<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 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 DIRECT MARKETING CORPORATION
(Exact name of registrant as specified in its charter)
(Formerly Diplomat Corporation)
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)
(914) 786-5552 (Registrant's telephone number, including area code)
--------------
Securities registered pursuant to Section 12 (b) of the Exchange Act
Title of each class Name of exchange on which registered
- ------------------- ------------------------------------
None None
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, $.0001 par value
------------------------------
(Title of Class)
Check whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of
<PAGE>
the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has
been subject to such filing requirements for the past 90 days. Yes | | No |X|
Transitional Small Business Disclosure Format Yes |_| No |X|
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-K contained in this form, and no disclosure will be
contained, to the best of 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. |_|
The aggregate market value, based on the closing bid price of the
registrant's common stock on February 26, 1999 of 1 13/16 of the voting stock
held by non-affiliates of the issuer as of February 26, 1999 of 7,450,405 shares
was $13,503,859.
ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS
Check whether the issuer has filed all documents and reports required
to be filed by Section 12, 13 or 15(d) of the Exchange Act after the
distribution of securities under a plan confirmed by a court. Yes |_| No |_|
APPLICABLE ONLY TO CORPORATE REGISTRANTS
The number of shares outstanding of the registrant's Common Stock,
$.0001 Par Value, on February 26, 1999 was 12,162,372 shares.
Documents incorporated by reference: None
<PAGE>
DIPLOMAT DIRECT MARKETING CORPORATION
1998 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I
Item 1. Business
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to Vote of Security Holders
PART II
Item 5. Market for Common Equity and Related Stockholder Matters
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
PART III
Item 10. Directors and Executive Officers
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management
Item 13. Certain Relationships and Related Transactions
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
<PAGE>
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements as
defined by the Private Securities Litigation Reform Act of 1995. Forward-looking
statements include statements concerning plans, objectives, goals, strategies,
future events or performance and underlying assumptions and other statements
which are other than statements of historical facts. These statements are
subject to uncertainties and risks including, but not limited to, product and
service demand and acceptance, changes in technology, economic conditions, the
impact of competition and pricing, government regulation, and other risks
defined in this document and in statements filed from time to time with the
Securities and Exchange Commission. All such forward-looking statements are
expressly qualified by these cautionary statements and any other cautionary
statements which may accompany the forward-looking statements. In addition,
Diplomat Direct Marketing Corporation disclaims any obligations to update any
forward-looking statements to reflect events of circumstances after the date
hereof.
INTRODUCTORY NOTE
The term "Company" used herein refers to Diplomat Direct Marketing
Corporation and its subsidiaries, Lew Magram Ltd. ("Lew Magram"), Brownstone
Holdings, Inc. ("Brownstone"), Ecology Kids, Inc. ("Ecology Kids") and
Diplomat Holdings, Inc.
<PAGE>
PART I
ITEM 1. BUSINESS
Industry Overview
A strong and growing market exists in the consumer catalog industry.
According to Gruppo, Levey Incorporated ("GLI"), a leading investment banking
firm in the direct marketing industry, 13.9 billion catalogs were mailed and
consumer catalog market sales reached $48.3 billion in 1997. Also, in 1997,
consumer apparel catalog market sales were $12.5 billion with women's apparel
holding the largest share of $8.4 billion.
The Company believes that retail catalog sales of women's apparel will
continue to increase as a result of the increase in the Company's target market
and the busy lifestyles of today's women demand the convenience and time savings
afforded by catalog and e-commerce shopping. The U.S. Census Bureau is
projecting the 35 to 64 year old female population to grow 20.8% from 1995 to
2005. This group of people, better known as baby-boomers, are entering in great
numbers an attractive age for catalog distributors. The Census Bureau also
reports that, in 1947, only 17 million American women were in the work force.
Now, there are in excess of 50 million women in the work force with
approximately 54% of all U.S. women presently working in administration,
clerical or professional positions.
The Company also believes that there are strategic opportunities for
growth in the direct marketing and e-commerce industry. Although the women's
retail catalog apparel market is highly concentrated, direct marketing in
complementary markets is highly fragmented. According to GLI, there are
approximately 12,000 catalog companies of which two-thirds are in the consumer
market. By combining its infrastructure and direct marketing expertise in this
environment, the Company believes that it can significantly expand its
operations and develop new business.
Business Strategy
The Company believes that the strong customer acceptance of its
high-quality, value-oriented merchandise combined with management's direct
marketing expertise provides the Company with a solid foundation for future
growth. The Company intends to capitalize on its competitive strengths to
increase sales to both existing and new customers, continue to improve in
operating efficiencies and increase leveraging of operating expenses.
The key elements of the Company's operating strategy are as follows:
Improve Timing of Merchandise Delivery to Meet Growing Demand and
Increase Customer Response
The Company is currently experiencing significant delays in fulfilling
merchandise orders. This is a result of the Company's difficulty in obtaining
timely shipment of inventory from its vendors to meet the strong customer
demand. Some of the Company's vendors and their lending institutions have been
reluctant to extend credit to the Company in such amounts and upon such terms as
to support timely delivery of inventory as needed to meet orders. This
reluctance is principally a result of the Company's insufficient working capital
to satisfy vendors extending additional credit. The Company's inability to
timely deliver merchandise has resulted in increased order cancellations. The
Company has received a non-binding proposal from a lending institution which, if
closed, will improve its working capital position, thereby strengthening its
ability to obtain improved credit availability on more favorable terms, timely
deliver merchandise
5
<PAGE>
to its customers, reduce order cancellations, and improve initial customer
response.
Expand Growth in Operating Facilities and Infrastructure to Meet
Growing Demand
The Company continually evaluates its operations to determine ways in
which it can better serve its customer by, among other things, reducing the time
it takes to place and deliver orders. The Company has made significant
investments in its operations infrastructure to meet its anticipated order
processing and fulfillment needs, including implementing a state of the art
information mail order system and call center operation. Where other direct
marketers have taken the strategy of investing in excess infrastructure capacity
to meet potential demand for their products, the Company's strategy is focused
on measured growth of its infrastructure to meet the current demand for its
merchandise. Under this strategy, the Company has minimized its overhead costs
and allowed management to focus the Company's growth on quality lines of
business rather than to compel unwarranted acquisitions to absorb high overhead
costs. The Company, which currently operates from three facilities in the New
York City area, intends to restructure its facilities within the next twelve
months to more efficiently handle its operations.
Increase Revenue of Core Catalog Business
The Company believes that opportunities exist to further penetrate its
target market by increasing the distribution of its catalogs and offering
deferred payment programs to prospective buyers. The Company plans to increase
the number of pages, where appropriate, to add products offered in its core
apparel business and to offer additional complementary products. In addition,
the Company intends to expand its private label credit card and deferred payment
programs. The Company's experience with these programs indicates an increase in
sales per book greater than 25% among customers offered the opportunity to defer
payments on merchandise for up to ninety days, or to those who purchase
merchandise on the Company' private label credit card.
Expand and Leverage Proprietary Customer Database
The Company is continually expanding its proprietary customer database
through a variety of techniques, including referrals, returns of catalog request
cards, repeat customers from rented mailing lists and targeted classified
advertising. The Company believes that, through statistical modeling and market
segmentation techniques, it can generate significant growth by cross-marketing
between its current brands and cross-marketing with brands of future product
acquisitions and strategic alliance partners. The Company's telemarketing
capabilities are also utilized to generate revenues by promoting other
retailers' products and services through the Company's call center facilities.
Continue to Refine Catalog Mailing Segmentation Techniques
The Company has developed and refined its data collection and
statistical analyses to better target its catalog mailings and more profitably
capitalize on its current proprietary database. The Company continually
evaluates its catalog presentation in order to provide the best formats for its
target customers. By refining its catalog market segmentation techniques, the
Company anticipates that it will be able to increase its response rate and the
dollar amount of purchases for each catalog mailed.
The key elements of the Company's growth strategy are as follows:
Expand through Strategic Acquisitions
6
<PAGE>
The Company believes significant consolidation opportunities exist in
the direct marketing industry focused primarily on catalog brands that
complement the Company's Lew Magram and Brownstone markets, such as catalog
offerings of women's fashion accessories, cosmetics, and fragrances. The Company
also believes that opportunities exist to acquire other women's apparel catalog
brands on potentially favorable terms. The Company seeks catalog brands that
have been unable to realize their growth and profitability potential due to
capital constraints and infrastructure limitations.
Expand through Strategic Alliances
The Company plans to pursue strategic alliances with catalog retailers,
other retailers, and e-commerce partners of brands complementary to the
Company's brands. Such alliances may include combining distribution of the
Company's catalogs with other direct marketers catalogs and utilizing the
Company's call center to process orders for complementary product retailers. The
Company believes that there are significant opportunities in offering direct
marketing access to complementary product retailers who have not historically
offered products through direct marketing or have not achieved appreciable
success at direct marketing as well as complementary online retailers who do not
have order processing and fulfillment capabilities. For example, the Company
presently provides its telemarketing experience and call center operations to
other non-apparel retailers without telemarketing capability for a service fee
per telephone call.
