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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-QSB
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For The Quarter Ended December 31, 1997 or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For The Transition Period from _______to_______
Commission File Number 0-22432
DIPLOMAT CORPORATION
--------------------
(Exact name of registrant as specified in its charter)
Delaware 13-3727399)
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
25 Kay Fries Drive, Stony Point, New York 10980
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 914 786-5552
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
-- --
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: January 31, 1998, 10,629,433 Common
Shares outstanding
Transitional Small Business Disclosure (check One):
Yes No X
-- --
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DIPLOMAT CORPORATION
INDEX
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PAGE
PART I - FINANCIAL INFORMATION
Item 1- Financial Statements
Consolidated Balance Sheet - December 31, 1997 3
Consolidated Statements of Operations - For the three months
ended December 31, 1997 and December 31, 1996 4
Consolidated Statements of Cash Flows - For the three months
ended December 31, 1997 and December 31, 1996 5
Notes to Financial Statements 6-10
Item 2 - Management's Discussion and Analysis of Financial
Conditions and Results of Operations 11-16
PART II - OTHER INFORMATION
Item 2 - Changes in Securities
Item 3 - Defaults Upon Senior Securities 17
Item 6 - Exhibits and Reports on Form 8-K 17
SIGNATURE 18
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DIPLOMAT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Unaudited)
DECEMBER 31,1997
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 753,544
Accounts receivable, trade,net 3,370,894
Inventories 14,571,601
Prepaid expenses 4,641,684
Other current assets 2,096,722
-----------
TOTAL CURRENT ASSETS 25,434,445
PROPERTY AND EQUIPMENT
less accumulated depreciation 3,769,124
OTHER ASSETS
Goodwill 13,651,182
Customer list 5,118,750
Other 580,687
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$48,554,188
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable-trade $ 9,823,391
Loans payable-stockholders 1,430,000
Loans payable-bank 8,615,562
Accrued expenses 9,686,421
Current maturities of long term debt 859,935
-----------
TOTAL CURRENT LIABILITIES 30,415,309
-----------
LONG TERM DEBT,less current maturities 1,320,781
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STOCKHOLDERS' EQUITY:
Preferred stock 16,363,068
Common stock 801
Paid-in capital 8,206,907
Accumulated deficit (7,752,678)
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TOTAL SHAREHOLDERS' EQUITY 16,818,098
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$48,554,188
See notes to financial statements.
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DIPLOMAT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STAEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended
Dec 31, Dec 31,
1997 1996
--------- --------
NET SALES $22,341,034 $ 7,047,522
COST OF SALES 10,070,993 3,206,950
----------- -----------
GROSS PROFIT 12,270,041 3,840,572
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 11,744,192 2,999,461
----------- -----------
OPERATING INCOME 525,849 841,111
OTHER EXPENSE, PRINCIPALLY INTEREST (302,195) (147,847)
----------- -----------
INCOME BEFORE INCOME TAXES 223,654 693,264
INCOME TAXES (BENEFIT) 0 171,863
----------- -----------
NET INCOME $223,654 $521,401
BASIC EARNINGS PER SHARE $0.02 $0.10
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DILUTED EARNINGS PER SHARE $0.01 $0.05
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WEIGHTED SHARES USED IN COMPUTATION:
Basic 8,880,733 5,256,025
Diluted 10,331,206 10,658,541
See notes to financial statements.
