to December 31, 1998 in consideration of Mr. Rubin's subordinated loan
to the Company made in connection with the credit agreement described above.
In July 1995, pursuant to the Company's 1992 Stock Option Plan,
the Company granted each of Sheldon R. Rose, Jonathan Rosenberg and Robert M.
Rubin, options to purchase 20,000 shares of the Company's common stock and Irwin
Oringer 15,000 shares of the Company's common stock, all at an
exercise price of $1.50 per share, exercisable over a five year term expiring
July 14, 2000. The common shares
31
<PAGE>
underlying such options were included in a registration statement that became
effective in March 1995. As of the date hereof, none of such stock options were
exercised.
In 1996, pursuant to the Company's 1992 Stock Option Plan, the Company
granted Jonathan Rosenberg Options to purchase 75,000 shares of the Company's
common stock at an exercise price of $1.50. To date, none have been exercised.
In February 1996, Mr. Rubin loaned the Company $2,353,500 to be used as part of
the acquisition price of Biobottoms. In connection with such loan, the Company
issued Mr. Rubin 100,000 shares of its Series A Preferred Stock, convertible
into 1,000,000 shares of common stock at the option of Mr. Rubin. The holder of
such shares of preferred stock will have the right subject to a subordination
and intercreditor agreement by and among Congress, Robert Rubin, American United
Global, Inc. and Joan Cooper and Anita Dimondstein as Agents, during any period
during which there shall be a n Event of Default under the Rubin/American United
Loans, as such term is defined therein, to designate a majority of the members
of the Board of Directors of the Company. Such right of designation will
continue during the duration of any such Event of Default. The Company has
agreed at its sole cost and expense to include the common shares issuable upon
conversion of the shares in any registration filed with the Securities and
Exchange Commission by the Company within six months of the date of the issue.
In the absence of such filing, the Company has agreed, at its sole cost and
expense and upon the request of Mr. Rubin, to file and use its best efforts to
effect a registration of such shares within three (3) months of his written
request.
The shares of common stock issuable upon conversion of the preferred
stock issued to Mr. Rubin will also be subject to a voting agreement by and
between Mr. Rubin ( or any transferees of such shares) Sheldon R. Rose and Lola
Rose, The President, a director and a principal shareholder of the Company and
his spouse, respectively, providing that such common shares shall be voted in
the proportion that such shares bear to the number of shares of common stock
owned by such persons, it being the intention of the parties that the issuance
of such common shares not change proportionate voting powers of such persons.
The Company has approved the issuance to Mr. Rubin of an aggregate of
550,000 shares of Common Stock in consideration of Mr. Rubin's waiver of certain
compensation owed to him and for restructuring certain debt owed to him, waiving
certain defaults and providing an additional loan to the Company in the
aggregate amount of $600,000.
As of September 30, 1996, the $600,000 loan was converted into 60,000
Shares of Series C Preferred Stock. The Series C Preferred Stock, which has a
liquidation value of $10.00 per Share is convertible into Common Stock at 75% of
the current market price based on the average closing price for the Common Stock
for the 10 days preceding the conversion. Each
32
<PAGE>
share of Series C Preferred Stock entitles the holder to 10 votes per share. The
Series C Preferred Stock pays an annual dividend of 9%, based on the per Share
liquidation value. In the event that the dividend, which is payable monthly, is
not paid for three consecutive months , Mr. Rubin shall be entitled to an
additional 100,000 Shares of Common Stock for each month that the dividend is
not paid.
As of September 30, 1996, Robert Rubin, a director and principal
stockholder of the Company, converted an aggregate of approximately $2,900,000
in outstanding debt into an aggregate of 290,000 Shares of Series B Preferred
Stock. The Series B Preferred Stock, which has a liquidation value of $10 per
share, is convertible into Common Stock at 75% of the current market price based
on the average closing price for the Common Stock for the 10 days preceding the
conversion. In addition, each share of Series B Preferred entitles the holder
thereof to 10 votes per share. The Series B Preferred Stock pays an annual
dividend of 9%, based on the per Share liquidation value. In the event that the
dividend, which is payable monthly, is not paid for three consecutive months,
Mr. Rubin shall be entitled to an additional 100,000 Shares of Common Stock for
each month that the dividend is not paid.
On September 9, 1996, the Company entered into an arrangement with
Gersten, Savage, Kaplowitz, Fredericks & Curtin, LLP ("GSKF&C") which provided
that GSKF&C will provide certain legal and consulting services to the Company
over an extended period of time. As compensation for its services, certain
individual members of GSKF&C received an aggregate of 350,000 shares of Common
Stock and options to purchase an aggregate of 150,000 shares of Common Stock at
$2.50 per share.
In November 1996, the Company issued an aggregate of 1,060,000 options
to 35 employees of the Company, including two executive officers and one outside
director, pursuant to the November 1996 Plan. The options are exercisable at
$1.00 per share, vest over a period of five years, and expire ten years from the
date of grant, if not sooner due to termination or death of the employee.
<PAGE>
Item 13. Exhibits, Lists and Reports on Form 8-K
(a) Exhibits (numbered in accordance with Item 601 of Regulation S-B).
Exhibit
No. Description
--- -----------
3a. Certificate of Incorporation, as amended*
3b By-laws, amended*
3d Amendment to Certificate of Incorporation*
4a Form of Common Stock Certificate*
4b Form of Warrant Agency Agreement between the Registrant and
North American Transfer Company*
4c Revised form of Unit Purchase Option*
4d Common Stock Purchase Warrant*
4e Form of Class B Warrant***
4f Form of Class C Warrant***
4g Form of Class D Warrant***
4h Certificate of Designation of Class B of Class C Preferred
Stock
10b Employment Agreement with Stuart A. Leiderman*
10c Stock Option Plan*
10c-1 1996 Stock Option Plan
10d Exclusive Distributorship Agreement by and between Ambrose &
Montgomery, Inc. and Diplomat Juvenile Corporation*
10e License Agreement by and between Diplomat Juvenile
Corporation, Wesley Howell and Steve Prested*
10f Loshell Realty mortgages with Union State Bank and Stony Point
Technical Park,
33
<PAGE>
Inc. and related Mortgage Notes, including Sheldon Rose
guarantee of Union State Bank*
10g Barter Agreement dated July 16, 1993 between Media Barter
Associates and Registrant with exhibits*
10h Agreement dated as of January 1, 1994 by and between Diplomat
Corporation and Robert M. Rubin**
10i Agreement dated as of March 1, 1994 by and between Francine H.
Nichols and Diplomat Corporation**
10j First Amendment to Exclusive Distributorship Agreement by and
between Ambrose & Montgomery, Inc. and Diplomat Corporation**
10k Collateral Assignment of Trademarks and Trademark Licenses
(Security Agreement) by and between Congress Financial
Corporation and Diplomat Corporation**
10l Second Amendment to Exclusive Distributorship Agreement
between Ambrose Montgomery, Inc. and Diplomat Corporation***
10m Letter Agreement between Diplomat Corporation and Boulder
Enterprises, Inc.***
10n Amended and Restated Subordinated and Intercreditor Agreement
dated as of February 9, 1996 by and among Congress Financial
Corporation, Robert Rubin, American United Global, Inc., Joan
Cooper and Anita Dimondstein, as agents, Diplomat Corporation
and Biobottoms, Inc. ****
10o Amendments No. 1, No. 2 and No. 3 to Loan and Security
Agreement by and between Congress Financial Corporation and
Diplomat Corporation. ****
10p Loan and Security Agreement made as of February 9, 1996 by and
among Robert M. Rubin, American United Global, Inc., Diplomat
Corporation and Biobottoms, Inc. ****
10q Secured Subordinated Term Note dated February 9, 1996 in the
principal amount of $2,353,100 of Diplomat Corporation payable
to American United Global, Inc. ****
10r Secured Subordinated Term Note dated February 9, 1996 in the
principal amount of $450,000 of Diplomat Corporation payable
to American United Global, Inc.
33
<PAGE>
****
10s Biobottoms, Inc. Guarantee of $2,353,100 Secured Subordinated
Term Note. ****
10t Biobottoms, Inc. Guarantee of $450,000 Secured Subordinated
Term Note. ****
10u Loan and Security Agreement dated February 9, 1996 by and
between Congress Financial Corporation and Biobottoms, Inc.
****
32
10v Diplomat Corporation Guarantee dated February 9, 1996 to
Congress Financial Corporation of Biobottoms, Inc.
Indebtedness. ****
10w Collateral Assignment of Trademarks and Trademark Licenses
dated February 9,1996 between Biobottoms, Inc. and Congress
Financial Corporation. ****
10x Security Agreement (Rights in Agreement and Plan of Merger)
dated February 9, 1996 between Biobottoms, Inc. Diplomat
Corporation and Congress Financial Corporation. ****
10y Agreement and Plan of Merger by and among Diplomat
Corporation, Diplomat Acquisition Corporation, Biobottoms,
Inc. and Principal Stockholders, together with Amendment No. 1
thereto. ****
10z Form of Secured Subordinated Term Note dated February 8, 1996
in the principal amount of $750,000 payable by Diplomat
Corporation to form Biobottoms' Stockholders payable November
9, 1996 and August 9, 1997. ****
10aa Form of Secured Convertible Term Note dated February 8, 1996
in the amount of $750,000 payable by Diplomat Corporation to
former Biobottoms' Stockholders payable August 9, 1996. ****
10bb Security Agreement dated February 9, 1996 by and between
Biobottoms, Inc., Diplomat Corporation, and Joan Cooper and
Anita Dimondstein, as Agents. ****
10cc Consulting Service Agreement dated February 9, 1996 by and
among Diplomat Corporation, Diplomat Acquisition Corporation,
Biobottoms, Inc., and Anita Dimondstein. ****
10dd Consulting Service Agreement dated February 9, 1996 by and
among Diplomat Corporation, Diplomat Acquisition Corporation,
Biobottoms, Inc., and Joan Cooper. ****
34
<PAGE>
21 Subsidiaries of the Registrant
* Incorporated by reference to Diplomat Corporation Registration
Statement No. 33-66910 NY
** Incorporated by reference to Diplomat Corporation Annual Report on Form
10KSB for the year ended January 1, 1994.