Expand the Company's Customer Base
The women's retail catalog apparel market generated approximately $8.4
billion in sales in 1997. The Company believes that approximately one-third of
the adult female population of the United States or 33 million women meet the
Company's target customer profile. As a result, the Company believes there is
opportunity to grow its customer base and thereby increase sales. The Company
intends to achieve such growth by continuing to enhance its proprietary customer
database and the implementation of advertising campaigns specifically designed
to add new customers. The Company also believes that a significant opportunity
exists to further increase sales to its core customer base as well as to attract
new customers by expanding additional product offerings in its existing
catalogs.
Utilize Experienced Marketing and Merchandising Talent to Expand
Opportunities
The Company has attracted highly qualified marketing and merchandising
professionals with many years of experience in the women's apparel direct
marketing industry. The Company views this talent as one of its most important
assets in identifying the Company's competitive advantages and growth
opportunities and developing and implementing the Company's business strategies.
Expand in E-Commerce Media
The Company is expanding its e-commerce presence by pursuing strategic
alliances with online hosts and vendors to incorporate the Company's catalog
products on their websites and leverage the operating infrastructure of the
Company. To that end, the Company has recently signed a letter of intent with
Enterprise Productivity Systems ("EPS"), a California based company, who, with
the Company's expertise, will develop a product called Commerce Direct,
utilizing CD-Rom technology to release the Company's e-commerce catalog
collection in the Spring of 1999. Sales through television set top smart boxes
are the eventual goal of this program and such boxes are expected to be widely
available by 2001. At the same time, the Company has web sites active for its
Lew
7
<PAGE>
Magram and Brownstone catalogs requests, and will soon sell merchandise from
both catalogs on the Company's website. The latest step in the Company's
e-commerce effort is its recent agreement to represent its catalogs on one of
the largest catalog shopping destinations called Catalog City, which went online
on February 1, 1999. Catalog City is affiliated with shopping.yahoo.com.
Company's Brands
The Company currently offers its products through its three operating
subsidiaries--direct mail catalog retail sales of apparel under the Brownstone
brand for the mature woman and under the Lew Magram brand for the middle age -
"baby boomer" -- woman, and sales of apparel and accessories for infants to mass
merchandisers under the Ecology Kids tradename. For financial information on the
operations of the Company's lines of businesses, see the Company's consolidated
financial statements commencing on page F-1 and the notes thereto.
Brownstone
Brownstone's catalogs--"Jean Grayson's Brownstone Studio" and "Studio
Collection"-- have been selling women's apparel since 1974. These catalogs were
acquired out of bankruptcy by a subsidiary of the Company from Jean Grayson's
Brownstone Studio, Inc. in October 1997. Kenneth Grossman, the divisional
president of the Company's subsidiary, Brownstone Holdings, Inc., was formally
president of Jean Grayson's Brownstone Studio, Inc.
Through its two catalog titles, Brownstone has become one of the
largest direct catalog marketers for mature women's apparel. Brownstone
attributes its market position principally to superior merchandising to its
target customers and by differentiating itself from its competitors through
enhanced quality and customer service. Brownstone focuses on high quality
presentation in its catalogs, frequently utilizing location shots to display its
merchandise to set the appropriate mood and tone for its catalogs. Brownstone
also focuses on providing a large selection of merchandise and unique fashion
products to its customers.
Brownstone has chosen to focus on a relatively narrow segment of the
consumer catalog market -- upscale older women's fashion--which has allowed
Brownstone to develop a strong image and identity with its customers. According
to American Demographics magazine, there were over 70 million Americans age 50
and over at the end of 1997, representing almost a quarter of the total U.S.
population. Approximately 17 million or 28%, of these people were women between
the ages of 50 and 64. Also according to American Demographics, the portion of
the US population ages 50 and over is forecast to increase by 59% to 97 million
in the year 2010, indicating a compound annual growth rate of 2.6%. Assuming the
current percentages for gender above age 50 remain constant, the number of women
in that age group should increase to 52 million from 33 million.
Brownstone seeks to increase its market share in this growing segment
of this consumer market. The typical Brownstone customer is the affluent older
woman. On Brownstone's house list, 55% are women 65 and older, 79% are women 55
and older, and 91% are women 45 and older. On Brownstone's customer list, 49%
have annual household income of $50,000 or more, and 86% own their own home.
The Brownstone proprietary customer database contains approximately 1.6
million names, of which 1.1 million are customers, 150,000 are gift recipients
and 350,000 are catalog inquirers. For the Fall 1997 season, Jean Grayson's
Brownstone Studio, Inc. was not operational and, as a result, incurred damage to
its customer base. Brownstone has begun to rejuvenate the "Jean Grayson's
Brownstone Studio" and "Studio Collection" names by resuming publication of
fashionable catalogs, producing and shipping orders in a more timely manner,
offering gift
8
<PAGE>
certificates to potential customers to compensate for amounts owing to customers
of Jean Grayson's Brownstone Studio, Inc., and, offering customers the benefit
of a private label credit card similar to the credit card instituted by Lew
Magram in 1993.
Brownstone mailed a total of approximately 22 million catalogs in ten
different issues through fiscal year 1998, with an average order value of
approximately $140, and plans to mail a similar number in 1999. By strengthening
customer relations with Brownstone customers, the Company believes that it can
improve initial customer response and increase average orders for the Brownstone
catalogs.
Lew Magram
Lew Magram, which has been engaged in the sale of women's apparel since
1984 as the successor to a men's apparel business founded in 1948, is a leading
catalog marketer of fashionable middle aged women's apparel. The Company
effectively acquired Lew Magram in July 1997.
The Lew Magram trademarked tagline "the Latest Fashions . . . the
Greatest Values," means unique, modern, affordable women's apparel to hundreds
of thousands of women across the nation. Lew Magram focuses on selecting and
developing clothing and accessories, which enable it to meet or surpass its
customers' expectations while allowing pricing that maintains its high gross
margins.
The Lew Magram target customer is among the most desirable demographic
groups in the marketplace today. She is a "baby boomer" concentrated in the 35-
to 55-year age range, who works outside the home on either a full- or part-time
basis. Geographically distributed close to that of the general U.S. population,
the Lew Magram customer has the strongest concentration in urban and suburban
settings. She is well educated with a household income of approximately $60,000
per year.
The Lew Magram customer is both fashion aware and value oriented. She
appreciates high-quality fabrics such as wool, silk and leather, and looks to
the Lew Magram brand to provide new and exclusive looks at prices that represent
real value. A particular niche for the Lew Magram catalog is the career suit and
dress business which includes the newest styles, colors and fabrics from the
designer market at prices geared toward the target customer. As this customer
has a busy social, as well as professional, life she also relies on Lew Magram
to provide her with her "day to dinner" and special occasion dressing needs. In
addition, Lew Magram is renowned in the catalog industry for having the premier
selection of leather and suede sportswear and outerwear in the direct mail
business today at the most competitive prices. Lew Magram enjoys unusually high
average order due to its customer's propensity to buy a complete Lew Magram
wardrobe from "head-to-toe" which often includes coordinating boots or shoes.
In addition, the recent expansion of women's size offerings has met
with a resounding response from the customers. With only 10% of the styles
currently offered in the women's size range and none yet offered in petite, this
represents an outstanding growth opportunity.
Lew Magram's products are marketed to a diverse audience, from the
value-oriented middle-income customer to the fashion-conscious executive who
spends hundreds of dollars per purchase. The average order from the catalog for
fiscal years 1997 and 1998 was $158 and $160, respectively. The buyer file
includes more than 500,000 customers who have made at least two purchases from
Lew Magram. In addition to accepting all major credit cards, Lew Magram also
sells its merchandise through a private label credit card which was launched in
1993. Approximately 110,000 people have the Lew Magram credit card which
accounts for approximately 25% of
9
<PAGE>
Lew Magram's sales.
Lew Magram's primary customer is the working woman with high disposable
income. In 1992, 68.3% of Lew Magram's customers were employed. By 1995, 74.1%
of Lew Magram's customers worked outside the home. Moreover, almost 59% of Lew
Magram's customers have no children in the household and so have more
discretionary income to spend on apparel. Lew Magram's customers typically live
in a single-family home, are approximately 40 years old and have a median
household income of $57,000.
Lew Magram has customers in all fifty states and in many foreign
countries. For each of the past two years, Lew Magram mailed approximately 30
million catalogs in ten different issues. The Company plans again to issue
approximately 30 million Lew Magram catalogs over the next year and to achieve
substantial response and increased average orders.