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DIPLOMAT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three months ended
Dec.31, Dec. 31,
1997 1996
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (Loss) $223,654 $521,400
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 398,797 76,515
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622,451 597,915
CHANGES IN ASSETS AND LIABILITIES
(Increase)decrease in accounts receivable (649,771) 51,451
(Increase) decrease in inventories 3,125 (266,098)
(Increase)decrease in prepaid expenses (1,576,025) 140,846
(Increase)decrease in other current assets 68,760 486,763
(Increase)decrease in other assets (1,893,970) (96,758)
Increase(decrease) in accounts payable 201,605 (602,037)
Increase(decrease) in accrued expenses 1,154,827 (475,615)
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(2,068,998) (163,533)
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CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment, net (236,946) (19,024)
Acquisition of subsidiaries (2,634,361) 0
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(2,871,307) (19,024)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of stock 4,420,020 245,000
Preferred stock dividend (126,640) 0
Proceeds from loans payable 133,097 0
Repayments of loans payable (87,042) (10,519)
Revolving credit agreement 1,302,540 (68,751)
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5,641,975 165,730
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NET INCREASE(DECREASE) IN CASH 701,670 (16,827)
CASH AND CASH EQUIVALENTS-beginning of period 51,873 69,258
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CASH AND CASH EQUIVALENTS-end of period $753,543 $52,431
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DIPLOMAT CORPORATION AND SUBSIDIARIES
-------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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THREE MONTHS ENDED DECEMBER 31, 1997 AND 1996
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1. SIGNIFICANT ACCOUNTING POLICIES
A. The financial statements include the accounts of the Company and its
wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated. The accompanying financial statements reflect
all adjustments which, in the opinion of management, are necessary for a fair
presentation of financial position and the results of operations for the interim
periods presented. Except as otherwise disclosed, all such adjustments are of a
normal and recurring nature. The results of operations for any interim period
are not necessarily indicative of the results attainable for a full fiscal year.
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")
issued Statement of Financial Accounting Standards ("SFAS") No. 121. "Accounting
For the Impairment of Long Lived Assets and For Long Lived Assets to be Disposed
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 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.
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
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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 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.
K. Revenue is recognized at the time merchandise is shipped to
customers. Proceeds received from merchandise not shipped are reflected as
"customers' unshipped orders", a current liability.
L. The term "the Company" shall include Diplomat Corporation
and its wholly-owned subsidiaries, Biobottoms, Inc. ("Biobottoms"), Brownstone
Holdings, Inc. ("Brownstone") and Lew Magram, Ltd. ("Magram"), unless otherwise
indicated. The term "Diplomat" shall refer to the operations of the Diplomat
Corporation exclusive of its subsidiaries.
M. In February 1997, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share"
(FAS No. 128"), which became effective for both interim and annual financial
statements for periods ending after December 15, 1997. FAS No. 123 requires a
presentation of "Basic" and (where applicable) "Diluted" earnings per share.
Generally, Basic earnings per share are computed on only the weighted average
number of common shares actually outstanding during the period, and the Diluted
computation considers potential shares issuable upon exercise or conversion of
other outstanding instruments where dilution would result. Furthermore, FAS No.
128 requires the restatement of prior period reported earnings per share to
conform to the new standard.
The following is a reconciliation of the numerator and denominator underlying
the earnings per share computations:
For the Quarter ended December 31, 1997
---------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Net Income $223,654
Preferred stock dividends (78,750)
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Basic EPS:
Income available to common shareholders $144,904 8,880,733 $.02
Effective of Dilutive Securities:
Options and Warrants 1,450,473
Diluted EPS:
Income available to common stockholders
and assumed conversions $144,904 10,331,206 $.01
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Other potentially dilutive securities outstanding at December 31,1997,
excluded from the computation because their effect is antidilutive, include
450,000 shares of preferred stock convertible into 2,090,343 shares of common
stock.
For the Quarter ended December 31, 1996
---------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Net Income $521,401
Preferred stock dividends 0
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Basic EPS:
Income available to common shareholders $521,401 5,256,025 $.10
Effect of Dilutive Securities:
Convertible preferred stock 0 5,402,516
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Diluted EPS:
Income available to common shareholders
and assumed conversions $521,401 10,658,541 $.05
2. ACQUISITION OF LEW MAGRAM, LTD.
-------------------------------
On February 19, 1998 the Company completed the acquisition of Lew
Magram, Ltd. (Magram), a New York corporation with a place of business in
Teaneck, New Jersey, which is in the business of mail order catalog sales of
womens' clothing. The accompanying financial statements include unaudited
pro-forma balance sheets and income statements as if the acquisition was
effected as of July 1, 1997, the date that the Company assumed effective control
of Magram. The acquisition was accounted for as a purchase and the consideration
consisted of the issuance of 95,000 shares of the Company's $.10 par value,
Series D convertible preferred stock and 250,000 shares of the Company's common
stock. The Series D preferred stock is convertible into 3,166,667 shares of the
Company's common stock. The fair market value of the consideration was
approximately $8.7 million and acquisition costs were approximately $646,000.