*** Incorporated by reference to Diplomat Corporation Registration No.
33-95986
**** Incorporated by reference to Diplomat Corporation Annual Report on Form
10KSB for the year ended December 31, 1995.
(b) Reports on Form 8-K. The Registrant filed a report on Form 8-K for a
reportable event dated November 26, 1996.
35
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Stockholders
Diplomat Corporation
Stony Point, New York
We have audited the accompanying consolidated balance sheet
of Diplomat Corporation and Subsidiary as of September 30, 1996 and December
30, 1995 and the related consolidated statements of operations, stockholders'
equity, and cash flows for the nine months ended September, 30, 1996 and the
year ended December 30, 1995. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the financial position of Diplomat
Corporation and Subsidiary as of September 30, 1996 and December 30, 1995 and
the results of its operations and its cash flows for the nine months ended
September 30, 1996 and the year ended December 30, 1995 in conformity with
generally accepted accounting principles.
Feldman Radin & Co., P.C.
Certified Public Accountants
New York, New York
January 16, 1997 (February 25, 1997
as to (i) the third and fourth
paragraphs of Note 10 and (ii)
subsection (a) of Note 11).
F-2
<PAGE>
DIPLOMAT CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 1996
<TABLE>
<S> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 69,258
Accounts receivable - trade, less allowance
for possible losses of approximately $ 75,000 1,663,511
Inventories 3,747,740
Prepaid expenses 1,006,978
Other current assets 732,978
------------
TOTAL CURRENT ASSETS 7,220,465
------------
PROPERTY AND EQUIPMENT,
less accumulated depreciation 2,222,348
OTHER ASSETS
Goodwill 3,616,444
Other 613,660
------------
$ 13,672,917
============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable - trade $ 4,903,719
Loans payable - bank, revolving credit agreement 2,170,652
Accrued expenses 2,069,123
Current maturities of other long term debt 705,981
Acquisition loans payable 1,500,000
------------
TOTAL CURRENT LIABILITIES 11,349,475
------------
LONG TERM DEBT, less current maturities 1,046,835
------------
STOCKHOLDERS' EQUITY
Preferred stock, $.10 par value, 1,000,000 shares authorized, 410,000
shares issued and outstanding 4,100,000
Common stock, $.0001 par value, 50,000,000 shares authorized,
4,993,525 shares issued and outstanding 500
Paid-in capital 6,076,399
Accumulated deficit (8,900,292)
------------
TOTAL STOCKHOLDERS' EQUITY 1,276,607
------------
$ 13,672,917
============
</TABLE>
See notes to financial statements.
F-3
<PAGE>
DIPLOMAT CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Nine
months ended Year ended
September 30, December 30
1996 1995
------------ ------------
<S> <C> <C>
NET SALES $ 19,222,801 $ 11,301,314
COST OF GOODS SOLD 13,334,588 6,913,011
------------ ------------
GROSS PROFIT 5,888,213 4,388,303
------------ ------------
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES 10,589,561 4,629,692
RESTRUCTURING EXPENSE 1,738,975 --
------------ ------------
OPERATING INCOME (LOSS) (6,440,323) (241,389)
OTHER INCOME 7,935 10,784
INTEREST EXPENSE (792,512) (490,273)
------------ ------------
LOSS BEFORE INCOME TAXES (7,224,900) (720,878)
INCOME TAXES (BENEFIT) -- --
------------ ------------
NET LOSS $ (7,224,900) $ (720,878)
============ ============
NET LOSS PER COMMON SHARE: $ (1.59) $ (0.16)
============ ============
AVERAGE NUMBER OF SHARES USED IN COMPUTATION 4,549,525 4,493,525
============ ============
</TABLE>
See notes to financial statements.
F - 4
<PAGE>
DIPLOMAT CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 1996 AND
YEARS ENDED DECEMBER 30, 1995 AND DECEMBER 31, 1994
<TABLE>
<CAPTION>
Common Stock Preferred Stock
------------------------- ------------------------- Paid-in Accumulated
Shares Amount Shares Amount Capital Deficit Total
----------- ----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1994 3,975,000 $ 398 -- $ -- $ 4,573,501 $ (515,056) $ 4,058,843
Issuance of common stock 10,755 2 (2) -- --
Net loss -- (439,459) (439,459)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance at December 31, 1994 3,985,755 400 -- -- 4,573,499 (954,515) 3,619,384
Issuance of common stock,
net costs of issuance
of $59,500 500,000 50 627,950 628,000
Issuance of common stock 7,770 8 (8) --
Net loss (720,878) (720,878)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance at December 30, 1995 4,493,525 $ 458 -- $ -- $ 5,201,441 $(1,675,393) $ 3,526,507
Exercise of Options, issuance
of 500,000 shares of common
stock par .0001 @ .95 500,000 50 474,950 475,000
Issuance of common stock 400,000 400,000
Issuance of preferred stock -- 4,100,000 4,100,000
Net loss (7,224,900) (7,224,900)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance at September 30, 1996 4,993,525 $ 508 -- $ 4,100,000 $ 6,076,391 $(8,900,293) $ 1,276,607
=========== =========== =========== =========== =========== =========== ===========
</TABLE>
See notes to financial statements.
F - 5
<PAGE>
DIPLOMAT CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the nine For the year
months ended ended
September 30, December 30,
1996 1995
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(7,224,900) $ (720,878)
Adjustment to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation 211,237 117,533
Issuance of common shares 400,000
CHANGES IN ASSETS AND LIABILITIES:
(Increase) decrease in accounts receivable (282,507) 42,990
(Increase) decrease in inventories 2,551,187 (658,489)
(Increase) decrease in prepaid expenses 400,240 81,559
(Increase) decrease in other current assets 702,866 8,315
(Increase) decrease in other assets 500,202 (58,068)
Increase (decrease) in accounts payable 502,311 14,639
Increase (decrease) in accrued expenses 1,552,586 38,224
----------- -----------
NET CASH USED BY OPERATING ACTIVITIES (686,788) (1,134,175)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash paid for Biobottoms, Inc. (net of cash acquiredof ($1,250) (2,899,211) --
Acquisition of property and equipment (211,096) (26,979)
----------- -----------
NET CASH FLOWS USED BY INVESTING ACTIVITIES (3,110,307) (26,979)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Long term advance from stockholder -- 250,000
Repayment of loans payable , stockholder -- (8,881)
Proceeds of loans payable, affiliate 450,000 --
Revolving credit agreement 583,650 589,531
Issuance of warrants -- 628,000
Issuance of common stock 475,000 --
Borrowings from stockholder 2,620,000 --
Repayment of long term debt and loan payables (393,678) (207,160)
----------- -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 3,734,972 1,251,490
----------- -----------
NET INCREASE (DECREASE) IN CASH (62,113) 90,336
CASH AND CASH EQUIVALENTS, at beginning of period 131,371 41,035
----------- -----------
CASH AND CASH EQUIVALENTS, at end of period $ 69,258 $ 131,371
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 706,000 $ 418,000
=========== ===========
Income taxes $ -- $ 21,600
=========== ===========
</TABLE>
See notes to financial statements.
F - 6
<PAGE>
DIPLOMAT CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 1996
AND THE YEAR ENDED DECEMBER 30, 1995
1. SIGNIFICANT ACCOUNTING POLICIES:
A. The financial statements include the accounts of the
Company and its wholly-owned subsidiary. All significant intercompany
balances and transactions have been eliminated.
B. Inventories are stated at the lower of cost or market.
Cost is determined by the first-in, first-out (FIFO) method.
C. Property and equipment are stated at cost. Depreciation is
provided using primarily the straight-line method and accelerated
methods (for machinery and equipment) over the expected useful lives
of the assets, which range from 31.5 years for the building and real
property, to between five and 10 years for machinery, furniture and
equipment.
D. The Company follows SFAS 109 for income taxes. Pursuant to
SFAS 109 deferred tax assets and liabilities are determined based on
differences between the financial reporting and tax basis of assets
and liabilities and are measured by applying enacted tax rates and
laws to taxable years in which such differences are expected to
reverse.
E. For purposes of the statement of cash flows, the Company
considers all highly liquid debt instruments purchased with an
original maturity of three months or less to be cash equivalents.
F. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenues and expenses during the reported period. Actual results could
differ from those estimates.
G. In March 1995, the Financial Accounting Standards Board
("FASB") isuued Statement of Financial Accounting Standards ("SFAS")
No. 121, "Accounting For the Impairment of Long Lived Assets and For
Long Lived Assets to be Diposed Of". SFAS No. 121 requires the
Company to review long-lived assets and certain identifiable assets
and any goodwill related to those assets for impairment whenever
circumstances and situations change
F - 7
<PAGE>
such that there is an indication that the carrying amounts may not be
recoverable. The adoption of SFAS No. 121 did not result in any
material adjustments in the financial statements for the period ended
September 30, 1996.
H. Effective December 30, 1995, the Company adopted SFAS No.
107, "Disclosures About Fair Value of Financial Instruments", which
requires disclosure of fair value information about financial
instruments whether or not recognized in the balance sheet. The
carrying amounts reported in the balance sheet for cash, trade
receivables, accounts payable and accrued expenses approximate fair
value based on the short term maturity of these instruments.