Ecology Kids
Ecology Kids, the Company's original business, sells infants apparel
and accessories. Ecology Kids designs, develops, markets and distributes infants
products, such as diapers, nursery accessories, bedding and travel products.
Ecology Kids products are sold directly to general mass merchandisers,
toy retailers, selected chain stores and independent retail stores. It creates
customized merchandising programs for its customers consisting of
point-of-purchase displays, which include broad selections of branded products
in a variety of products category. In this regard, Ecology Kids develops uniform
packaging with branded product identification designed to promote a theme of
one-stop shopping for all infant needs. The Company has found this approach to
be particularly appealing to the buyers and mass merchandise and chain stores
channels of distribution, who would otherwise need to work with multiple
suppliers.
Ecology Kids believes that customer service is an important component
of its marketing strategy and tends to be a significant factor in gaining access
to large chain store accounts. Ecology Kids offers its customers high quality,
value oriented products. Its customer service strategy is designed to assist
customers through the development of improved packaging, product mix, display,
and pricing strategies and effective promotional programs.
Ecology Kids markets its products directly through its internal sales
force and, to a lesser extent, through independent sales organizations, which
are given principal responsibility for maintaining accounts in specific
geographic regions. Ecology Kids sell 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, Ecology Kids'
customers include Burlington Coat Factory, Kids "R" Us, Winn-Dixie Supermarkets,
American Drug Stores, Eckerd Drugs, Walgreen Drug, Target Stores and Publix
Supermarkets. Due to a change in retail marketplace, Ecology Kids has
experienced a reduction in the number of retail accounts from prior periods,
with an increased emphasis on mass merchandisers and chain stores.
The Company has recently entered into an agreement with Warner Bros. to
market and distribute a line of products with the Warner Bros. Baby Looney Toons
characters. The Company is currently developing wholesale direct marketing of
Ecology Kids products through catalog offerings, utilizing the Company's direct
marketing expertise.
10
<PAGE>
Marketing
The Company's marketing strategy combines its extensive proprietary
customer database with its experienced and talented marketing team to identify
growth opportunities and implement the Company's business strategies.
Proprietary Customer Database
The Company has developed its proprietary customer database over many
years through a variety of techniques, including referrals, gift certificates,
catalog requesters, customers from other mailing lists who have made a purchase
and targeted classified advertising. The Company's proprietary customer database
generates a greater response rate than purchased or rented mailing lists. The
Company's proprietary customer database currently includes approximately four
million names, which includes approximately 2.8 million customers who have made
at least one purchase from the Company.
The Company uses traditional mail order techniques to grow its catalog
businesses by mailing its catalogs to a combination of names on its customer
file and prospect lists. The proprietary customer database comprises over 2.8
million buyers and more than 1.2 million catalog requesters and gift recipients.
The Company employs industry standard RFM segmentation techniques for
mailing its catalogs to names on its proprietary customer database. Typical
mailing criteria include recency of purchase, frequency of purchase and monetary
value of the customer's purchase ("RFM"). Lists with high recency and dollar
characteristics are ordered and assembled in a computerized merge-purge process
in order to identify duplicates and multi-buyers. The output information allows
the assignment of the segmented names to the appropriate number of mailings as
well as the appropriate promotions and page counts.
The Company uses MBS/Multimode in Central Islip, New York and First
Data Solutions in Naperville, Illinois for its merge and file services and
maintaining the Company's customer list rental files.
The Company's best prospects are sourced from other mail order
companies in the women's apparel market. Recent successes with cooperative
databases offer additional sources of volumes of economical names. Typically
one-half of the Company's catalog mailings are to prospect names.
As is common throughout the direct mail industry, the Company routinely
exchanges names with its competitors and rents its list to its competitors and
other businesses. Approximately two-thirds of the catalogs mailed to prospects
in 1998 were obtained on an exchange basis, thereby requiring no cash outlay by
the Company. Those same exchange relationships along with the ability to offer
two of the most responsive lists in the marketplace, has over time built a list
business that typically has turned over 30 million names annually. Income from
list rentals net of services and brokerage costs has been over $1 million in
each of the last three years in the combined Lew Magram and Brownstone
businesses.
The Company is an acknowledged leader in the industry with regard to
efficiency of catalog configuration. Most catalogs mail a single edition of
their book per mailing, along with perhaps a few different covers or a signature
change for a remail. The Company utilizes selective binding in order to mail
multiple versions. In the Company's Lew Magram catalog, a typical book would
comprise one large assemblage of pages in common to the entire mailing, plus an
additional supplemental set of pages to a narrower audience, plus one or two
other
11
<PAGE>
supplements to yet a narrower audience, plus perhaps a clearance supplement. Any
of these parts might appear in any drop of a book, depending on a number of
variables, all selectively bound and mailed as parts of a greater whole.
Brownstone uses this technique but to a lesser degree.
12
<PAGE>
<TABLE>
<CAPTION>
Brownstone
Lew Magram Catalog Demand
Catalog Demand Summary Summary
--------------------------------------------- ---------------------
Fiscal 1996 Fiscal 1997 Fiscal 1998 Fiscal 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Circulation (000s) 30,899 30,426 27,490 22,111
Average Pages per Book 75.3 71.7 68.5 74.0
Gross Demand(1) (000s) $89,621 $83,658 $74,641 $61,758
Dollars per Book $2.90 $2.75 $2.72 $2.79
Dollars per Book per Page $0.0385 $0.0384 $0.0396 $0.0377
</TABLE>
- ------------
(1) Gross demands are before cancellations or returns.
The tables below show recent buyer file counts for the preceding 24
months in the aggregate and the distribution by size of customers' purchases
during such customers' lifetimes.
Lew Magram
Customer Distribution by Lifetime Purchases
<TABLE>
<CAPTION>
Last Purchase Date Total $0-$99 $100-$499 $500+
------------------ ----- ------ --------- ---------
<S> <C> <C> <C> <C>
0-6 Months 179,659 19,630 82,286 77,743
7-12 Months 126,280 18,005 61,053 47,222
------- ------ -------- ---------
0-12 Months 305,939 37,635 143,339 124,965
13-24 Months 217,918 42,203 110,420 65,295
------- ------ ------- ---------
0-24 Months 523,857 79,838 253,759 190,260
======= ====== ======= =========
</TABLE>
Brownstone
Customer Distribution by Lifetime Purchasers
<TABLE>
<CAPTION>
Last Purchase Date Total $0-$99 $100-$499 $500+
------------------ ----- ------ --------- ---------
<S> <C> <C> <C> <C>
0-6 Months 160,304 12,640 52,893 94,771
7-12 Months 105,203 9,362 37,254 58,587
------- ------ -------- ---------
0-12 Months 265,507 22,002 90,147 153,358
13-24 Months 127,716 10,865 46,039 70,812
------- ------ -------- ---------
0-24 Months 393,223 32,867 136,186 224,170
======= ======= ======= =========
</TABLE>
For example, Lew Magram has had approximately 306,000 buyers in the
last twelve months, approximately 125,000 of which who have purchased more than
$500 in Lew Magram merchandise in their lifetime.
Marketing Team
The Company's marketing team is managed by Jonathan Rosenberg, the
Company's President and
13
<PAGE>
Chief Executive Officer, Warren H. Golden, the Company's Executive Vice
President and Chief Operating Officer, Stephanie Sobel, the Company's Senior
Vice President of Merchandising, and Robert Kramer, the Company's Vice
President of Marketing, and is supplemented by the expertise of the mail order
divisional presidents Erv Magram and Kenneth Grossman. With a combined 90 years
of direct marketing experience, this marketing team is one of the Company's most
important assets. The marketing team is supported by a four person marketing
department and two service bureaus which implement the Company's marketing
segmentation techniques.
The Company's marketing team has instituted numerous special promotions
to increase revenues. For example, the Company has instituted its private label
credit card which provides customers with deferred billing, accelerated shipping
and toll free customer service. The private label credit card generates 25% to
30% more revenues in dollars per book than from customers with other methods of
payment. Credit card billing inserts with special promotions also generated
significant customer response.
"Bounceback catalogs" or catalogs delivered with a customer's
merchandise delivery, accompanied by short-term discount offers, generate
significant revenues. The Company has experienced customer response double to
that of catalogs delivered separately. The Company also delivers other materials
with customers merchandise packages, such as clearance merchandise offer inserts
and other retailers' offerings.
The Company has recently introduced a point system, similar to the
airline industry's frequent flyer miles, which allows customers to earn gift
certificates for purchases on the Company's proprietary credit card.
The Company's marketing team is also devoting time and attention to the
use of data base marketing to launch its new e-commerce business.
Merchandising
Merchandise Selection Process
The merchandise selection process of Lew Magram and Brownstone is an
on-going process with the goal of providing a consistent flow of selections that
fit the lifestyle needs of the customer. For each season's catalog, the
Company's merchandisers consider the following factors.
