<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
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 March 31, 1998 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: May 12, 1998, 11,049,872
Common Shares outstanding
Transitional Small Business Disclosure (check One):
Yes -------No---X----
<PAGE>
DIPLOMAT CORPORATION
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I - FINANCIAL INFORMATION
Item 1- Financial Statements
Consolidated Balance Sheet - March 31, 1998 3
Consolidated Statements of Operations - For the three months and six
months ended March 31, 1998 and March 31, 1997 4
Consolidated Statements of Cash Flows - For the six months ended
March 31, 1998 and March 31, 1997 5
Notes to Financial Statements 6-11
Item 2 - Management's Discussion and Analysis of Financial
Conditions and Results of Operations 12-15
PART II - OTHER INFORMATION
Item 2 - Changes in Securities 16
Item 3 - Defaults Upon Senior Securities
16
Item 6 - Exhibits and Reports on Form 8-K
16
SIGNATURE 17
</TABLE>
<PAGE>
DIPLOMAT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Unaudited)
MARCH 31,1998
ASSETS
<TABLE>
<S> <C>
CURRENT ASSETS:
Cash and cash equivalents $1,443,497
Accounts receivable, trade,net 3,778,573
Inventories 10,327,084
Prepaid expenses 3,646,951
Other current assets 2,857,068
---------
TOTAL CURRENT ASSETS 22,053,173
NOTES RECEIVABLE 1,270,000
PROPERTY AND EQUIPMENT
less accumulated depreciation 3,355,245
INTANGIBLE ASSETS 19,107,344
OTHER ASSETS 696,202
-------
$46,481,964
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable-trade $5,819,666
Loans payable-stockholders 230,000
Loans payable-bank 7,482,981
Accrued expenses 13,312,700
Current maturities of long term debt 747,306
-------
TOTAL CURRENT LIABILITIES 27,592,653
----------
LONG TERM DEBT,less current maturities 1,076,509
----------
STOCKHOLDERS' EQUITY:
Preferred stock 16,362,807
Common stock 1,092
Paid-in capital 9,728,152
Accumulated deficit (8,279,249)
-----------
TOTAL SHAREHOLDERS' EQUITY 17,812,802
----------
$46,481,964
</TABLE>
See notes to financial statements.
3
<PAGE>
DIPLOMAT CORPORATION AND SUBSIDIARIES
STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended Three Months Ended
March 31 March 31 March 31 March 31
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
NET SALES $36,515,628 $3,619,032 $18,531,637 $2,229,755
COST OF SALES 17,029,324 1,636,779 9,165,051 821,621
---------- --------- --------- -------
GROSS PROFIT 19,486,304 1,982,253 9,366,586 1,408,134
SELLING, GENERAL AND ADMINISTRATIVE 17,070,661 854,538 7,898,825 346,147
---------- ------- --------- -------
OPERATING INCOME 2,415,643 1,127,715 1,467,761 1,061,987
INTEREST EXPENSE (642,249) (260,349) (304,288) (140,733)
--------- --------- --------- ---------
INCOME BEFORE INCOME TAXES 1,773,394 867,366 1,163,473 921,254
INCOME TAXES 0 198,000 0 139,000
- ------- - -------
INCOME FROM CONTINUING OPERATIONS 1,773,394 669,366 1,163,473 782,254
INCOME (LOSS) FROM DISCONTINUED OPERATIONS (2,072,098) 296,842 (1,685,832) (242,311)
----------- ------- ----------- ---------
NET INCOME (298,704) 966,208 (522,359) 539,943
PREFERRED STOCK DIVIDENDS 157,500 131,250 78,750 78,750
------- ------- ------- ------
NET INCOME (LOSS) TO COMMON
SHAREHOLDERS ($456,204) $834,958 ($601,109) $461,193
NET INCOME (LOSS) PER COMMON SHARE
CONTINUING OPERATION $0.16 $0.13 $0.10 $0.13
DISCONTINUED OPERATIONS ($0.21) $0.05 ($0.15) ($0.04)
------- ------ ------- -------
NET INCOME (LOSS) PER COMMON SHARE-BASIC ($0.05) $0.18 ($0.05) $0.09
NET INCOME (LOSS) PER COMMON SHARE-DILUTED ($0.02) $0.10 ($0.03) $0.06
AVERAGE NUMBER OF SHARES USED IN COMPUTATION-
BASIC 9,941,023 5,293,525 10,975,873 5,343,525
DILUTED 16,269,007 9,475,344 17,303,857 9,525,344
</TABLE>
See notes to financial statements.