I. The Company accounts for stock transactions in accordance
with APB No. 25, "Accounting for Stock Issued to Employees". In
accordance with SFAS No. 123, "Accounting for Stock based
Compensation", the Company has adopted the pro-forma disclosure
requirements contained therein.
J. Direct response advertising costs, consisting primarily of
catalog preparation, printing and postage expenditures, are amortized
over the period during which the benefits are expected. Advertising
costs, principally the amortization of such prepaid catalog costs, of
approximately $3,033,000 are included in the accompanying statement of
operations for the eight months ended September 30, 1996. Included in
other current assets at September 30, 1996, is approximately $463,000
of prepaid catalog costs.
2. BUSINESS:
The Company is engaged in two lines of business and
accordingly its operations are classified into two business segments:
specialty catalog retail operations of natural fiber apparel and
related products utilizing environmentally "friendly" materials for
children from infancy to early adolescence, and the manufacturing
marketing and distribution of infants accessories principally to mass
merchants.
As of 1995, the Company reported its results of operations on
a fifty-two/fifty-three week year ending on the Saturday closest to
December 31. However, on November 12, 1996, the Company has changed
its reporting date to September 30.
3. ACQUISITION OF BIOBOTTOMS, INC. AND RELATED FINANCING:
A. Acquisition of Biobottoms, Inc.: On February 9, 1996, the
Company completed the acquisition of Biobottoms, Inc. ("Biobottoms"),
a California-based mail-order catalog company, specializing in apparel
and accessories for newborn through preteen children, pursuant to an
Agreement and Plan of Merger made as of December 22, 1995 by and among
Diplomat Corporation, Diplomat Acquisition Corp., a wholly-owned
subsidiary
F - 8
<PAGE>
of the Company, organized under the laws of the State of Delaware
("DAC"), Biobottoms and Joan Cooper and Anita Dimondstein, individuals
and principal stockholders of Biobottoms (the "Merger Agreement").
Biobottoms has become a wholly-owned subsidiary of the Company and
will continue its principal place of business in Petaluma, California.
The Company paid $2,500,000 for Biobottoms, $1,000,000 in
cash and $1,500,000 in the form of two promissory notes to Biobottoms'
shareholders, each in the amount of $750,000 ("Acquisition notes").
The notes bear interest at 1% over the prime rate as defined in the
agreements. One such note is due six months from the acquisition date
and the second note is due in two equal installments of $375,000, nine
months and eighteen months after the date of acquisition,
respectively. Additionally, the Company incurred costs related to the
acquisition in the amount of approximately $720,000. Of this amount,
$600,000 represents the estimated fair value of 100,000 shares of the
Company's convertible Series A preferred stock issued to a significant
stockholder (who is also a member of the Board of Directors), as a fee
for his assistance in consummating the acquisition. The Series a
preferred shares are convertible into 1,000,000 common shares of the
Company. The Series A preferred stock is not entitled to any specific
dividends or liquidation rights.
The acquisition of Biobottoms has been accounted for as a
purchase and accordingly, its results of operations are included with
the Company's beginning February 9, 1996.
The following unaudited pro-forma summary combines the
consolidated results of operations of the Company and Biobottoms as if
the acquisition had occurred at the beginning of 1995, after giving
effect to certain adjustments, including amortization of goodwill,
increased interest expense on the acquisition debt, and the
adjustments required as a result of changes to certain employment
agreements as a direct result of the acquisition.
Year ended
December 30, 1995
-----------------
(unaudited)
Net sales $ 27,137,857
Net loss (1,719,030)
Net loss per common share (0.38)
The pro-forma results do not necessarily represent results
which would have occurred if the acquisition had taken place on the
basis assumed above, nor are they indicative of the results of future
combined operations.
F - 9
<PAGE>
B. Financing: Simultaneously with the closing of the
Biobottoms acquisition, the Company and Biobottoms entered into a loan
and subordinated security agreement with a director and principal
stockholder of the Company and an affiliate of such individual
pursuant to which the Company borrowed from such director and
principal stockholder and affiliate $2,353,100 and $450,000,
respectively. The loan from the director and principal stockholder was
utilized to fund the acquisition of Biobottoms in part. The loan from
the affiliate has been utilized for working capital purposes. Subject
to an intercreditor agreement between the Company's asset based lender
and other lenders, the $450,000 loan is payable in full on May 4,
1996. If the repayment is not made on such date, the Company will be
required to pay a default fee of $50,000.
In connection with such aforementioned loan by a director and
principal stockholder of the Company in the amount of $2,353,100, the
Company issued 100,000 shares of its Series A Preferred Stock, which
are convertible into 1,000,000 shares of common stock at the option of
the director and principal stockholder. The holder of such shares of
preferred stock will have the right, subject to a subordination and
intercreditor agreement by and among Congress Financial Corporation
and others, during any period during which there shall be an Event of
Default under such loans, as such term is defined therein, to
designate a majority of the members of the Board of Directors of the
Company. Such right of designation will continue during the duration
of any such Event of Default. The Company has agreed at its sole cost
and expense to include the common shares issuable upon conversion of
the shares in any registration statement filed with the Securities and
Exchange Commission by the Company within six months of the date
hereof.
4. MANAGEMENT PLANS:
For the nine months ended September 30, 1996 and the years
ended December 31, 1995 and 1994, the Company's net loss was
approximately $7,225,000, $721,000 and $439,000, respectively.
Management attributes the losses in 1995 and 1994 to lower sales
without corresponding reductions in operating expenses . In 1996,
significantly lower sales, additional interest expenses from the
acquisiton of Biobottoms, Inc., and expenses incurred as a result of
management's restructuring plan were the principal components for the
substanial loss. These losses placed a severe strain on the Company's
liquidity and working capital and diverted management attention to
financial matters, as well as substantially increased legal fees and
the cost of financing.
The Company has taken several actions to improve its ability
to meet its obligations and enhance working capital. Subsequent to
September 30, 1996, the Company commenced negotiations with lenders to
extend due dates of currently due obligations and concurrently, is in
the process of negotiating to sell equity secuities via private
placement. Management believes that the actions taken and its plans to
reduce expenses and improve operating margins will allow the Company
to meet its obligations and achieve positive cash flow. However, no
assurances can be given that the Company will be successful in
achieving those
F - 10
<PAGE>
reductions and achieving profitability or positive cash flow.
5. RESTRUCTURING OF OPERATIONS:
During the quarter ended September 30, 1996, management
instituted various actions designed to significantly cut costs in the
Company's manufacturing operation located in Stony Point, New York,
and to refocus the operation on its most profitable product lines and
channels of distribution. Towards this end, the following significant
decisions were made: (i) the former Chief Executive Officer's
contract, which expired in October 1996, was not renewed, and all ties
with this officer were severed; (ii) certain royalty agreements,
specifically those related to products which the Company is
discontinuing, were not renewed by the Company; (iii) a decision was
made to target primarily mass merchant customers; and (iv) significant
permanent cutbacks in personnel and other operating costs were made.
As a result of the actions taken, the Company incurred
restructuring charges of approximately $1,738,975. The restructuring
charges include approximately $568,000 primarily for write-offs and
other costs associated with the discontinuance of various products and
$771,000 for severance pay and professional and consulting fees
payable in connection with the restructuring plan.
6. CONVERSION OF STOCKHOLDER DEBT AND ISSUANCE OF SERIES B
PREFERRED STOCK
Effective September 30, 1996, a significant stockholder and member of
the Company's Board of Directors converted $3,500,285 of indebtedness
into 290,000 shares of Series B preferred stock of the Company and
60,000 shares of the Company's Series C preferred stock. Both the
Series Band C shares of preferred stock have a liquidation preference
of $10 per share ("Liquidation Value") and a normal dividend of 9% of
Liquidation Value, payable monthly. Should the Company not pay the
dividends on either the Series B or C preferred stock for three
consecutive months, the holder will be entitled to receive 100,000
shares of the Company's common stock for each month that the dividend
has not been paid as a penalty. The preferred stock, based on
Liquidation Value is convertible into common stock of the Company at
75% of the average market value of the common stock for the ten
trading days immediately preceding the day of conversion. The
preferred stock also has voting rights equal to 3,500,000 shares of
common stock on all matters on which common stock votes, including
election of directors. As part of the consideration for the conversion
the holder was issued 500,000 shares of the Company's common stock.
The issuance of the common stock was valued at approximately $0.80 per
share, the estimated fair value of such shares at the time of
issuance.
F - 11
<PAGE>
7. INVENTORIES:
Inventories consist of the following:
September 30,
1996
-------------
Raw materials and packaging $ 297,776
Work-in-process 409,177
Finished goods 3,040,787
=============
$ 3,747,740
=============
8. PROPERTY AND EQUIPMENT:
Property and equipment consist of the following:
September 30,
1996
-------------
Land $ 420,000
Building 1,807,347
Equipment 1,680,206
-------------
3,907,553
Less accumulated depreciation 1,685,205
-------------
$ 2,222,348
=============
9. OTHER ASSETS:
September 30,
1996
-------------
Goodwill $ 3,616,444
Noncurrent deferred tax asset 581,535
Deposits 32,125
=============
$ 4,230,104
=============
F - 12
<PAGE>
10. REVOLVING CREDIT AGREEMENTS:
(a) In April 1994, the Company entered into an agreement with
Congress Financial Corporation ("Congress") providing the Company with
a $3,000,000 collateralized line of credit to be utilized for loans
and trade letters of credit. The loan is collateralized by
substantially all of the Company's personal property, including
accounts receivable, inventory, and trademarks. The interest rate on
loans is 2% above the prime rate announced by Philadelphia National
Bank. The prime rate was 8.25% and 8.75% at September 30, 1996 and
December 30, 1995, respectively.