. A thorough review of same season performance for the prior
year, which analysis includes the overall success of a given
category, the performance of new versus relist items, space
productivity, price point and best and worst selling items.
. A review of current sales trends on all the above criteria
plus an overview from the marketing department on current
customer database productivity, customer profile trends,
circulation and mail date plans.
. A trend and fashion direction presentation highlighting the
most important and customer-appropriate styles, colors and
fabrics for the upcoming season.
From this analysis emerges an outline for the new season's
merchandising needs. Armed with the tools of historical and current sales
performance data and fashion direction, the merchants set out to develop an
exclusive line of styles that reflect the customer's taste at prices she can
afford. To accomplish this task, each
14
<PAGE>
merchant is an experienced, seasoned professional who combines creativity with
business acumen and an outstanding reputation in the manufacturing community.
Approximately one-half of Lew Magram's and Brownstone's merchandise are
private label products designed by the Company's merchandising staff and are
sold under the Lew Magram and Brownstone labels. The other half are branded
products from such well-known design houses such as Kenneth Cole, Guess, Mary
McFadden, Oleg Cassini and ABS.
Both Lew Magram and Brownstone merchants are "specialists" in their
fashion category. They must be aware of all market trends, stay abreast of
current market research, work with the manufacturer's representatives, research
the fabric market, shop competitive retail stores and catalogs for ideas and
items and regularly consult the fashion publications as well as trend and color
services. The merchant regularly shops the major manufacturers and fashion shows
as well as the premiere stores in cities with a strong fashion culture-primarily
Los Angeles and New York. The specialist in each category works with the various
members of the management team to assemble ideas on new looks for the upcoming
season. They extensively review and interpret all fashion publications for
products which could be developed, attend fabric shows and track color trends
for each season, and develop new product style ideas by cloning past winners,
expanding or improving them with a modified style or a new color choice. In
addition, the merchant ascertains the long-term availability of each prospective
item, as each item must have the potential to be offered on an ongoing basis.
Lew Magram works with over 250 vendors, with no one supplier
representing more than 8% of Lew Magram's sales volume. Brownstone works with
over 150 vendors but is using six key vendors to produce approximately 70% of
Brownstone's private label apparel. As the Lew Magram and Brownstone catalogs
increase the amount and type of merchandise offered in their catalogs, the
Company anticipates that it will increase the number of vendors it uses as well
as reduce reliance on any particular vendor.
In the pursuit of new products and fashion ideas, the Company's
merchants will actively consider 1,500 to 2,000 new products/concepts in a given
season. They will typically bring in-house more than 500 samples before
selecting new merchandise for the catalog. The samples are reviewed where each
item is presented on a live model and evaluated on the basis of style, fit
quality, lifestyle, fashion relevance, value and price. The most promising items
are marked for the maximum circulation while categories and items considered to
be more questionable are prepared for a low circulation testing supplement.
Creative Processes
The Company's in-house creative team designs the catalogs and controls
all aspects of the preparation of the catalogs. This in-house capability allows
the Company the flexibility to direct the production schedule and reduce
production lead time and costs.
Once the new merchandise is decided upon for the upcoming catalog, the
photo shoot begins. As the first photography is accumulated, it is sent to the
color separator who creates high and low resolution scans. Low resolution scans
are sent via ISDN (modem) line to the artist for use in layout creation.
Once the photo shoot is complete, final layouts are created by a
partnership of the Company's creative and merchandising staff. Along with
deciding which items should be marketed together, the focus of each catalog is
discussed and pagination is designated to be as user-friendly as possible.
Every page is looked at from the customer's point of view. This pagination is
then given to the artist who begins the final creative process.
15
<PAGE>
While the artist is creating the layouts, photo corrections are being
worked on by the separator. The Company takes pride in utilizing the latest
computer technology to modify features of products offered such as changing a
dress color, narrowing a waist, changing the model's shoes or sleeve length.
By utilizing ISDN high-speed transmission, changes are immediately accessible to
all parties allowing for last minute adjustments. Once finalized, the print file
is transmitted by the color separator to the printer with state of the art
technology. Utilization of all of the latest technology allows the Company to
put a catalog together from the finish of photography to the printing of the
book in about two weeks. This same technology makes high resolution data
files available for the Company's e-commerce efforts.
Quality Control
Every item selected undergoes a vigorous quality control review that
addresses the fit, styling, quality, and construction elements that the customer
has come to expect. The experienced technical design team works with the
merchant to fit each garment on a live model in advance of production. "Spec"
sheets are prepared to ensure best fit in all sizes and counter samples are
provided by the manufacture when necessary. A top-of-production garment is
inspected in each case in order to identify any problems in advance of shipment.
Manufacturers can then correct any problem at their facility. Finally, upon
receipt of the goods, they are once again inspected and fit before they are
shipped to the customer.
Operations
The primary components of the Company's Lew Magram and Brownstone
integrated operations are its telemarketing and call center services,
merchandise returns, distribution and fulfillment, inventory management, and
management information systems.
Telemarketing and Call Center Services
Orders are received at the Company's call center by phone, fax and
mail, of which approximately 87% of all orders are by phone. The Company
provides its customers with 24-hour, seven-days-a-week, toll-free telephone
access for placing orders through voice activation or key pad depression.
Customer service representatives process orders directly into the Company's
management information system, which provides customer information and order
history, product specifications, available substitutes and accessories, expected
ship date and order number. The customer service representatives are provided
with a sales script and are versed in product sizes, colors and features. To
capitalize on each customer contact, the Company provides telemarketing services
to other retailers and is compensated with a fee for each such customer contact.
This service is in its infancy but the Company believes that it will be a
significant generator of net income.
The Company believes that its customers are particularly sensitive to
the way merchants and sales people communicate with them. The Company strives to
hire energetic, service-oriented customer service representatives who can
understand and relate to customers. Customer service representatives begin with
order training and, upon passing a qualifying examination, are placed with a
more experienced person, or mentor. After several weeks in order taking, the
customer service representative goes back to the classroom to learn more
difficult elements of customer service. The Company's telephone system routes
telephone calls accordingly. After training, customer service representatives
are monitored to review performance and are retrained periodically.
16
<PAGE>
The Company's call center operates on a sophisticated telephone system
which, utilizing special telephone management features, handles over 130
incoming and outgoing telephone lines. Approximately 5,000 calls are received
per day in the Company's Teaneck, New Jersey facility. The Company currently has
approximately 80 in-house phone stations which operate from 8:00 a.m. to 10:30
p.m., Eastern Time, on weekdays with abbreviated schedules on weekends and
holidays. The call center is supported by two outside service bureaus which
handle overflow orders and orders placed during the hours when the Company's
in-house call center is closed. The Company's system processes orders in
approximately two to four minutes, depending upon the nature of the order and
whether the customer is a first-time or repeat customer. The Company has
recently renegotiated the toll-free telephone rates reducing these costs by
approximately 30%. The Company's telephone system automatically routes orders to
the overflow centers after twenty seconds if no in-house customer service
representative is available thereby practically eliminates the risk of lost
order calls.
The telephone system Voice Recognition Unit ("VRU") allows customers to
access status of order or item availability without interference of an operator.
The VRU option permits a customer to reach an operator at any time for
assistance.
The Company's order taking system will directly interface with its
e-commerce order entry for a seamless transmission of data.
Merchandise Returns
The Company has a liberal return policy allowing customers the ability
to return regular-priced merchandise for a full refund within 60 days of
receiving the merchandise. Customers may return sale-priced items for
merchandise credits good for one year redeemable for the Company's merchandise
only. Most returns are returned to inventory for future sale usually requiring
minimal refurbishing. Less than five percent of merchandise returned is
unsaleable and not returnable to vendors.
Distribution and Fulfillment
The Company's distribution center in Teaneck, New Jersey is efficiently
integrated with the Company's order entry system to enable the Company to send
out orders in a timely manner. Once a customer's telephone order is completed,
the Company's management information system forwards the order to the Company's
distribution center order processing where all necessary distribution and
shipping documents are printed to facilitate processing. Orders are prepared,
packaged and shipped throughout the day until the distribution center is closed.
Shipped orders are bar-coded and scanned and the merchandise ship date and
weight are entered automatically into the customer order history file and to
create United Parcel Service ("UPS") and United States Postal Service ("USPS")
billing information. The Company's system also employs "least cost routing"
which automatically determines the most cost effective means of shipping
merchandise. The Company takes great pride in its packaging. Each shipment is
packed in a corrugated box with customized tissue paper and sealed with an
embossed foil seal with the Lew Magram or Brownstone logo. Each shipment also
contains a current catalog, a thank-you note which is a turnaround postcard
inviting customer comments, and the pick ticket (packing slip). A bar-coded
label containing the customer's name, address and shipping information is
applied to the outside of the box. After being placed on a conveyor belt, each
box is sealed and shipped.