The Company recorded the carryover basis for a certain selling stockholder of
Magram who is also a principal stockholder of the Company.
The net fair market value of the identifiable assets acquired was
approximately $1.9 million, and included customer lists valued at $5 million.
The customer lists are being amortized over a period of 10 years. Goodwill
amounted to approximately $7.4 million and is being amortized over 25 years.
The following unaudited pro-forma summary combines the consolidated
results of operations of the Company and Magram as if the acquisition had
occurred at the beginning of 1996, after giving effect to certain adjustments,
including amortization and preferred stock dividends.
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Three months Three months
ended ended
December 31, December 31,
1997 1996
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(Unaudited) (Unaudited)
Net sales $22,341,034 $22,650,633
Net income (loss) to
common shareholders $(56,971) $305,055
Net income (loss) per common share $(.01) $.06
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.
On October 30, 1997, the Company acquired out of bankruptcy all the
assets of Jean Grayson's Brownstone Studios, Inc., a mail order catalog company.
As a result of this acquisition, the scope of the Company's business has
expanded into the mature women's apparel and accessories markets primarily
through direct mail catalog. Brownstone has moved from its Secaucus,NJ facility
and is operating from the facilities of Lew Magram in Teaneck,NJ.
3. ACQUISITION OF BIOBOTTOMS, INC. AND RELATED FINANCING
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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
Corporation, a wholly-owned subsidiary 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 as long as no default
occurs. One such note was due six months from the acquisition date and the
second note was 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, 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 shareholders 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
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undertake to conduct a private placement of its securities to raise funds for
the remaining balance due on the acquisition notes. In July 1997, the Company
received proceeds from a Private Placement and pursuant to an agreement with the
Biobottoms shareholders paid $1,500,000 in full satisfaction of all amounts due
under the acquisition notes, and also amended its consulting agreements with
Joan Cooper and Anita Dimondstein to provide for additional compensation of
29,204 shares each of the Company's common stock. 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 to 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.
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 was payable in full on May 4, 1996 and was paid in full together
with a financing fee of $50,000 paid in May 1997.
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 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 within six months of
the date hereof.
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Three Months Ended December 31, 1997 Compared to Three Months Ended
December 31, 1996
NET SALES
Consolidated net sales for the Three Month Period ended
December 31, 1997 ("1997 Period") increased approximately $15,293,000 from the
Three Month Period ended December 31, 1996 ("1996 Period"), primarily as a
result of the sales of the Magram and Brownstone operations in the 1997 period.
There was a decrease in Biobottoms sales of $1,301,000 and increases in Diplomat
sales of $74,000 from 1996 to 1997. The sales of Diplomat for the 1997 Period
were $1,463,000 as compared to $1,389,000 for the 1996 Period. The sales of
Biobottoms were $4,357,000 in the 1997 Period as compared to $5,658,000 in the
1996 Period.
Consolidated cost of sales were 45% of net sales in the 1997 Period and
46% in the 1996 Period. The increase in cost of sales of $6,864,000 in the 1997
Period was primarily from Magram and Brownstone.
OPERATING EXPENSES
Consolidated operating expenses, which include selling, general,
administrative, warehouse and distribution expenses increased approximately
$8,745,000 from the 1996 Period to the 1997 Period, primarily as a result of the
purchase of Magram and Brownstone in 1997. There was an increase of $231,000 of
Biobottoms operating expenses in the 1997 Period. Operating expenses of Diplomat
for the 1997 Period were $552,000 as compared to $508,000 in the 1996 Period.
Operating expenses of Biobottoms increased $231,000 primarily from increased
catalog expenses from the 1996 Period to the 1997 Period. Consolidated operating
expenses were 62% of net sales in the 1997 Period and 43% in the 1996 Period.