Pursuant to the amended terms dated October 1995, the Company
may borrow up to an amount equal to the sum of:
(I) 85% of eligible accounts receivable (as defined)
(ii) 100% of cash collateral
(iii) the lesser of 35% of eligible inventory (as defined) or
$1,250,000, less
(iv) any availability reserves.
The revolving credit agreement contains restrictions relating
to the payment of dividends, and the maintenance of working capital
and stockholders' equity. As of September 30, 1996, the Company was in
violation of the financial covenants contained in the agreement. On
February 24, 1997, the violations were waived by the lender and
concurrently, the lender and the Company agreed on revised financial
covenants for the remainder of the Company's fiscal year ending
September 30, 1997. The Company expects to be in compliance with the
revised financial covenants at each measurement date. Up to $375,000
of such loan is guaranteed by a director and significant stockholder.
(b) On February 9, 1996, the Company's, a wholly owned subsidiary
(Biobottoms), entered into a new financing arrangement with Congress
which includes a $2,000,000 revolving credit line, restricted to the
lesser of 45% of the value of eligible inventory or 80% of the value
of an orderly liquidation of such inventory. Borrowings on the line of
credit bear interest at the prime rate plus 2% and it expires on
February 9, 1999. Fees are paid on the unused line of credit at the
rate of 1/2%. The line of credit is collateralized by substantially
all of the Company's assets. As of September 30, 1996, as a result of
cross defaults due to the violations described in the preceeding
paragraph, Biobottoms was in violation of certain of the financial
covenants contained in the agreement. On February 24, 1997, these
violations were waived by the lender and concurrently, the lender and
the Company agreed on revised financial covenants for the remainder of
the Company's fiscal year ending September 30, 1997. The Company
expects to be in compliance with the revised covenants at each
measurement date.
F - 13
<PAGE>
11. LONG-TERM DEBT:
Long-term debt consists of the following at September 30, 1996:
Note payable - bank, payable in monthly
installments of $10,018 which includes interest at
8.375%, due August 2010. The note is collateralized
by land and buildings and is guaranteed by a
stockholder. $ 986,581
Note payable - bank, payable in monthly
installments of $7,201 which includes interest at
12%, due January 1997. The note is collateralized
by land and buildings and is cosigned by a
stockholder. (b) 582,049
Equipment Loans - payable in monthly installments 184,186
Acquisition notes payable. (a) 1,500,000
--------------
3,252,816
--------------
Current portion - acquisition notes, former stockholders 1,500,000
Current maturities of other long term debt 705,981
--------------
Total current 2,205,981
--------------
Long - term debt $ 1,046,835
==============
The maturities of long term debt is as follows:
1997 $ 2,205,981
1998 93,759
1999 92,448
2000 52,125
Thereafter 808,503
------------
$ 3,252,816
============
(a) The Company paid $1,500,000 in the form of two promissory notes to
Biobottoms' shareholders, each in the amount of $750,000 ("Acquisition
notes"). The notes bear interest at 1% over the prime rate as defined
in the agreements. One such note is due six months from the
acquisition date and the second note is due in two equal installments
of $375,000 nine months and eighteen months after the date of
acquisition respectively. The Company did not make the payments which
were required in August and November 1996. On December 9,
F - 14
<PAGE>
1996 the Company received notification of the default from the former
Biobottoms shareholders, which required that the Company cure the
default under the notes within 270 days, or be subject to enforcement
action. On February 25, 1997, the Biobottoms former stockholders
agreed not to initiate enforcement action as a result of this or
subsequent defaults until not earlier than December 31, 1997. In
connection with obtaining this agreement, Diplomat agreed to pay the
Biobottoms shareholders ten installments of $5,000 to be
applied against the Acquisition Notes, commencing on February 21, 1997
and to undertake to conduct a private placement of its securities to
raise funds for the repayment of the remaining balance due on the
Acquisition Notes. Should the Company fail to raise enough funds for
repayment, it has agreed to pay the Biobottoms shareholders
additional payments of $50,000 on July 1, 1997 and $100,000 on
December 15, 1997 to be applied against the Acquisition Notes.
(b) Full payment of this mortgage was due on January 26, 1997. The
lender has agreed to extend the mortgage for an additional twelve
months in exchange for an extension fee of 15,000 and the agreement to
bring certain past due amounts current.
12. STOCKHOLDERS' EQUITY:
A. On December 31, 1992, the Board of Directors has adopted a
stock option plan which allows for the grant of option to employees
and non-employees to purchase up to 200,000 shares of the Company's
common stock. The exercise price per share cannot be less than the
fair market value of the Company's common stock on the date of grant.
During each of 1996 and 1995, the Company issued 75,000 options
exercisable at $1.50 per share. There were no options exercised or
canceled during either of the years presented.
B. There are currently 581,175 warrants outstanding to
purchase shares of the Company's common stock at $3.50 per share. The
warrants, which were issued in connection with the Company's initial
public offering of its common stock, are exercisable until November 4,
1998. To date, these warrants have not been exercised.
C. During 1995, warrants to purchase 1,500,000 shares of
common stock were granted; 500,000 of these warrants, exercisable at
$1.37 per share, were exercised resulting in net proceeds to the
Company of $628,000. The remaining 1,000,000 warrants were exercisable
as follows, (I) 500,000 at $3.00 per share expiring on July 18, 1996
and (ii) 500,000 at $1.00 per share expiring on July 18, 1997. The
warrants expiring July 18, 1996 were not exercised.
D. In September 1996, the Company issued 500,000 common
shares at $0.95 per share to previously unrelated investors from the
exercise of options. Net proceeds to the Company were $475,000.
E. In November 1996, the Company adopted an Incentive Stock
option Plan (the 1996 Plan) pursuant to which options to purchase a
maximum of 1,500,000 shares of the company's common stock (subject to
adjustment in the case of stock splits, stock dividends,
recapitalizations and other capital adjustments) may be granted to
employees, oficers and directors of the Company and other persons who
provide services to the Company. As of January 31, 1997, 985,000 of
such options have been granted at an exercise price of $1.00 per
share. The 1996 Plan provides that options granted thereunder shall be
exercisable during a period of no more than ten years from the date of
grant, and with respect to incentive stock options, the exercise price
shall be at least equal to 100% of the fair market valuee of the
common stock at the date of grant. No options under the plan were
exercised as of January
F - 15
<PAGE>
31, 1997.
13. CONCENTRATION OF CREDIT RISKS:
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of trade accounts
receivable. Concentrations of credit risk with respect to trade
receivables include concentrations of trade accounts in the juvenile
products industry.
To counter the credit risk associated with the Company's
trade receivables, the Company purchases credit insurance covering
substantially all major customers.
14. NET SALES:
For the nine months ended September 30, 1996 and the years
ended December 30, 1995 and December 31, 1994 two customers accounted
for 6% and 15%, 23% and 36% and 28% and 34% of net sales,
respectively.
15. COMMITMENTS AND CONTINGENCY:
A. Effective July 1, 1993, the Company entered into a license
agreement with an unaffiliated third party, pursuant to which the
Company was granted an exclusive license to the use of a registered
trademark for the manufacture, advertisement, promotion, distribution
and sales of certain products within the United States.
An amendment effective January 1995, obligates the Company to
distribute a number of Authorized Products sufficient to generate
minimum net annual sales of $4,500,000 for the twelve months ended
December 30, 1995, and each year thereafter during the term of the
agreement. In the event that such minimum net sales goals are not
achieved, the Company must pay the licensor the Distribution Fee based
upon such volumes. Additionally, the Company paid the licensor 9% of
net sales of licensed products of up to $5,000,000 and 10% of such net
sales in excess of $5,000,000. This license agreement expired on June
30, 1996 and was not renewed by the Company.
B. The Company's former Chief Executive Officer was employed
under a three-year employment agreement effective November, 1993, as
amended in April 1994 pursuant to which he was paid a base salary of
$212,500 per annum and was entitled to an annual cash bonus, based
upon the Company's reported pretax income from operations. The
employment agreement expired in November 1996 and was not renewed.
An executive vice-president of the Company is employed under
a three-year agreement, effective November 1993, pursuant to which he
earns an annual salary of $150,000 and is entitled to an annual bonus
as determined by the Company's Board of Directors. The contract
expired in November 1996. The employee continues to be employed by the
company pursuant to the terms of the original agreement.
F - 16
<PAGE>
C. In January 1994, the Company entered into a three-year
financial consulting agreement with a director and principal
stockholder of the Company, providing for the payment of $125,000 per
annum.
D. Leases:
The Company leases its office, warehouse, and retail store
facilities under operating lease agreements. The terms of the lease
agreements provide for the minimum annual rentals.
Furniture minimum annual lease payments under lease
agreements with terms in the excess of one year, at September 30,
1996, are as follows:
1997 $217,000
The operating leases provide for annual increases in lease
payments. The Company recognizes the total lease expense on a
straight-line basis over the lives of the leases in accordance with
generally accepted accounting principles.
Rent expense for operating leases in excess of one year was
approximately $226,000 and $351,802 for the fiscal years ended
September 30, 1996 and January 28, 1996, respectively.
E. Litigation
In September 1996, the Company was named as a
defendant in an action brought in the Supreme Court of New York. The
plaintiff alleges that the defendants' (including the Company)
negligent maintenance of a railroad crossing adjacent to the Company's
property caused him to collide with a train. The plaintiff is seekink
$10,000,000 in damages for his injuries, and his spouse is seeking an
additional $1,000,000 in damages for loss of the plaintiff's services.
The Company and its insurance carrier intend to vigorously defend this
action. The ultimate outcome of the litigation cannot be presently
determined. The Company does maintain $1,000,000 of insurance coverage
which could be applied to any liability posed by this matter.