4
<PAGE>
DIPLOMAT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Six months ended
March 31, March 31,
1998 1997
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (Loss) (298,704) 966,208
Adjustments to reconcile net income to net cash
provided by operating activities:
Change in operating assets & liabilities (2,800,733)
Writeoff of goodwill from subsidiary sold 3,458,175
Depreciation and amortization 401,803 142,621
-------- -------
760,541 1,108,829
CHANGES IN ASSETS AND LIABILITIES
(Increase)decrease in accounts receivable (2,055,742) (316,898)
(Increase) decrease in inventories (3,972,465) (1,648,641)
(Increase)decrease in prepaid expenses (2,788,732) (540,210)
(Increase)decrease in other current assets 1,260 1,022,893
(Increase)decrease in other assets (6,757,034) 60,598
Increase(decrease) in accounts payable (59,300) 49,905
Increase(decrease) in accrued expenses 8,272,432 (706,034)
---------- ---------
(6,599,040) (969,558)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment,net (525,643) (80,104)
Sale of Biobottoms assets 1,000,000 0
Acquisition of subsidiaries (451,807) 0
--------- -
22,550 (80,104)
------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common & preferred stock 3,941,294 0
Preferred stock dividend (205,390) (131,250)
Proceeds from loans payable 0 200,000
Repayments of loans payable (159,749) (122,784)
Revolving credit agreement 4,399,083 1,078,030
---------- ---------
7,975,238 1,023,996
---------- ---------
NET INCREASE(DECREASE) IN CASH 1,398,748 (25,666)
CASH AND CASH EQUIVALENTS-beginning of period 44,747 69,258
------- ------
CASH AND CASH EQUIVALENTS-end of period 1,443,495 43,592
</TABLE>
5
<PAGE>
DIPLOMAT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED MARCH 31, 1998 AND 1997
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
sheet for cash, trade receivables, accounts payable and accrued expenses
approximate fair value based on the short term maturity of these instruments.
6
<PAGE>
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. 128 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:
<TABLE>
<CAPTION>
For the Six Months ended March 31, 1998
---------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- --------
<S> <C> <C> <C>
Income from continuing operations $1,773,394
Preferred stock dividends (157,500)
----------
Basic EPS:
Income (loss) available to common shareholders $1,615,894 9,941,023 $.16
Effect of Dilutive Securities:
Options, warrants and conversions 157,500 6,327,984
------- ----------
963,539
Diluted EPS:
Income (loss) available to common stockholders
and assumed conversions $1,773,394 16,269,007 $.11
</TABLE>
7
<PAGE>
<TABLE>
<CAPTION>
For the Six months ended March 31, 1997
------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
<S> <C> <C> <C>
Income from continuing operations $669,366
Preferred stock dividends (131,250)
---------
Basic EPS:
Income available to common shareholders $538,116 5,293,525 $.10
Effect of Dilutive Securities:
Options, warrants and conversions 131,250 4,181,819
-------- ---------
Diluted EPS:
Income available to common shareholders
and assumed conversions $669,366 9,475,344 $.07
</TABLE>
<TABLE>
<CAPTION>
For the Quarter ended March 31, 1998
--------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
<S> <C> <C> <C>
Income from continuing operations $1,163,473
Preferred stock dividends (78,750)
-----------
Basic EPS:
Income (loss) available to common
shareholders $1,084,723 10,975,873 $.10
Effect of Dilutive Securities:
Options, warrants and conversions 78,750 6,327,984
------- ---------
Diluted EPS:
Income (loss) available to common
stockholders and assumed conversions $1,163,473 17,303,857 $.07
</TABLE>
8
<PAGE>
<TABLE>
<CAPTION>
For the Quarter ended March 31, 1997
------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
<S> <C> <C> <C>
Income from continuing operations $782,254
Preferred stock dividends (78,750)
---------
Basic EPS:
Income available to common shareholders $703,504 5,343,525 $.13
Effect of Dilutive Securities:
Options, warrants and conversions 78,750 4,181,819
---------- ----------
Diluted EPS:
Income available to common shareholders
and assumed conversions $782,254 9,525,344 $.08
</TABLE>
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 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 1997, after giving effect to certain adjustments,
including amortization and preferred stock dividends.