A majority of the Company's orders of in-stock merchandise are shipped
within 48 hours. Customers generally receive their merchandise within three to
five business days after shipping and credit card customers receive their
merchandise within two days. Approximately one-half of the Company's products
are shipped through
17
<PAGE>
UPS and one-half through USPS. UPS and USPS provide trailers at the Company's
Teaneck office to receive shipments, transport the trailers at the end of the
day and replace them for the next day's shipments.
Inventory Management
The goal of the inventory department is to ensure that each item has
sufficient quantity by size and color to fill the projected needs within the
shortest possible lead time. The Company's management information system enables
the Company to forecast four catalogs simultaneously within each catalog title
and make constant adjustments to update selling curves and needs by item. When
overstocks do occur, there is a four-step process for their liquidation:
. Strong selling items can often be successfully re-introduced in the
catalogs at a 10-20% discount. In these cases, the merchants are often
able to negotiate significant cost reductions on reorders which enable
the catalog to enjoy healthy sales while maintaining a strong gross
margin, thus giving the item an all-new selling life.
. Items that have reached the end of their selling-life cycle are
eligible for sale inserts. At markdowns of 35-60%, most of those are
sold through in their entirety at or above cost, where quantities in
size and color permit.
. Smaller quantities can be liquidated in a very low cost, high return
manner through the on-going package insert program.
. Items that are not in significant quantity to be placed in a catalog
are sent to the Company's two outlet stores located in Teaneck and
Secaucus, New Jersey, and are sold at a 30-70% discount. Remaining
merchandise that is not sold in the stores are sold to a liquidator to
recover approximately 15-20% of the cost.
Largely due to this four-step process, the Company has enjoyed
above-average gross margin performances which have not been seriously
deteriorated by liquidation of merchandise below cost.
Management Information Systems
The mail order operations are supported by the CommercialWare Mozart
software program -- a leading mail order technology -- for order-taking,
shipping, credit card authorization, billing, inventory control and maintenance
of online perpetual inventory. Lew Magram was one of six development partners
with CommercialWare in the development of the Mozart software program. This
software program operates on an IBM AS400. The system has recently been upgraded
and is Year 2000 compliant, and the Company believes that the system will
adequately provide for future growth and expansion. The Company's telephones,
the Isotech System designed by Executone, which supports both mail orders and
business lines in all locations is expandable to meet the Company's future
needs. The Company's marketing, accounting systems and clerical services are
handled through a Novell P.C. Network.
Governmental Regulation
The Company's direct marketing business and the catalog industry in
general are subject to regulation by a variety of state and federal laws
relating to, among other things, advertising, imports and sales taxes. The U.S.
18
<PAGE>
Federal Trade Commission ("FTC") regulates the Company's advertising and trade
practices and the Consumer Product Safety Commission has issued regulations
governing the safety of the Company's products. The Company also is subject to
Department of Treasury customs regulations with respect to goods that it
directly imports, including customs duties, quotas and other import
restrictions.
As a seller of infants products, the Company is subject to laws and
regulations administered by various states and the FTC. 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 infants 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 applicable laws and applicable regulations in all material
respects.
Product Liability
The Company has an aggregate $5,000,000 of product liability insurance
with an umbrella policy up to an aggregate of $20,000,000. The Company believes
that it maintains adequate product liability insurance consistent with industry
standards.
Intellectual Property
The Company's success depends, in part, upon the continued development
of strong brand identification for its catalogs and products. The Company has
registered trademark protection for the names Ecology Kids, Lew Magram, Jean
Grayson's Brownstone Studio, and Studio Collection among other trademarks as
well as many supporting trade names. The Company has applied for trademark
protection for its name, Diplomat Direct Marketing Corporation and its corporate
logo. The Company may apply to register other trademarks as it deems
appropriate.
Competition
The markets in which the Company's Lew Magram and Brownstone
subsidiaries participate are highly competitive and served by a number of
catalog companies and retailers including traditional department stores,
discount retailers, and specialty chains. The Company competes generally in the
retail women's apparel market and, more specifically, the direct mail catalog
market. Lew Magram directly competes with catalog retailers which target the
middle age women's market, which include Spiegel, Victoria's Secret, Chadwick's
of Boston and Clifford & Wills. Brownstone directly competes with catalog
retailers which target the mature women's market, which include Talbot's, Nicole
Somers, Damon's & Draper's, Papillon, as well as specialty store catalogs such
as Nordstrom's, Saks and Nieman Marcus. Many of the Company's competitors have
substantially greater resources than the Company and greater name recognition
and market share than Lew Magram and Brownstone. The Company's competitive
advantage is the combination of its experienced marketing team, talented
merchandising and operational efficiencies. The Company believes that it can
maintain and improve its competitive position in the market by utilizing its
proprietary customer database, soliciting new customers, identifying distinct
fashion trends and continuing to address the needs and fashion tastes of its
customers.
The infant products industries are highly competitive and Ecology Kids
faces substantial competition in each of its product lines. Ecology Kids
competes in a variety of segments within these product categories, including
diapers. Ecology Kids competes by focusing on product quality, promotions, name
recognition and service.
19
<PAGE>
Employees
As of December 31, 1998, the Company had approximately 407 full-time
and 86 part-time employees. Of these employees, 11 were senior executives of the
Company, 2 of which were employed by Ecology Kids, and 2 of which were employed
by Lew Magram and Brownstone. Lew Magram, Brownstone and Ecology Kids had 52
employees related to marketing and merchandising (including store employees),
236 in its call center, 154 in operations and distribution, and 40 in other
administrative positions. None of the Company's employees are represented by a
labor union. The Company considers its relations with the employees to be good.
ITEM 2. PROPERTIES
The Company's executive offices and Lew Magram and Brownstone
operations are located in 414 Alfred Avenue, Teaneck, New Jersey, where the
Company leases approximately 73,000 square feet of warehouse and office space.
Total fixed monthly charges are approximately $49,000 subject to annual
escalation clauses. The lease expires in August 1999, subject to two five-year
renewal options. The Company also leases approximately 11,000 square feet in the
Garment District in New York City at $19,000 per month for its Lew Magram and
Brownstone operations. The Company is currently seeking larger facilities to
expand its warehousing needs.
The Company owns its warehouse and distribution facilities for Ecology
Kids located at 25 Kay Fries Drive, Stony Point, New York. The Company pays
approximately $26,000 per month for both mortgage payments and real estate taxes
on its Stony Point facilities.
The Company also operates two retail stores, one located at its Teaneck
facility and one located in Secaucus, New Jersey. The Secaucus store is
approximately 4,300 square feet. Monthly rent and other fixed charges are
approximately $5,000.
ITEM 3. LEGAL PROCEEDINGS
In September 1996, the Company was named as one of several defendants
in an action brought by Richard Tracy and Anne Tracy in Rockland County Supreme
Court. 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's insurance carrier is currently defending this action.
In March 1998, Paul Russo filed a complaint against the Company
alleging that he is entitled to the Unit Purchase Option granted by the Company
as part of the Company's initial public offering in November 1993. Mr. Russo
demands unspecified compensatory and punitive damages.
The Company believes that these claims are without merit and intends to
defend vigorously against them. The ultimate outcome of either matter cannot
presently be determined, and, accordingly, no provision for liability has been
made in the accompanying financial statements.
Other than the above claims, the Company has no notice of any pending
material litigation.
20
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not required.
21
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Price
The Company's Common Stock is traded on The Nasdaq SmallCap Market
("Nasdaq SmallCap") under the symbol "DIPL." The following table sets forth, for
the two most recent fiscal years, the high and low bid prices per share of the
Common Stock as reported by the Nasdaq SmallCap for each quarter. The prices
represent inter-dealer quotations without adjustments for mark-ups, mark-downs
or commission and may not represent actual transactions.
Fiscal 1997 High Low
----------- ---- ---
First Quarter 2 7/8
Second Quarter 2 3/8 7/8
Third Quarter 3 1/2 1 5/8
Fourth Quarter 3 5/8 2 5/8
Fiscal 1998 High Low
----------- ---- ---
First Quarter 4 11/32 3 1/4
Second Quarter 4 3/16 2 11/16
Third Quarter 3 3/4 2
Fourth Quarter 2 1/2 31/32
As of February 26, 1999, there were approximately 142 holders of record
of the Company's 12,162,372 outstanding shares of Common Stock. On February 26,
1999, the last sales price for the Common Stock as reported on the Nasdaq
SmallCap was 1 13/16.
Dividend Policy
Since June 1992, the Company has never paid or declared dividends on
its Common Stock. The payment of cash dividends, if any, in the future is within
the discretion of the Board of Directors and will depend upon the Company's
earnings, its capital requirements, financial condition and other relevant
factors. The Company's existing loan agreements with its lenders generally
restrict its ability to pay dividends or make other distributions on its Common
Stock without the prior approval of the lender. The Company intends, for the
foreseeable future, to retain future earnings for use in the Company's business.