16. INCOME TAXES:
The following analyzes the deferred tax assets and
liabilities required at September 30, 1996:
Deferred tax asset:
Net operating loss carry forward $ 2,579,000
Restructuring reserves 1,287,000
Inventory 176,000
F - 17
<PAGE>
Other items 174,000
------------
4,216,000
Less: Valuation allowance (3,047,000)
------------
Deferred tax asset 1,169,000
Deferred tax liability
Tax basis of assets less than basis for financial
reporting purposes and other items (103,000)
============
$ 1,066,000
============
A valuation allowance is provided to reduce the deferred tax
assets to a level which, more likely than not, will be realized. The
net deferred tax asset reflects management's estimates of the amount
which will be realized from future profitability which can be
predicted with reasonable certainty. The valuation allowance was
$3,047,000 at September 30, 1996, which represents an increase of
$2,769,000 over the amount reported at December 30, 1995.
As of December 30, 1995, the Company has net operating loss
carry forwards for Federal income tax purposes of approximately
$1,263,000 which are available to offset future Federal taxable income
through 2009.
The provision for income taxes differs from the amount
computed by applying the 34% federal statutory income tax rate to the
net loss before provision for income taxes as follows:
<TABLE>
<CAPTION>
Nine months
ended Year ended Year ended
September 30, December 30, December 31,
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Income tax benefit computed at statutory rate $(2,456,000) $ (112,805) $ (214,000)
State tax benefit, net of federal tax benefit (313,000)
Adjustment to valuation allowance 2,769,000 112,805 88,000
----------- ----------- -----------
Income tax (benefit) as reported $ -- $ -- $ (126,000)
=========== =========== ===========
</TABLE>
17. BUSINESS SEGMENT INFORMATION:
Summarized financial information by business segment for nine
months ending September 30, 1996 is as follows:
F - 18
<PAGE>
Nine months
ended
September 30,
1996
------------
Net sales:
Specialty catalog retail $ 11,672,908
operations
Mass merchant manufacturing
and distribution 7,549,893
------------
19,222,801
============
Operating income (loss):
Specialty catalog retail (1,085,728)
operations
Mass merchant manufacturing (2,154,973)
and distribution
------------
(3,240,701)
============
Total assets:
Specialty catalog retail
operations 5,310,725
Mass merchant manufacturing
and distribution 7,762,192
------------
13,072,917
============
Depreciation and amortization:
Specialty catalog retail
operations 125,555
Mass merchant manufacturing
and distribution 85,682
------------
211,237
============
Capital expenditures:
F - 19
<PAGE>
Specialty catalog retail 202,633
operations
Mass merchant manufacturing
and distribution 8,463
------------
$ 211,096
============
18. NINE MONTHS ENDED SEPTEMBER 30, 1995 (UNAUDITED):
The following summarizes the Company's results of operations
for nine months ended September 30, 1995:
Nine months
ended
September 30, 1995
-----------
Net sales $ 9,947,418
Cost of sales 5,668,256
-----------
Gross profit 4,279,162
Operating expenses 3,414,301
-----------
Operating income 864,861
Other income 14,739
Interest expense (374,121)
-----------
Income before income taxes 505,479
Income taxes 47,000
-----------
Net income $ 458,479
===========
Net income per share $ 0.12
===========
Number of shares used in
computation 3,985,755
F - 20
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form
10-KSB to be signed on its behalf by the undersigned, thereunto duly authorized.
DIPLOMAT CORPORATION
By: /s/ Jonathan Rosenberg
______________________________
Jonathan Rosenberg
President, Chief Executive
Officer
Dated: April 2, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons, which include the
Chief Executive Officer, the Chief Financial Officer and a majority of the Board
of Directors, on behalf of the Registrant and in the capacities and on the dates
indicated:
<TABLE>
<CAPTION>
Name Title Date
---- ----- ----
<S> <C> <C>
/s/ Jonathan Rosenberg
_______________________________ President, Chief Executive Officer April 2, 1997
Jonathan Rosenberg and Director
(Principal Executive Officer)
/s/ Robert M. Rubin
_______________________________ Chairman of the Board and a April 2, 1997
Robert M. Rubin Director
/s/ Stuart A. Leiderman
_______________________________ Executive Vice President of April 2, 1997
Stuart A. Leiderman Sales and Marketing and a Director
_______________________________ Director April 2, 1997
Edward E. Hinds
_______________________________ Director April 2, 1997
Howard Katz
/s/ Irwin Oringer
_______________________________ Principal Accounting Officer April 2, 1997
Irwin Oringer and Controller
</TABLE>
<PAGE>
CERTIFICATE OF DESIGNATION
OF THE PREFERRED STOCK OF
DIPLOMAT CORPORATION
Pursuant to the provisions of Section 151 of the Delaware Corporations
Law, Diplomat Corporation (the "Company"), a corporation organized and existing
under the Delaware Corporations Law, hereby adopts the following Designations,
Rights and Limitations of its Series B and Series C Preferred Stock.
Designation of Series B Preferred Stock
Of the 1,000,000 shares of Preferred Stock authorized pursuant to the
Company's Certificate of Incorporation, Two Hundred and Ninety Thousand
(290,000) of such shares are hereby designated as the Series B Preferred Stock.
The powers, designations, preferences, and relative, participating,
optional or other special rights of the Series B Preferred Stock authorized
hereunder and the qualifications, limitations and restrictions of such
preferences and rights are as follows:
1. Liquidation Preference. The entire class of Series B
Preferred Stock shall have a liquidation preference of
$2,900,285 (the "Liquidation Value").
2. Dividends. The Series B Preferred Stock shall receive an
annual dividend of 9% of the Liquidation Value commencing
January 1, 1997, payable monthly in arrears. In the event that
the Company does not pay such dividend for three consecutive
months, the holder shall receive 100,000 shares of the
Company's common stock for each month that the dividend is not
fully paid.
3. Conversion. The Series B Preferred Stock is convertible, based
on its Liquidation Value, into shares of the Company's common
stock at 75% of the average market value of the common stock
for the ten trading days immediately preceding the day of
conversion. The Series B Preferred Stock is convertible any
time at the option of the holder.
4. Voting. The Series B Preferred Stock shall have voting rights
equal to 2,900,285 shares of the Company's common stock on all
matters on which the common stock votes.
38
<PAGE>
Designation of Series C Preferred Stock
Of the 1,000,000 shares of Preferred Stock authorized pursuant to the
Company's Certificate of Incorporation, Sixty Thousand (60,000) of such shares
are hereby designated as the Series C Preferred Stock.
The powers, designations, preferences, and relative, participating,
optional or other special rights of the Series C Preferred Stock authorized
hereunder and the qualifications, limitations and restrictions of such
preferences and rights are as follows:
1. Liquidation Preference. The entire class of Series C
Preferred Stock shall have a liquidation preference of
$600,000 (the "Liquidation Value").
2. Dividends. The Series C Preferred Stock shall receive an
annual dividend of 9% of the Liquidation Value commencing
January 1, 1997, payable monthly in arrears. In the event that
the Company does not pay such dividend for three consecutive
months, the holder shall receive 100,000 shares of the
Company's common stock for each month that the dividend is not
fully paid.
3. Conversion. The Series C Preferred Stock is convertible, based
on its Liquidation Value, into shares of the Company's common
stock at 75% of the average market value of the common stock
for the ten trading days immediately preceding the day of
conversion. The Series C Preferred Stock is convertible any
time at the option of the holder.
4. Voting. The Series C Preferred Stock shall have voting rights
equal to 600,000 shares of the Company's common stock on all
matters on which the common stock votes.
This Certificate of Designation has been duly adopted by the Board of
Directors of the Company pursuant to authority vested in the Board of Directors
by the Certificate of Incorporation of the Company, as amended.
39
<PAGE>
Signed and attested to on November 20, 1996
/s/ Jonathan Rosenberg
--------------------------
Jonathan Rosenberg,
President
Attest:
/s/ Stuart A. Leiderman
- ---------------------------
Stuart A. Leiderman, Secretary
40
<PAGE>
EXHIBIT 4.H
CERTIFICATE OF DESIGNATION
OF THE PREFERRED STOCK OF
DIPLOMAT CORPORATION
Pursuant to the provisions of Section 151 of the Delaware Corporations
Law, Diplomat Corporation (the "Company"), a corporation organized and existing
under the Delaware Corporations Law, hereby adopts the following Designations,
Rights and Limitations of its Series B and Series C Preferred Stock.
Designation of Series B Preferred Stock
Of the 1,000,000 shares of Preferred Stock authorized pursuant to the
Company's Certificate of Incorporation, Two Hundred and Ninety Thousand
(290,000) of such shares are hereby designated as the Series B Preferred Stock.
The powers, designations, preferences, and relative, participating,
optional or other special rights of the Series B Preferred Stock authorized
hereunder and the qualifications, limitations and restrictions of such
preferences and rights are as follows:
1. Liquidation Preference. The entire class of Series B
Preferred Stock shall have a liquidation preference of
$2,900,285 (the "Liquidation Value").
2. Dividends. The Series B Preferred Stock shall receive an
annual dividend of 9% of the Liquidation Value commencing
January 1, 1997, payable monthly in arrears. In the event that
the Company does not pay such dividend for three consecutive
months, the holder shall receive 100,000 shares of the
Company's common stock for each month that the dividend is not
fully paid.
3. Conversion. The Series B Preferred Stock is convertible, based
on its Liquidation Value, into shares of the Company's common
stock at 75% of the average market value of the common stock
for the ten trading days immediately preceding the day of
conversion. The Series B Preferred Stock is convertible any
time at the option of the holder.
4. Voting. The Series B Preferred Stock shall have voting rights
equal to 2,900,285 shares of the Company's common stock on all
matters on which the common stock votes.