Six months
ended
March 31,
---------
1997
(Unaudited)
9
<PAGE>
Net sales $30,619,933
Net income (loss) to
common shareholders $ 246,988
Net income (loss) per common share $ .05
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. DISCONTINUED OPERATIONS
On April 17, 1998, the Company entered into an Asset Purchase
Agreement (the "Agreement") with Genesis Direct Thirty-Four, LLC ("Buyer") in
which the Buyer purchased substantially all of the assets and assumed certain of
the liabilities of Biobottoms. The Buyer paid $2,270,000 in cash and a note and
assumed $5,749,000 in liabilities. The note is subject to reduction depending on
the net assets acquired as determined in a Closing Date Balance Sheet. If the
amount of the Net Value of Acquired Assets is less than negative $778,000 or the
accrued expenses and customer liabilities included in the Assumed Liabilities
exceed $828,877, the greater of such deficiencies will reduce the amount of the
note.
The Company shall retain all claims for tax refunds, tax loss
carry forwards or carrybacks of tax credits of any kind applicable to the
business of Biobottoms prior to the closing of the Asset Sale. The Agreement
further specifies that certain intercompany and affiliated person liabilities
will not be assumed by the Buyer.
The following is a summary of the loss on the disposition of
Biobottom's operations:
Property and equipment written off:
Cost $(1,702,887)
Less: Accumulated depreciation 1,378,348
------------
Net property written off (324,539)
Other assets written off:
Accounts receivable (430,743)
Inventory (1,973,998)
Prepaid expenses (972,433)
Other assets (46,993)
10
<PAGE>
Goodwill (3,458,175)
-----------
Total Assets written off (7,206,881)
-----------
Liabilities to be assumed:
Accounts payable 3,425,782
Accrued liabilities 679,969
Loans payable-bank 1,430,000
Obligations under capital leases 116,765
Other 51,645
---------
Total Liabilities written off 5,704,161
------------
Proceeds to be received 2,270,000
------------
Gain on disposal of assets 767,280
Loss to measurement date 11/30/97 (449,444)
Loss through disposal date (2,389,934)
------------
Loss from discontinued operations $(2,072,098)
11
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Except for historical matters contained herein, the matters discussed herein
are forward-looking statements and are made pursuant to the safe harbor
provisions of The Private Securities Litigation Reform Act of 1995. These
forward-looking statements reflect assumptions and involve risks and
uncertainties which may affect the Company's business and prospects and cause
actual results to differ materially from these forward-looking statements.
RESULTS OF OPERATIONS
Six Months Ended March 31, 1998 Compared to Six Months Ended March 31, 1997
NET SALES
Consolidated net sales for the Six Month Period ended March 31, 1998
("1998 Period") increased approximately $32,896,000 from the Six Month Period
ended March 31, 1997 ("1997 Period"), primarily as a result of the sales
attributable to the Magram and Brownstone operations in the 1998 period. The
sales of Diplomat for the 1998 Period were $4,007,000 as compared to $3,619,000
for the 1997 Period.
Consolidated cost of sales were 47% of net sales in the 1998 Period and
45% in the 1997 Period. The increase in cost of sales of $15,392,000 in the 1998
Period was primarily from Magram and Brownstone.
OPERATING EXPENSES
Consolidated operating expenses, which include selling, general,
administrative, warehouse and distribution expenses increased approximately
$16,100,000 from the 1997 Period to the 1998 Period, primarily as a result of
the purchase of Magram and Brownstone in 1997. Operating expenses of Diplomat
for the 1998 Period were $1,281,000 as compared to $855,000 in the 1997 Period.
Consolidated operating expenses were 47% of net sales in the 1998 Period and 24%
in the 1997 Period because of the restructuring in 1997.