22
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data of the Company
presented below for the years ended September 30, 1998 and September 30, 1997,
the nine months ended September 30, 1996, and the years ended December 31, 1995
and December 31, 1994 have been derived from the Company's consolidated
financial statements. The selected financial data of Lew Magram Ltd. presented
below for the six months ended June 30, 1997, the year ended January 4, 1997,
the six months ended December 30, 1995, the year ended July 1, 1995 and the year
ended July 1, 1994 have been derived from Lew Magram Ltd.s financial statements.
For financial accounting reporting purposes, the Company effectively
acquired Lew Magram Ltd. on July 1, 1997, and Lew Magram Ltd. is considered, for
financial accounting reporting purposes, as the predecessor issuer. The
information contained in the selected consolidated financial data is qualified
by reference to, and should be read in conjunction with the Management's
Discussion and Analysis of Financial Condition and Results of Operations, the
Consolidated Financial Statements and notes thereto, and other financial
information appearing elsewhere in this Annual Report. Percentages are percent
of Net Sales.
The Company's Income Statement Data (000's):
<TABLE>
<CAPTION>
- ------------------------------- --------------------------------- ----------------------- ---------------------------------
Year ended September 30 Nine Months ended Year ended December 31,
----------------------- ------------------ -----------------------
September 30
------------
- ------------------------------- ---------- ------ --------- ----- ------------ ---------- --------- ------ ---------- -----
1998 % 1997 % 1996 % 1995 % 1994 %
---- - ---- - ---- - ---- - ---- -
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net Sales 74,586 100 17,465 100 7,449 100 11,301 100 10,279 100
Gross Margin 40,152 54 8,744 50 56 1 4,388 39 4,390 43
SG&A Exp. net of other
Income before Depr., 35,660 48 6,537 37 5,311 71 4,409 39 4,129 40
Amort. and Interest
Earnings before Interest,
Taxes, Depreciation and
Amortization 4,492 6 2,207 13 (5,255) (70) (21) --- 240 3
(Loss) income from continuing
operations before income taxes 1,260 2 1,262 7 (6,057) (81) (721) (6) (439) (4)
Net Income (1,426) (2) 818 5 (7,225) (97) (721) (6) (439) (4)
Basic and Diluted Net Income
(Loss) Per Common Share
from continuing operations .08 --- .19 --- (1.34) --- (.16) --- (.11) ---
Basic and Diluted
Net Income (Loss)
Per Common Share (.13) --- .14 --- (1.59) --- (.16) --- (.11) ---
</TABLE>
23
<PAGE>
The Company's Balance Sheet Data: (000's)
<TABLE>
<CAPTION>
September 30, December 31,
------------- ------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Total assets......................... 50,959 33,012 4,848 8,654 8,071
Total liabilities.................... 34,423 18,945 6,144 5,128 4,452
Working capital...................... (4,460) (3,374) (3,145) 3,162 3,154
Long term debt....................... 6,384 1,155 1,047 2,061 1,993
Stockholders' equity................. 16,536 14,068 2,523 3,526 3,619
</TABLE>
Lew Magram Ltd.'s Income Statement Data: (000's)
<TABLE>
<CAPTION>
Six Months Ended Year Ended Six Months Year Ended Year Ended
June 30, 1997 January 4, 1997 Ended July 1, 1995 July 1, 1994
% % December % % %
30, 1995
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net Sales 19,642 100 51,927 100 23,145 100 57,616 100 49,680 100
Gross Margin 7,682 39 26,815 52 11,940 52 28,883 50 26,501 53
SG&A Expenses
Net of Other Income 14,888 76 27,605 53 12,421 54 30,368 53 23,746 48
(Loss) Income before
income taxes (7,206) (37) (790) (1) (481) (2) (1,485) (3) 2,755 5
Net (Loss) income (7,276) (37) (790) (1) (465) (2) (1,494) (3) 2,636 5
</TABLE>
- -------------
24
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the Financial Statements and Notes thereto appearing elsewhere herein.
Except for historical information contained herein, certain statements herein
are forward-looking statements that are made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements involve known and unknown risks and uncertainties
which may cause the Company's actual results in future periods to differ
materially from forecasted results. Those risks include, among others,
the receipt and timing of future customer orders, price pressures and other
competitive factors leading to a decrease in anticipated revenues and gross
profit margins.
The Company's core business has historically focused on the wholesale
marketing and distribution of infants apparel and accessories. Through recent
acquisitions, the Company has repositioned its business to direct mail catalog
retailing with a significant emphasis on the women's apparel market.
Ecology Kids, a wholly owned subsidiary of the Company, manufactures
and distributes cloth diapers, diaper covers, layette, infant and child travel
products and other infants accessories marketed primarily under the Ecology Kids
name, primarily to major mass merchandisers.
On October 30, 1997, Brownstone, a newly formed, wholly owned
subsidiary of the Company, acquired out of bankruptcy all of 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.
On February 19, 1998, the Company completed the acquisition of Lew
Magram Ltd., a New York corporation, resulting in Lew Magram becoming a wholly
owned subsidiary of the Company. Lew Magram is a direct-mail cataloger of
women's fashion clothing founded approximately 50 years ago. The Company, which
effectively took control over Lew Magram in July 1997, has integrated the
operations of Brownstone and Lew Magram.
On April 17, 1998, the Company sold substantially all of the assets of
its then wholly owned subsidiary Biobottoms, Inc. ("Biobottoms") for $2,270,000
in cash and notes and $5,749,000 in assumption of liabilities.
The Company is currently experiencing significant delays in fulfilling
merchandise orders. This is a result of the Company's difficulty in obtaining
timely shipment of inventory from its vendors to meet the strong customer
demand. Some of the Company's vendors and their lending institutions have been
reluctant to extend credit to the Company in such amounts and upon such terms as
to support timely delivery of inventory as needed to meet orders. This
reluctance is principally a result of the Company's insufficient working capital
to satisfy vendors extending additional credit. The Company's inability to
timely deliver merchandise has resulted in increased order cancellations, which
for the year ended September 30, 1998, have been approximately 25% of demand.
The Company's order cancellations have historically been 10% of demand, which is
consistent with industry standards. The Company has received a non-binding
proposal for new financing to improve its working capital position, thereby
strengthening its ability to obtain improved credit availability on more
favorable terms, timely deliver merchandise to its customers, reduce order
cancellations, and improve initial customer response.
25
<PAGE>
Results of Operations
Comparison of the Company's Fiscal Year 1998 to Fiscal Year 1997
Net Sales
Consolidated net sales from continuing operations for fiscal year 1998
increased by 328% to $74.6 million from $17.4 million in fiscal year 1997. This
significant sales growth was primarily due to the acquisition of Lew Magram,
Ltd. effective July 1, 1997, and the acquisition by Brownstone of the assets of
Jean Grayson's Brownstone Studio out of bankruptcy as of October 26, 1997. These
two new subsidiaries accounted for sales of $68.8 million in 1998.
Maintaining the prior circulation of both acquired catalogs while
streamlining catalog and operational expenses allowed the Company to be
profitable in the year of acquisition where both companies suffered substantial
losses in the year preceding acquisition. Unfortunately, the Company lost the
opportunity in 1998 to even further increase sales and profits in this segment
of the business due to excessive customer order cancellations exacerbated by
credit conditions which limited timely delivery of merchandise.
The Company believes that its strategy to maintain circulation plans
but convert more orders to shipped sales, plus its entry into e-commerce in
1999, can substantially increase sales without proportionate expense.
Gross Profit
Consolidated gross profit from continuing operations increased by 362%
from $8.7 million in 1997 to $40.2 million in 1998 primarily as a result of the
Company's acquisitions. Gross profit from continuing operations as a percentage
of net sales increased from 50% in 1997 to 54% in 1998 due to the higher margins
generally available in the women's apparel catalog marketplace.
Selling, General and Administrative Expenses
Operating expenses net of other income but before depreciation,
amortization and interest from continuing operations as a percent of net sales
increased from 37% for 1997 to 48% for 1998. A major increase in expenses for
the year is attributable to the increase in the catalog production costs which
are typically written off over the sales life of the catalog. In 1998 these
costs were $21.1 million or 28% of net sales. As noted above, order
cancellations resulted in lost net sales and an inflated catalog cost
relationship.
Other operating expenses as a percent of net sales increased in 1998
due primarily to an increase in depreciation and amortization of tangible and
intangible assets as well as interest expense.
Income from Continuing Operations
Income from continuing operations before income taxes for 1998 was
approximately $1.3 million and was approximately the same as that of 1997,
despite a period of consolidation and re-structuring to assimilate the newly
acquired women's apparel catalog businesses.
Comparison of the Company's Fiscal Year 1997 to Fiscal Year 1996
26
<PAGE>
Results of operations compares the twelve months ended September 30,
1997 with the nine months ended September 30, 1996.