41
<PAGE>
Designation of Series C Preferred Stock
Of the 1,000,000 shares of Preferred Stock authorized pursuant to the
Company's Certificate of Incorporation, Sixty Thousand (60,000) of such shares
are hereby designated as the Series C Preferred Stock.
The powers, designations, preferences, and relative, participating,
optional or other special rights of the Series C Preferred Stock authorized
hereunder and the qualifications, limitations and restrictions of such
preferences and rights are as follows:
1. Liquidation Preference. The entire class of Series C
Preferred Stock shall have a liquidation preference of
$600,000 (the "Liquidation Value").
2. Dividends. The Series C Preferred Stock shall receive an
annual dividend of 9% of the Liquidation Value commencing
January 1, 1997, payable monthly in arrears. In the event that
the Company does not pay such dividend for three consecutive
months, the holder shall receive 100,000 shares of the
Company's common stock for each month that the dividend is not
fully paid.
3. Conversion. The Series C Preferred Stock is convertible, based
on its Liquidation Value, into shares of the Company's common
stock at 75% of the average market value of the common stock
for the ten trading days immediately preceding the day of
conversion. The Series C Preferred Stock is convertible any
time at the option of the holder.
4. Voting. The Series C Preferred Stock shall have voting rights
equal to 600,000 shares of the Company's common stock on all
matters on which the common stock votes.
This Certificate of Designation has been duly adopted by the Board of
Directors of the Company pursuant to authority vested in the Board of Directors
by the Certificate of Incorporation of the Company, as amended.
42
<PAGE>
Signed and attested to on November 20, 1996
/s/ Jonathan Rosenberg
----------------------------
Jonathan Rosenberg,
President
Attest:
/s/ Stuart A. Leiderman
- -------------------------
Stuart A. Leiderman, Secretary
43
<PAGE>
EXHIBIT 10.C-1
DIPLOMAT CORPORATION
1996 STOCK OPTION PLAN
Adopted as of November 26, 1996
44
<PAGE>
1. PURPOSE OF PLAN; ADMINISTRATION
1.1 Purpose.
The Diplomat Corporation 1996 Stock Option Plan (hereinafter, the
"Plan") is hereby established to grant to officers and other employees of
Diplomat Corporation (the "Company") or of its parents or subsidiaries (as
defined in Sections 424(e) and (f), respectively, of the Internal Revenue Code
of 1986, as amended (the "Code")), if any (individually and collectively, the
Company"), and to non-employee directors, consultants and advisors and other
persons who may perform significant services for or on behalf of the Company, a
favorable opportunity to acquire common stock, $.0001 par value ("Common
Stock"), of the Company and, thereby, to create an incentive for such persons to
remain in the employ of or provide services to the Company and to contribute to
its success.
The Company may grant under the Plan both incentive stock options
within the meaning of Section 422 of the Code ("Incentive Stock Options") and
stock options that do not qualify for treatment as Incentive Stock Options
("Nonstatutory Options"). Unless expressly provided to the contrary herein, all
references herein to "Options," shall include both incentive Stock Options and
Nonstatutory Options.
1.2 Administration.
The Plan shall be administered by the Board of Directors of the Company
(the "Board"), if each member is a "Non-Employee Director" within the meaning of
Rule 16b-3 under the Securities Exchange Act of 1934, as amended ("Rule 16b-3"),
or a committee (the "Committee") of two or more directors, each of whom is a
Non-Employee Director. Appointment of Committee members shall be effective upon
acceptance of appointment. Committee members may resign at any time by
delivering written notice to the Board. Vacancies in the Committee may be filled
by the Board.
A majority of the members of the Committee shall constitute a quorum
for the purposes of the Plan. Provided a quorum is present, the Committee may
take action by affirmative vote or consent of a majority of its members present
at a meeting. Meetings may be held telephonically as long as all members are
able to hear one another, and a member of the Committee shall be deemed to be
present for this purpose if he or she is in simultaneous communication by
telephone with the other members who are able to hear one another. In lieu of
action at a meeting, the Committee may act by written consent of a majority of
its members.
Subject to the express provisions of the Plan, the Committee shall have
the authority to construe and interpret the Plan and all Stock Option Agreements
(as defined in Section 3.4) entered into pursuant hereto and to define the terms
used therein, to prescribe, adopt, amend and rescind rules and regulations
relating to the administration of the Plan and to make all other determinations
necessary or advisable for the administration of the Plan; provided, however,
that the Committee may delegate nondiscretionary administrative duties to such
employees of the Company as it deems proper; and, provided, further, in its
absolute discretion, the Board may
<PAGE>
at any time and from time to time exercise any and all rights and duties of the
Committee under the Plan. Subject to the express limitations of the Plan, the
Committee shall designate the individuals from among the class of persons
eligible to participate as provided in Section 1.3 who shall receive options,
whether an optionee will receive Incentive Stock Options or Nonstatutory
Options, or both, and the amount, price, restrictions and all other terms and
provisions of such options (which need not be identical).
Members of the Committee shall receive such compensation for their
services as members as may be determined by the Board. All expenses and
liabilities which members of the Committee incur in connection with the
administration of this Plan shall be borne by the Company. The Committee may,
with the approval of the Board, employ attorneys, consultants, accountants,
appraisers, brokers or other persons. The Committee, the Company and the
Company's officers and directors shall be entitled to rely upon the advice,
opinions or valuations of any such persons. No members of the Committee or Board
shall be personally liable for any action, determination or interpretation made
in good faith with respect to the Plan, and all members of the Committee shall
be fully protected by the Company in respect of any such action, determination
or interpretation.
1.3 Participation.
Officers and other employees of the Company, non-employee directors,
consultants and advisors and other persons who may perform significant services
on behalf of the Company shall be eligible for selection to participate in the
Plan upon approval by the Committee; provided, however, that only "employees"
(within the meaning of Section 3401(c) of the Code) of the Company shall be
eligible for the grant of Incentive Stock Options. An individual who has been
granted an option may, if otherwise eligible, be granted additional options if
the Committee shall so determine. No person is eligible to participate in the
Plan by matter of right; only those eligible persons who are selected by the
Committee in its discretion shall participate in the Plan.
1.4 Stock Subject to the Plan.
Subject to adjustment as provided in Section 3.5, the stock to be
offered under the Plan shall be shares of authorized but unissued Common Stock,
including any shares repurchased under the terms of the Plan or any Stock Option
Agreement entered into pursuant hereto. The cumulative aggregate number of
shares of Common Stock to be issued under the Plan shall not exceed 1,500,000,
subject to adjustment as set forth in Section 3.5.
If any option granted hereunder shall expire or terminate for any
reason ithout having been fully exercised, the unpurchased shares subject
thereto shall again be available for the purposes of the Plan. For purposes of
this Section 1.4, where the exercise price of options is paid by means of the
grantee's surrender of previously owned shares of Common Stock, only the net
number of additional shares issued and which remain outstanding in connection
with such exercise shall be deemed "issued" for purposes of the Plan.
3
<PAGE>
2. STOCK OPTIONS
2.1 Exercise Price; Payment.
(a) The exercise price of each Incentive Stock Option granted under the
Plan shall be determined by the Board of Directors or the Committee, whichever
the case may be, but shall not be less than 100% of the "Fair Market Value" (as
defined below) of Common Stock on the date of grant. If an Incentive Stock
Option is granted to an employee who at the time such option is granted owns
(within the meaning of section 424(d) of the Code) more than 10% of the total
combined voting power of all classes of capital stock of the Company, the option
exercise price shall be at least 110% of the Fair Market Value of Common Stock
on the date of grant. The exercise price of each Nonstatutory Option also shall
be determined by the Committee, but shall not be less than 85% of the Fair
Market Value of Common Stock on the date of grant. The status of each option
granted under the Plan as either an Incentive Stock Option or a Nonstatutory
Option shall be determined by the Committee at the time the Committee acts to
grant the option, and shall be clearly identified as such in the Stock Option
Agreement relating thereto.
"Fair Market Value" for purposes of the Plan shall mean: (i) the
closing price of a share of Common Stock on the principal exchange on which
shares of Common Stock are then trading, if any, on the day immediately
preceding the date of grant, or, if shares were not traded on the day preceding
such date of grant, then on the next preceding trading day during which a sale
occurred; or (ii) if Common Stock is not traded on an exchange but is quoted on
Nasdaq or a successor quotation system, (1) the last sales price (if Common
Stock is then listed on the Nasdaq Stock Market) or (2) the mean between the
closing representative bid and asked price (in all other cases) for Common Stock
on the day prior to the date of grant as reported by Nasdaq or such successor
quotation system; or (iii) if there is no listing or trading of Common Stock
either on a national exchange or over-the-counter, that price determined in good
faith by the Committee to be the fair value per share of Common Stock, based
upon such evidence as it deems necessary or advisable.
(b) In the discretion of the Committee at the time the option is
exercised, the exercise price of any option granted under the Plan shall be paid
in full in cash, by check or by the optionee's interest-bearing promissory note
(subject to any limitations of applicable state corporations law) delivered at
the time of exercise; provided, however, that subject to the timing requirements
of Section 2.7, in the discretion of the Committee and upon receipt of all
regulatory approvals, the person exercising the option may deliver as payment in
whole or in part of such exercise price certificates for Common Stock of the
Company (duly endorsed or with duly executed stock powers attached), which shall
be valued at its Fair Market Value on the day of exercise of the option, or
other property deemed appropriate by the Committee; and, provided further, that,
subject to Section 422 of the Code, so-called cashless exercises as permitted
under applicable rules and regulations of the Securities and Exchange Commission
and the Federal Reserve Board shall be permitted in the discretion of the
Committee. Without limiting the Committee's discretion in this regard,
consecutive book entry stock-for-stock
4
<PAGE>
exercises of options (or "pyramiding") also are permitted in the Committee's
discretion.