Interest expense increased $382,000 from 1997 to 1998 as a result
of borrowings of Magram and Brownstone in 1997.
Income from continuing operations increased from $669,366 for the 1997
Period to $1,773,394 for the 1998 Period. On April 17, 1998, substantially all
the assets of Biobottoms were sold resulting in a loss from discontinued
operations of $(2,072,096).
The net loss for the 1998 Period was $(298,704) as compared to net
income of $834,958 for the 1997 Period.
At March 31, 1998, 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.
12
<PAGE>
Three Months Ended March 31, 1998 Compared to Three Months Ended March 31, 1997
NET SALES
Consolidated net sales for the Three Month Period ended March 31, 1998
("1998 Period") increased approximately $16,300,000 from the Three Month Period
ended March 31, 1997 ("1996 Period"), primarily as a result of the sales
attributable to the Magram and Brownstone operations in the 1997 Period. The
sales of Diplomat for the 1998 Period were $2,544,000 as compared to $2,230,000
for the 1997 Period.
Consolidated cost of sales were 49% of net sales in the 1998 Period and
37% in the 1997 Period. The increase in cost of sales of $8,343,000 in the 1998
Period was primarily from Magram and Brownstone.
OPERATING EXPENSES
Consolidated operating expenses, which include selling, general,
administrative, warehouse and distribution expenses increased approximately
$7,500,000 from the 1997 Period to the 1998 Period, primarily as a result of the
purchase of Magram and Brownstone in 1997. Operating expenses of Diplomat for
the 1998 Period were $618,000 as compared to $347,000 in the 1997 Period.
Consolidated operating expenses were 42% of net sales in the 1998 Period and 16%
in the 1997 Period because of the restructuring in 1997.
Interest expense increased $164,000 from 1997 to 1998 as a result of
borrowings of Magram and BBrownstone in 1997.
Income from continuing operations increased from $782,254 for the 1997
Period to $1,163,473 for the 1998 Period. On April 17, 1998, substantially all
the assets of Biobottoms were sold resulting in a loss from discontinued
operations of $(1,685,832).
The net loss for the 1998 Period was $(522,359) as compared to net
income of $539,943 for the 1997 Period.
On April 17, 1998, substantially all the assets of Biobottoms were sold
resulting in a loss from discontinued operations of $(1,685,832).
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 additional issuance of its securities in order to fund its operations,
including financing the approximately $6,600,000 decrease in cash flow from
operations for the six months ended March 31, 1998, which was primarily used in
the operations of Magram and Brownstone.
13
<PAGE>
At March 31, 1998, there was a working capital deficiency of approximately
$5,500,000. The Company is currently investigating potential sources of capital
through long term debt or equity financing.
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 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. Upon the
acquisition of Lew Magram, these covenants were waived by Congress, and the
Company and Congress are currently negotiating revised contracts.
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 $1,500,000.
The Company has also financed its operations and acquisitions through
loans from Mr. Rubin, including approximately $2,900,000 in connection with the
acquisition of Biobottoms in February 1996, a
14
<PAGE>
$600,000 working capital loan in November 1996, a $200,000 working capital loan
in February 1997, and, with Jay Kaplowitz, a $2,205,000 loan for the financing
of Jean Grayson's Brownstone Studio, Inc. prior to the asset acquisition by
Brownstone and working capital for Biobottoms and the Company. Except for the
$200,000 working capital loan, each of the above mentioned loans have been
converted into the Company's stock.
A significant source of financing for the Company was the sale of
common stock.
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
and in May 1997 issued an additional 150,000 options at an exercise price of
$2.375 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.
15
<PAGE>
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 19, 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.
On March 5, 1998, the Company filed a report dated February 19, 1998 on
Form 8-K Item 2, covering the acquisition of Lew Magram Ltd.
16
<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 report to be signed on
its behalf by the undersigned, thereunto duly authorized.
DIPLOMAT CORPORATION
May 15, 1998 By: /s/ Jonathan Rosenberg
----------------------
Jonathan Rosenberg
Chief Executive Officer
May 15, 1998 By: /s/ Irwin Oringer
-----------------
Irwin Oringer
Principal Accounting Officer and
Controller
17
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