Net Sales
Consolidated net sales from continuing operations for fiscal year 1997
of $17.5 million increased $10.0 million or 135% from fiscal year 1996 of $7.4
million, as a result of the Lew Magram sales of $10.6 million from July 1, 1997.
The Company took effective control of Lew Magram on July 1, 1997 even though the
aquisition was not completed until February 19, 1998.
Gross Profit
Gross profit in 1996 was essentially non-existant due to inventory
write downs while restructuring, and rose to 50% in 1997 due to normal Ecology
Kids operations and increased margins made available in the last fiscal quarter
due to the Lew Magram acquisition.
Selling, General and Administrative Expenses
Operating expenses from continuing operations were very high in 1996
due to restructuring costs. These expenses normalized as a percentage of net
sales to 37% in 1997 due to normal operations of Ecology Kids and expenses
applicable to Lew Magram for the final quarter.
Interest expense decreased from $0.8 million in 1996 to $0.6 million in
1997 as a result of the conversion of debt to preferred stock by a principal
stockholder.
Income from Continuing Operations
The net income from continuing operations for 1997 was approximately
$1.3 million as compared to a net loss of approximately $6.1 million for 1996.
At September 30, 1997, the Company has recorded deferred tax assets of
$1.3 million. 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 necessary for utilizing such deferred tax assets will be
approximately $3.4 million. Based on the current year's operations, such
realization would take approximately three years.
Comparison of Lew Magram Ltd.'s Six Months Ended June 30, 1997 to Year
Ended January 4, 1997
Net sales
Lew Magram Ltd. had begun to feel the effects of insufficient working
capital. Net sales decreased from $51.9 million (full year) to $19.6 million
(six months) due to Lew Magram's inability to purchase all of the merchandise
needed for timely delivery to customers.
Gross Profit
Gross profit as a percent of net sales decreased from 52% to 39%
primarily due to the premium Lew Magram Ltd. paid for some merchandise which
could not be delivered in a timely manner at normal prices, as well as the need
to clear excess inventory, once delivered, at lesser margins.
27
<PAGE>
Selling, General and Administrative Expenses
Selling general and administrative expenses net of other income as a
percent of net sales increased from 53% to 76%. This increase is a result of
Lew Magram Ltd.'s inability to timely ship merchandise resulting in increased
returns or failure to ship merchandise at all resulting in cancellations while
it was still incurring the catalog production and operating expenses to mail
catalogs and take and maintain catalog orders.
Net Loss
Net loss increased from $0.8 million to $7.3 million, or, as a percent
of net sales increased from 1% to 37%.
Liquidity and Capital Resources
The Company's principal source of working capital is asset based loan
facilities provided by Congress Financial Corporation ("Congress"). Each of the
Company's operating subsidiaries, Ecology Kids, Lew Magram and Brownstone, has a
separate loan facility from Congress. Each loan facility is guaranteed by the
Company and cross-guaranteed by each operating subsidiary. In addition, Robert
M. Rubin, the Company's Chairman of the Board, has personally guaranteed the
Brownstone and Lew Magram loan facilities up to an aggregate of $1.0 million.
The loan facility with Ecology Kids provides Ecology Kids with a
maximum $3 million secured line of credit to be used for loans and trade letters
of credit. The loan facility is secured by substantially all of the assets of
the Ecology Kids. The interest rate is 1 1/2% above the prime rate announced by
CoreStates Bank. The loan facility contains certain restrictive covenants
including restrictions relating to the payment of dividends. Ecology Kids is
required to maintain a minimum of $(250,000) in stockholders' equity and a
minimum of $1,500,000 of working capital (excluding the Congress loan and
certain subordinated debt). Under the terms of the agreement, the Company could
borrow up to 80% of the amount of eligible accounts receivable (as defined in
the agreement), not to exceed the maximum credit.
The loan facility with Brownstone provides Brownstone with a maximum
$5.5 million secured line of credit to be used for loans and trade letters of
credit. The loan facility is secured by all of the assets of Brownstone. The
interest rate is 2% above the prime rate announced by CoreStates Bank. The loan
facility provides for certain restrictive covenants, including restrictions on
additional debt financing, dividends and distributions, and transactions with
the Company and its subsidiaries, and requires Brownstone maintain minimum
working capital and net worth.
The Loan Facility with Magram provides 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. The interest rate
is 1 1/2% above the prime rate announced by CoreStates 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, and requires Magram maintain minimum working capital and
net worth.
On June 29, 1998, the Company issued $5,000,000 principal amount of its
8% subordinated secured debentures to Sirrom Capital Corporation, d/b/a Tandem
Capital ("Tandem Debentures"). The debentures are
28
<PAGE>
due June 29, 2003, and bear interest at 8%, payable quarterly. The Tandem
Debentures are secured by all of the personal property of the Company and its
subsidiaries and includes certain restrictive covenants, including restrictions
on dividends and distributions, additional debt financing and transaction with
the Company and its subsidiaries. The Company also issued warrants in connection
with the issuance of the Tandem Debentures. The Company issued warrants to
purchase up to 208,300 shares of its Common Stock exercisable at $2.35 for five
years. The exercise price is to be adjusted downward if the Company's common
stock price is below this exercise price on June 29, 1999 to an exercise price
equal to the greater of 80% of the market price or $2.00 per share. Tandem will
also receive 416,600 warrants on February 28, 1999 and 200,000 warrants each
June 29 commencing in 1999. The Company may avoid issuing these additional
warrants by redeeming the Tandem Debentures.
The Company is currently experiencing working capital shortages and
requires additional capital resources to fund its existing operations. The
Company has borrowed the maximum amounts available under each of the Congress
loan facilities as of the date hereof and there is no unused loan availability.
Several letters of intent have been received by the Company from lending
institutions, one of which is anticipated to be closed before the end of March
1999 creating additional working capital availability of over $4.0 million. The
majority stockholder has agreed to bridge up to $1.5 million of the Company's
new financing. 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 the
Company. 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 alter operations
significantly.
The Company has recently raised capital by the sale of the Company's
equity securities and from the sale of its Biobottoms subsidiary.
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 $3,630,000 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.
In April 1998, the Company sold substantially all of the assets of its
Biobottoms, Inc. subsidiary. From the sale, the Company received $1 million in
cash and a note in the principal amount of $1.27 million of which $400,000 has
been collected.
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.
Seasonality
The Company's business does not follow the seasonal pattern typical of
the retail apparel industry, but is, instead, more closely related to the timing
and distribution of catalog mailings. The combined net sales of Lew Magram,
Brownstone and Ecology Kids for each quarter of the fiscal years ended September
30, 1996, September 30, 1997, and September 30, 1998, presented as a percentage
of net sales for each such year, were as follows:
29
<PAGE>
Percentage of Annual Sales
<TABLE>
<CAPTION>
First Second Third Fourth
Fiscal Year Quarter Quarter Quarter Quarter
<S> <C> <C> <C> <C>
September 30, 1996 27% 24% 30% 19%
September 30, 1997 33% 25% 24% 18%
September 30, 1998 24% 23% 28% 25%
</TABLE>
Through 1997 there were significant variations in the Company's
seasonal sales volume with the largest volume period being first quarter, ending
December 31. In 1998, the Lew Magram and Brownstone acquisitions helped to
spread out the volume evenly throughout the year since mail order volume varies
only in proportion to the orders generated and merchandise shipped. Accordingly,
the Company is now less susceptible to seasonable variations.
Inflation
There was no significant impact on the Company's operations as a result
of inflation during fiscal year 1996, fiscal year 1997 or fiscal year 1998.
Impact of the Year 2000 Issue
The Year 2000 ("Y2K") issue is the result of computer programs being
written using two digits rather than four to define the applicable year. Any of
the Company's computer programs that have date sensitive software may recognize
a date using "00" as the year 1900 rather than the year 2000. This could result
in a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities.
The Company is totally Y2K compliant in its catalog operations software
and Ecology Kids operating software. Certain minor changes may be required in
ancillary network related software which are not critical to daily operations.
The Company plans to complete these changes by July 31, 1999.
The Company has a plan in place to contact all of its significant
suppliers to determine the extent to which the Company is vulnerable to those
third parties' failure to remedy their own Year 2000 issues. There can be no
guarantees that the systems of third parties on which the Company's systems rely
or which influence the business of the Company's suppliers will be timely
remedied, that any attempted remediation will be successful, or that such
conversions would be compatible with the Company's systems.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable
ITEM 8. FINANCIAL STATEMENTS
The financial statements are included at the end of this Annual Report
on Form 10-K at the pages indicated below.