Interest expense increased $154,000 from 1996 to 1997 as a result
of borrowings of Magram and Brownstone
in 1997.
The net income for the 1997 Period was $224,000 as compared to net
income of $521,000 for the 1996 Period.
At December 31, 1997, the Company has recorded deferred tax assets of
$1,362,000. The full utilization of such deferred tax assets is dependent upon
the Company realizing taxable income in future years. The total amount of future
taxable income for utilizing such deferred tax assets will be approximately
$3,400,000. Based on the current period's operations, such realization would
take approximately three years.
LIQUIDITY AND CAPITAL RESOURCES
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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, 1996 and 1997 in order to fund its operations.
The Company's principal working capital credit facility is provided by
Congress Financial Corporation.
In April 1994, the Company entered into an agreement with Congress
providing the Company with a maximum $3 million secured line of credit to be
used for loans and trade letters of credit. 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 (2%) percent above the prime rate announced by Core States Bank.
The credit agreement contains restrictions relating to the payment of dividends.
Additionally, prior to amendment, the Company was 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, 1996, the Company was not in compliance with these financial
covenants, however Congress continued to extend the Company credit 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, and shall be increased
during the fiscal year ending September 30, 1997 to (250,000) and 1,500,000,
respectively. The Company has been 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% (reduced to 80% in the third quarter of 1997) 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.
As of October 30, 1997, Brownstone entered into a loan agreement with
Congress providing Brownstone with a maximum $5.5 million secured line of credit
to be used for loans and trade letters of credit. The line of credit is secured
by all of the assets of Brownstone and guaranteed by the Company and Magram. The
interest rate is two percent (2%) above the prime rate announced by Core States
Bank. The loan agreement provides for certain restrictive covenants, including
restrictions on Brownstone's debt financing, dividends and distributions, and
transactions with the Company and its subsidiaries. The loan agreement also
requires Brownstone maintain a net worth (excluding debt subordinated to the
Congress loan) of $300,000 until June 30, 1998, and $500,000 thereafter.
Prior to the acquisition of Magram, Magram had entered into a loan
agreement, dated as of August 13, 1996, with Congress providing Magram with a
maximum $5.0 million secured line of credit to be used for loans and trade
letters of credit. The line of credit is secured by all of the assets of Magram
and guaranteed by the Company and Brownstone. The interest rate is one and
one-half percent (1 1/2%) above the prime rate announced by Core States Bank.
The loan agreement provides for certain restrictive covenants, including
restrictions on Magram's debt financing, dividends and distributions and
transactions with the Company and its subsidiaries. The loan agreement also
requires Magram maintain working capital of at least $1,500,000 and net worth
(excluding debt subordinated to the Congress loan) of $1,600,000.
The lines of credit between Congress and each of the Company,
Brownstone and Magram are each guaranteed by Robert M. Rubin up to an aggregate
maximum amount of $500,000.
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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 was 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 would have been required to make payments
of $174,800 in 1997. The balance of the debt was converted into Preferred Stock
in September, 1996.
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 had been due August 9, 1997 together with
interest. The August and November payments have not been made which accelerated
the entire amount to be due. On December 9, 1996, the holders of these notes
gave notice of default in accordance with the acquisition agreement. Under the
Intercreditor Agreement ( as such term is defined below) the holders of the
notes must wait 270 days after giving notice before taking any 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 the obtaining of 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. In July
1997, the Company received proceeds from a Private Placement and pursuant to an
agreement with the Biobottoms shareholders paid $1,500,000 in full satisfaction
of all amounts due under the acquisition notes, and also amended its consulting
agreements with Joan Cooper and Anita Dimondstein to provide for additional
compensation of 29,204 shares each of the Company's common stock. Mr. Rubin
furnished the former Biobottoms shareholders 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, Mr. 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 issued 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 on 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 million and on the date of Closing, $848,531 was available and
borrowed.
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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, 1996, Biobottoms was not in compliance with certain covenants of the loan
agreement, however Congress continued to extend Biobottoms credit under the
terms of the agreement. On February 25, 1997 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 the Series B and C Preferred
Stock are referred to hereafter as the "Rubin Obligations".