Irrespective of the form of payment, the delivery of shares issuable
upon the exercise of an option shall be conditioned upon payment by the optionee
to the Company of amounts sufficient to enable the Company to pay all federal,
state, and local withholding taxes resulting, in the Company's judgment, from
the exercise. In the discretion of the Committee, such payment to the Company
may be effected through (i) the Company's withholding from the number of shares
of Common Stock that would otherwise be delivered to the optionee by the Company
on exercise of the option a number of shares of Common Stock equal in value (as
determined by the Fair Market Value of Common Stock on the date of exercise) to
the aggregate withholding taxes, (ii) payment by the optionee to the Company of
the aggregate withholding taxes in cash, (iii) withholding by the Company from
other amounts contemporaneously owed by the Company to the optionee, or (iv) any
combination of these three methods, as determined by the Committee in its
discretion.
2.2 Option Period.
(a) The Committee shall provide, in the terms of each Stock Option
Agreement, when the option subject to such agreement expires and becomes
unexercisable, but in no event will an Incentive Stock Option granted under the
Plan be exercisable after the expiration of ten years from the date it is
granted. Without limiting the generality of the foregoing, the Committee may
provide in the Stock Option Agreement that the option subject thereto expires 30
days following a Termination of Employment (as defined in Section 3.2 hereof)
for any reason other than death or disability, or six months following a
Termination of Employment for disability or following an optionee's death.
(b) Outside Date for Exercise. Notwithstanding any provision of
this Section 2.2, in no event shall any option granted under the Plan be
exercised after the expiration date of such option set forth in the applicable
Stock Option Agreement.
2.3 Exercise of Options.
Each option granted under the Plan shall become exercisable and the
total number of shares subject thereto shall be purchasable, in a lump sum or in
such installments, which need not be equal, as the Committee shall determine;
provided, however, that each option shall become exercisable in full no later
than ten years after such option is granted, and each option shall become
exercisable as to at least 10% of the shares of Common Stock covered thereby on
each anniversary of the date such option is granted; and provided, further, that
if the holder of an option shall not in any given installment period purchase
all of the shares which such holder is entitled to purchase in such installment
period, such holder's right to purchase any shares not purchased in such
installment period shall continue until the expiration or sooner termination of
such holder's option. The Committee may, at any time after grant of the option
and from time to time, increase the number of shares purchasable in any
installment, subject to the total number of shares subject to the option and the
limitations set forth in Section 2.5. At any time and from
5
<PAGE>
time to time prior to the time when any exercisable option or exercisable
portion thereof becomes unexercisable under the Plan or the applicable Stock
Option Agreement, such option or portion thereof may be exercised in whole or in
part; provided, however, that the Committee may, by the terms of the option,
require any partial exercise to be with respect to a specified minimum number of
shares. No option or installment thereof shall be exercisable except with
respect to whole shares. Fractional share interests shall be disregarded, except
that they may be accumulated as provided above and except that if such a
fractional share interest constitutes the total shares of Common Stock remaining
available for purchase under an option at the time of exercise, the optionee
shall be entitled to receive on exercise a certified or bank cashier's check in
an amount equal to the Fair Market Value of such fractional share of stock.
2.4 Transferability of Options.
Except as the Committee may determine as aforesaid, an option granted
under the Plan shall, by its terms, be nontransferable by the optionee other
than by will or the laws of descent and distribution, or pursuant to a qualified
domestic relations order (as defined by the Code), and shall be exercisable
during the optionee's lifetime only by the optionee or by his or her guardian or
legal representative. More particularly, but without limiting the generality of
the immediately preceding sentence, an option may not be assigned, transferred
(except as provided in the preceding sentence), pledged or hypothecated (whether
by operation of law or otherwise), and shall not be subject to execution,
attachment or similar process. Any attempted assignment, transfer, pledge,
hypothecation or other disposition of any option contrary to the provisions of
the Plan and the applicable Stock Option Agreement, and any levy of any
attachment or similar process upon an option, shall be null and void, and
otherwise without effect, and the Committee may, in its sole discretion, upon
the happening of any such event, terminate such option forthwith.
2.5 Limitation on Exercise of Incentive Stock Options.
To the extent that the aggregate Fair Market Value (determined on the
date of grant as provided in Section 2.1 above) of the Common Stock with respect
to which Incentive Stock Options granted hereunder (together with all other
Incentive Stock Option plans of the Company) are exercisable for the first time
by an optionee in any calendar year under the Plan exceeds $100,000, such
options granted hereunder shall be treated as Nonstatutory Options to the extent
required by Section 422 of the Code. The rule set forth in the preceding
sentence shall be applied by taking options into account in the order in which
they were granted.
2.6 Disqualifying Dispositions of Incentive Stock Options.
If Common Stock acquired upon exercise of any Incentive Stock Option is
disposed of in a disposition that, under Section 422 of the Code, disqualifies
the option holder from the application of Section 421(a) of the Code, the holder
of the Common Stock immediately before the disposition shall comply with any
requirements imposed by the Company in order to enable the Company to secure the
related income tax deduction to which it is entitled in such event.
6
<PAGE>
2.7 Certain Timing Requirements.
At the discretion of the Committee, shares of Common Stock issuable to
the optionee upon exercise of an option may be used to satisfy the option
exercise price or the tax withholding consequences of such exercise, in the case
of persons subject to Section 16 of the Securities Exchange Act of 1934, as
amended, only (i) during the period beginning on the third business day
following the date of release of the quarterly or annual summary statement of
sales and earnings of the Company and ending on the twelfth business day
following such date or (ii) pursuant to an irrevocable written election by the
optionee to use shares of Common Stock issuable to the optionee upon exercise of
the option to pay all or part of the option price or the withholding taxes made
at least six months prior to the payment of such option price or withholding
taxes.
2.8 No Effect on Employment.
Nothing in the Plan or in any Stock Option Agreement hereunder shall
confer upon any optionee any right to continue in the employ of the Company, any
Parent Corporation or any subsidiary or shall interfere with or restrict in any
way the rights of the Company, its Parent Corporation and its Subsidiaries,
which are hereby expressly reserved, to discharge any optionee at any time for
any reason whatsoever, with or without cause.
For purposes of the Plan, "Parent Corporation" shall mean any
corporation in an unbroken chain of corporations ending with the Company if each
of the corporations other than the Company then owns stock possessing 50% or
more of the total combined voting power of all classes of stock in one of the
other corporations in such chain. For purposes of the Plan, "Subsidiary" shall
mean any corporation in an unbroken chain of corporations beginning with the
Company if each of the corporations other than the last corporation in the
unbroken chain then owns stock possessing 50% or more of the total combined
voting power of all classes of stock in one of the other corporations in such
chain.
3. OTHER PROVISIONS
3.1 Sick Leave and Leaves of Absence.
Unless otherwise provided in the Stock Option Agreement, and to the
extent permitted by Section 422 of the Code, an optionee's employment shall not
be deemed to terminate by reason of sick leave, military leave or other leave of
absence approved by the Company if the period of any such leave does not exceed
a period approved by the Company, or, if longer, if the optionee's right to
reemployment by the Company is guaranteed either contractually or by statute. A
Stock Option Agreement may contain such additional or different provisions with
respect to leave of absence as the Committee may approve, either at the time of
grant of an option or at a later time.
7
<PAGE>
3.2 Termination of Employment.
For purposes of the Plan "Termination of Employment," shall mean the
time when the employee-employer relationship between the optionee and the
Company, any Subsidiary or any Parent Corporation is terminated for any reason,
including, but not by way of limitation, a termination by resignation,
discharge, death, disability or retirement; but excluding (i) terminations where
there is a simultaneous reemployment or continuing employment of an optionee by
the Company, any Subsidiary or any Parent Corporation, (ii) at the discretion of
the Committee, terminations which result in a temporary severance of the
employee-employer relationship, and (iii) at the discretion of the Committee,
terminations which are followed by the simultaneous establishment of a
consulting relationship by the Company, a Subsidiary or any Parent Corporation
with the former employee. Subject to Section 3.1, the Committee, in its absolute
discretion, shall determine the affect of all matters and questions relating to
Termination of Employment; provided, however, that, with respect to Incentive
Stock Options, a leave of absence or other change in the employee-employer
relationship shall constitute a Termination of Employment if, and to the extent
that such leave of absence or other change interrupts employment for the
purposes of Section 422(a)(2) of the Code and the then-applicable regulations
and revenue rulings under said Section.
3.3 Issuance of Stock Certificates.
Upon exercise of an option, the Company shall deliver to the person
exercising such option a stock certificate evidencing the shares of Common Stock
acquired upon exercise. Notwithstanding the foregoing, the Committee in its
discretion may require the Company to retain possession of any certificate
evidencing stock acquired upon exercise of an option which remains subject to
repurchase under the provisions of the Stock Option Agreement or any other
agreement signed by the optionee in order to facilitate such repurchase
provisions.
3.4 Terms and Conditions of Options.
Each option granted under the Plan shall be evidenced by a written
Stock Option Agreement ("Stock Option Agreement") between the option holder and
the Company providing that the option is subject to the terms and conditions of
the Plan and to such other terms and conditions not inconsistent therewith as
the Committee may deem appropriate in each case.
3.5 Adjustments Upon Changes in Capitalization; Merger and
Consolidation.