In September 1997, Mr. Rubin made an additional loan to the Company
in the amount of $1,200,000 for working capital purposes.
The Deferred Payment notes and the Rubin Obligations are, and the
American United loans were 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 Obligations 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 Obligations, 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 Obligations were
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 Obligations, 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
interest on the Deferred Payment Notes.
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 respect 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.
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.
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Proceeds from the Congress loan and the Rubin/American United Loans
were used on February 9, 1996 or remained otherwise available 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 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 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, $2.50
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. The Class C Warrants were exercised in April 1997 providing the Company
with proceeds of $500,000.
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.
In November 1996, the Company, in connection with an Incentive Stock
Option Plan, issued 1,060,000 options at an exercise price of $1.00 per share.
In May 1997, the Company, in connection with a Private Placement,
offered 1,250,000 shares of Common Stock at a price of $2.00 per share.
In October 1997, in part to raise capital for the Company's
acquisition out of bankruptcy of substantially all of the assets of Jean
Grayson's Brownstone Studio, Inc., the Company completed a private placement of
its securities which raised $3,345,000 from accredited investors. The private
placement consisted of units, each unit consisting of ten shares of Series E
Preferred Stock and 7,500 shares of Common Stock at a purchase price of $10,000
per unit.
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.
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During the three months ended December 31, 1997, there was a
decrease in cash flow from operating activities of approximately $2,069,000
primarily from an increase in inventory required for the sale of seasonal
products and for prepaid catalog costs. This increase was funded by the
revolving line of credit from Congress and proceeds from a private placement.
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PART II OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES
In October 1997, the Company issued in a private placement offering
334.5 units, each unit consisting of ten shares of Series E Preferred Stock and
7,500 shares of Common Stock. The issuance was exempt from registration by
virtue of Section 4(2) under the Securities Act of 1933, as amended (the "Act").
On October 30, 1997, the Company issued in connection with the
acquisition of assets of Jean Grayson's Brownstone Studio, Inc. and Wilroy,
Inc. options to purchase up to 200,000 shares of the Company's Common Stock.
The issuance was exempt from registration by virtue of Section 4(2) under
the Act.
On December 23, 1997, the Company entered into a definitive agreement
for the acquisition of Lew Magram, Ltd. In connection with the acquisition,
95,000 shares of Series D Preferred Stock, which are convertible into a total of
3,166,667 shares of Common Stock, and 250,000 shares of Common Stock were issued
simultaneous with the closing of the acquisition on February, 1998. The issuance
was exempt from registration by virtue of the exemption under Section 4(2) under
the Act.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
As of December 31,1996, the Company was not in compliance with its
credit agreement with Congress Financial Corporation ("Congress"). Under the
agreement, the Company must maintain $4,500,000 in working capital (excluding
the Congress loan and certain subordinated debt), and stockholder's equity of
$3,500,000. At December 31,1996, the balance due to Congress was approximately
$2,101,900. On February 25, 1997, the violations were waived by Congress and the
Company and Congress agreed on revised financial covenants. The Company expects
to be in compliance with the revised financial covenants at each measurement
date.
In August, 1996 and November, 1996 the Company failed to pay Deferred
Payment Notes, totaling $1,125,000 which it owed in connection with the
acquisition of Biobottoms, Inc. ("Biobottoms"). On December 9, 1996, the holders
of the 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 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 July 1997, these notes were
paid in full.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
On November 14, 1997, the Company filed a report dated October 30, 1997
on Form 8-K, Item 2, covering the acquisition by the Company's wholly-owned
subsidiary, Brownstone Holdings, Inc., of substantially all of the assets of
Jean Grayson's Brownstone Studio., Inc.
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SIGNATURES
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Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
DIPLOMAT CORPORATION
February 20, 1998 By: /s/ Jonathan Rosenberg
----------------------
Jonathan Rosenberg
Chief Executive Officer
February 20, 1998 By: /s/ Irwin Oringer
-----------------
Irwin Oringer
Principal Accounting Officer and
Controller
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