If the outstanding shares of Common Stock are changed into, or
exchanged for cash or a different number or kind of shares or securities of the
Company or of another corporation through reorganization, merger,
recapitalization, reclassification, stock split-up, reverse stock split, stock
dividend, stock consolidation, stock combination, stock reclassification or
similar transaction, an appropriate adjustment shall be made by the Committee in
the number and kind of shares as to which options may be granted. In the event
of such a change or exchange, other than for shares or securities of another
corporation or by reason of reorganization, the
8
<PAGE>
Committee shall also make a corresponding adjustment changing the number or kind
of shares and the exercise price per share allocated to unexercised options or
portions thereof, which shall have been granted prior to any such change, shall
likewise be made. Any such adjustment, however, shall be made without change in
the total price applicable to the unexercised portion of the option (except for
any change in the aggregate price resulting from rounding-off of share
quantities or prices).
In the event of a "spin-off" or other substantial distribution of
assets of the Company which has a material diminutive effect upon the Fair
Market Value of the Common Stock, the Committee in its discretion shall make an
appropriate and equitable adjustment to the exercise prices of options then
outstanding under the Plan.
Where an adjustment under this Section 3.5 of the type described above
is made to an Incentive Stock Option, the adjustment will be made in a manner
which will not be considered a "modification" under the provisions of subsection
424(b)(3) of the Code.
In connection with the dissolution or liquidation of the Company or a
partial liquidation involving 50% or more of the assets of the Company, a
reorganization of the Company in which another entity is the survivor, a merger
or reorganization of the Company under which more than 50% of the Common Stock
outstanding prior to the merger or reorganization is converted into cash or into
a security of another entity, a sale of more than 50% of the Company's assets,
or a similar event that the Committee determines, in its discretion, would
materially alter the structure of the Company or its ownership, the Committee,
upon 30 days prior written notice to the option holders, may, in its discretion,
do one or more of the following: (i) shorten the period during which options are
exercisable (provided they remain exercisable for at least 30 days after the
date the notice is given); (ii) accelerate any vesting schedule to which an
option is subject; (iii) arrange to have the surviving or successor entity grant
replacement options with appropriate adjustments in the number and kind of
securities and option prices, or (iv) cancel options upon payment to the option
holders in cash, with respect to each option to the extent then exercisable
(including any options as to which the exercise has been accelerated as
contemplated in clause (ii) above), of any amount that is the equivalent of the
Fair Market Value of the Common Stock (at the effective time of the dissolution,
liquidation, merger, reorganization, sale or other event) or the fair market
value of the option. In the case of a change in corporate control, the Committee
may, in considering the advisability or the terms and conditions of any
acceleration of the exercisability of any option pursuant to this Section 3.5,
take into account the penalties that may result directly or indirectly from such
acceleration to either the Company or the option holder, or both, under Section
280G of the Code, and may decide to limit such acceleration to the extent
necessary to avoid or mitigate such penalties or their effects.
No fractional share of Common Stock shall be issued under the Plan on
account of any adjustment under this Section 3.5.
9
<PAGE>
3.6 Rights of Participants and Beneficiaries.
The Company shall pay all amounts payable hereunder only to the option
holder or beneficiaries entitled thereto pursuant to the Plan. The Company shall
not be liable for the debts, contracts or engagements of any optionee or his or
her beneficiaries, and rights to cash payments under the Plan may not be taken
in execution by attachment or garnishment, or by any other legal or equitable
proceeding while in the hands of the Company.
3.7 Government Regulations.
The Plan, and the grant and exercise of options and the issuance and
delivery of shares of Common Stock under options granted hereunder, shall be
subject to compliance with all applicable federal and state laws, rules and
regulations (including but not limited to state and federal securities law) and
federal margin requirements and to such approvals by any listing, regulatory or
governmental authority as may, in the opinion of counsel for the Company, be
necessary or advisable in connection therewith. Any securities delivered under
the Plan shall be subject to such restrictions, and the person acquiring such
securities shall, if requested by the Company, provide such assurances and
representations to the Company as the Company may deem necessary or desirable to
assure compliance with all applicable legal requirements. To the extent
permitted by applicable law, the Plan and options granted hereunder shall be
deemed amended to the extent necessary to conform to such laws, rules and
regulations.
3.8 Amendment and Termination.
The Board or the Committee may at any time suspend, amend or terminate
the Plan and may, with the consent of the option holder, make such modifications
of the terms and conditions of such option holder's option as it shall deem
advisable, provided, however, that, without approval of the Company's
stockholders given within twelve months before or after the action by the Board
or the Committee, no action of the Board or the Committee may, (A) materially
increase the benefits accruing to participants under the Plan; (B) materially
increase the number of securities which may be issued under the Plan; or (C)
materially modify the requirements as to eligibility for participation in the
Plan. No option may be granted during any suspension of the Plan or after such
termination. The amendment, suspension or termination of the Plan shall not,
without the consent of the option holder affected thereby, alter or impair any
rights or obligations under any option theretofore granted under the Plan. No
option way be granted during any period of suspension nor after termination of
the Plan, and in no event may any option be granted under the Plan after the
expiration of ten years from the date the Plan is adopted by the Board.
3.9 Time of Grant And Exercise of Option.
An option shall be deemed to be exercised when the Secretary of the
Company receives written notice from an option holder of such exercise, payment
of the exercise price determined pursuant to Section 2.1 of the Plan and set
forth in the Stock Option Agreement, and all representations, indemnifications
and documents reasonably requested by the Committee.
10
<PAGE>
3.10 Privileges of Stock Ownership; Non-Distributive Intent;
Reports to Option Holders.
A participant in the Plan shall not be entitled to the privilege of
stock ownership as to any shares of Common Stock not actually issued to the
optionee. Upon exercise of an option at a time when there is not in effect under
the Securities Act of 1933, as amended, a Registration Statement relating to the
Common Stock issuable upon exercise or payment therefor and available for
delivery a Prospectus meeting the requirements of Section 10(a)(3) of said Act,
the optionee shall represent and warrant in writing to the Company that the
shares purchased are being acquired for investment and not with a view to the
distribution thereof.
The Company shall furnish to each optionee under the Plan the Company's
annual report and such other periodic reports, if any, as are disseminated by
the Company in the ordinary course to its stockholders.
3.11 Legending Share Certificates.
In order to enforce any restrictions imposed upon Common Stock issued
upon exercise of an option granted under the Plan or to which such Common Stock
may be subject, the Committee may cause a legend or legends to be placed on any
share certificates representing such Common Stock, which legend or legends shall
make appropriate reference to such restrictions, including, but not limited to,
a restriction against sale of such Common Stock for any period of time as may be
required by applicable laws or regulations. If any restriction with respect to
which a legend was placed on any certificate ceases to apply to Common Stock
represented by such certificate, the owner of the Common Stock represented by
such certificate may require the Company to cause the issuance of a new
certificate not bearing the legend.
Additionally, and not by way of limitation, the Committee may impose
such restrictions on any Common Stock issued pursuant to the Plan as it may deem
advisable, including, without limitation, restrictions under the requirements of
any stock exchange upon which Common Stock is then traded.
3.12 Use of Proceeds.
Proceeds realized pursuant to the exercise of options under the Plan
shall constitute general funds of the Company.
3.13 Changes in Capital Structure; No Impediment to Corporate
Transactions.
The existence of outstanding options under the Plan shall not affect
the Company's right to effect adjustments, recapitalizations, reorganizations or
other changes in its or any other corporation's capital structure or business,
any merger or consolidation, any issuance of bonds, debentures, preferred or
prior preference stock ahead of or affecting Common Stock, the dissolution or
liquidation of the Company's or any other corporation's assets or business, or
any
11
<PAGE>
other corporate act, whether similar to the events described above or otherwise.
3.14 Effective Date of the Plan.
The Plan shall be effective as of the date of its approval by the
stockholders of the Company within twelve months after the date of the Board's
initial adoption of the Plan. Options may be granted but not exercised prior to
stockholder approval of the Plan. If any options are so granted and stockholder
approval shall not have been obtained within twelve months of the date of
adoption of this Plan by the Board of Directors, such options shall terminate
retroactively as of the date they were granted.
3.15 Termination.
The Plan shall terminate automatically as of the close of business on
the day preceding the tenth anniversary date of its adoption by the Board or
earlier as provided in Section 3.8. Unless otherwise provided herein, the
termination of the Plan shall not affect the validity of any option agreement
outstanding at the date of such termination.
3.16 No Effect on Other Plans.
The adoption of the Plan shall not affect any other compensation or
incentive plans in effect for the Company, any Subsidiary or any Parent
Corporation. Nothing in the Plan shall be construed to limit the right of the
Company (i) to establish any other forms of incentives or compensation for
employees of the Company, any Subsidiary or any Parent Corporation or (ii) to
grant or assume options or other rights otherwise than under the Plan in
connection with any proper corporate purpose including but not by way of
limitation, the grant or assumption of options in connection with the
acquisition by purchase, lease, merger, consolidation or otherwise, of the
business, stock or assets of any corporation, partnership, firm or association.
* * *
12
<PAGE>
EXHIBIT 21
Subsidiaries of the Registrant:
Biobottoms, Inc.
13
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 69,258
<SECURITIES> 0
<RECEIVABLES> 1,738,511
<ALLOWANCES> (75,000)
<INVENTORY> 3,797,740
<CURRENT-ASSETS> 7,220,465
<PP&E> 3,907,553
<DEPRECIATION> (1,685,205)
<TOTAL-ASSETS> 13,672,917
<CURRENT-LIABILITIES> 11,349,475
<BONDS> 0
0
4,100,000
<COMMON> 500
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 13,672,917
<SALES> 19,222,801
<TOTAL-REVENUES> 19,230,736
<CGS> 13,334,588
<TOTAL-COSTS> 13,334,588
<OTHER-EXPENSES> 12,328,536
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 792,512
<INCOME-PRETAX> (7,224,900)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,224,900)
<EPS-PRIMARY> (1.59)
<EPS-DILUTED> 0.000
</TABLE>