30
<PAGE>
Page
Financial Statements: Number
------
Diplomat Direct Marketing Corporation and Subsidiaries
Reports of Independent Certified Public Accountants........................F - 2
Consolidated Balance Sheets as of September 30, 1998 and 1997..............F - 4
Consolidated Statements of Operations
for the fiscal years ended September 30, 1998, 1997 and 1996..........F - 5
Consolidated Statements of Changes in Stockholders' Equity
for the fiscal years ended September 30, 1998, 1997 and 1996..........F - 6
Consolidated Statements of Cash Flows
for the fiscal years ended September 30, 1998, 1997 and 1996..........F - 7
Notes to Consolidated Financial Statements.................................F - 8
Lew Magram Ltd.
Reports of Independent Certified Public Accountants.......................F - 36
Statements of Operations
for the fiscal years ended June 30, 1997 and January 4, 1997.........F - 38
Statements of Cash Flows
for the fiscal years ended June 30, 1997 and January 4, 1997.........F - 39
Notes to Financial Statements.............................................F - 40
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On July 15, 1998, the Company appointed the accounting firm of BDO
Seidman, LLP of New York, New York, as principal independent accountants for
fiscal year ended September 30, 1998 to replace Feldman Sherb Ehrlich & Co.,
P.C. (formerly known as Feldman Radin & Co., P.C.), who were dismissed as
principal independent accountants effective with such appointment. Feldman Sherb
Ehrlich & Co., P.C. will continue to perform certain accounting services for the
Company.
During the two most recent fiscal years and interim period subsequent
through July 15, 1998, there have been no disagreements with Feldman Sherb
Ehrlich & Co., P.C. on any matter of accounting principals or practices,
financial statement disclosure or auditing scope or procedure or any other
reportable events.
Feldman Sherb Ehrlich & Co., P.C. report on the financial statements
for the past two years contained
31
<PAGE>
no adverse opinion or disclaimer of opinion and was not qualified or modified as
to uncertainty, audit scope or accounting principles.
32
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
Directors, Executive Officers and Key Personnel
The following table sets forth certain information about the directors
and executive officers and key personnel of the Company:
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Robert M. Rubin 57 Chairman of the Board
Jonathan Rosenberg 37 President, Chief Executive Officer and Director
Warren H. Golden 57 Executive Vice President, Chief Operating Officer and
Director
Irwin Oringer 62 Chief Accounting Officer
Stuart A. Leiderman 53 Divisional President of Ecology Kids, Secretary and Director
Howard Katz 56 Director
David Abel 57 Director
Stephanie Sobel 38 Senior Vice President of Merchandising
Irving Magram 48 Divisional President of Lew Magram
Kenneth Grossman 55 Divisional President of Brownstone
Sherry Dolin-Shikora 49 Vice President of Creative Services
Robert Kramer 45 Vice President of Marketing
Jeffrey Ayes 44 Vice President of Operations and Administration
</TABLE>
Directors and Executive Officers
Robert M. Rubin has served as a Director of the Company since June 1992
and has been Chairman since November 1996. 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
taxpayers 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.
Since October 1990, Mr. Rubin has served as the Chairman of the Board and Chief
Executive Officer of American United Global Inc., a telecommunications and
software company. 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. Until 1997, Mr.
Rubin was also Chairman, Chief Executive Officer and a principal stockholder of
ERD Waste Corp., a public
33
<PAGE>
company specializing in the management and disposal of municipal solid waste,
industrial and commercial nonhazardous solid waste and hazardous waste. In
September 1997, ERD Waste Corp. filed for protection under Chapter 11 of the
Bankruptcy Code.
Jonathan Rosenberg was appointed to the Board of Directors in July 1995
and has been President and Chief Executive Officer since November 1996. From
1993 to November 1996, Mr. Rosenberg served as a consultant to the
Company, and served as the Company's Chief Operating Officer from August 1995
to November 1996, 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 international sourcing of imports and manufacturing activities on an
agency basis for textile related products.
Warren H. Golden has been Executive Vice President, Chief Operating
Officer of the Company since February 1998, and has been with Lew Magram since
1991. From 1989-1991, Mr. Golden was with S.C. Corporation, most recently as
President. From 1983-1989, he was Vice President of Operations, Chief Financial
Officer and Treasurer of Honeybee, Inc. Prior thereto, Mr. Golden was Senior
Vice President, Operations and Control, for Plymouth Shops, a New York apparel
retailer. Mr. Golden is a graduate of Long Island University.
Irwin Oringer, a Certified Public Accountant, has been Chief Accounting
Officer 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 1991 he held a variety
of financial management positions with subsidiaries of Kenrich, Inc., a holding
company for businesses 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.
Stuart A. Leiderman was appointed as Divisional President of Ecology
Kids, Inc. in October 1998. Previously to that date he 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.
Howard Katz has been a Director of the Company since October 1996. Mr.
Katz has been Executive Vice President of American United Global, Inc. 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 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.
David Abel has been a Director of the Company since May 1998. Mr. Abel
has been president of United Realty since its inception in 1972, an industrial
and commercial real estate company. Mr. Abel has served as a director of
numerous companies, and is currently a director of M.S. Farrell Holdings, Inc.
and Innapharma, Inc. Mr. Abel is a member of the Society of Industrial Realtors
and The Commercial Industrial Brokers Society. Mr. Abel received his BA from the
Bernard Baruch School of Business in 1962.
34
<PAGE>
Stephanie Sobel has held the position of Senior Vice President of
Merchandising for the Company since 1995. Prior to joining Lew Magram, Ltd. As
Divisional Merchandise manager in 1990,Ms. Sobel also held that position at
Honeybee Inc., a store retailer and cataloger of women's apparel, also in New
York City, where she worked for five years. She had two years of buying
experience at Macy's New York and was a graduate of the management training
program at Abraham & Straus Department Stores. Ms. Sobel graduated from Cornell
University in 1982 with a degree in Arts & Sciences.
Irving Magram joined Lew Magram, Ltd. in 1971 after receiving a
Bachelors Degree from American University in Washington DC. He became president
of the family business, Lew Magram Ltd., in 1980, following the retirement of
Lew Magram, his father and the company's founder. From 1981 to 1984, he directed
the metamorphosis of the company from retailer and catalog marketer of
exclusively men's wear to that of exclusively women's wear. The Company acquired
Lew Magram Ltd. in July 1997.
Kenneth Grossman, joined Wilroy Inc., a family business engaged in the
manufacture of misses apparel, in 1969, where he founded the Brownstone Studio
catalog in 1972. He was responsible at both companies for overseeing
merchandising and product development. Mr. Grossman became divisional President
of the Company's Brownstone subsidiary when Brownstone acquired the assets of
Wilroy Inc. and Jean Grayson's Brownstone Studio, Inc. in October 1997. Mr.
Grossman holds a bachelors degree from Princeton University and a law degree
from New York University Law School.
Jeffrey Ayes holds a B.A. from the University of Hartford. From 1976 to
1985 he occupied various positions at Hoffritz for Cutlery, most recently as
Advertising and Catalog Manager. He joined Lew Magram in 1985. In 1989, he was
made Vice President. Mr. Ayes is currently Vice President of Operations for the
Company and is responsible for the daily operations of MIS, Distribution, Human
Resources, and the Customer Telemarketing Center.
Sherry Dolin-Shikora joined the Company with the acquisition of Lew
Magram Ltd. and was with Lew Magram Ltd. since 1988. Prior to that, she served
as Director of Retail and Catalog Advertising and Marketing for Coward Shoe in
New York City. She spent a number of years with consumer advertising agencies
specializing in the casino/hotel industry, where she was Account Supervisor, as
well as Radio and TV Copywriter and Producer. For a few years, she had her own
radio advertising production company. With a Master's Degree in Literature from
Temple University in Philadelphia, Ms. Dolin-Shikora also taught high school for
three years.
Robert A. Kramer was educated at Washington University, St. Louis,
specializing in research psychology and experimental design. From 1976 to 1986,
he held numerous merchandising positions at Saks Fifth Avenue, including
management, buying, and catalog administration. During his next four years, he
was Circulation Manager, then Marketing Manager for the cataloger Comfortably
Yours. He joined Lew Magram in 1991 as Marketing Manager, and became Vice
President in 1993. He continues in that capacity with the Company, while being
similarly responsible for marketing all other catalog titles.
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.
Compensation Committee Interlocks and Insider Participation
No member of the Company's Compensation Committee is a current or
former officer or employee of the Company. Robert Rubin, a member of the
Compensation Committee, has made substantial equity and debt
35
<PAGE>
investments in the Company, has personally guaranteed a portion of the Congress
Loan Facilities, was a controlling stockholder of Lew Magram, Ltd. immediately
prior to the acquisition by the Company, and has a consulting agreement with the
Company. See "Certain Relationships and Related Transactions."
Compliance with Section 16(a) of the Exchange Act
To the knowledge of the Company, no officers, directors, beneficial
owner of more than ten percent of any class of equity securities of the Company
registered pursuant to Section 12 of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), or any other person subject to Section 16 of the
Exchange Act with respect to the Company, failed to file on a timely basis
reports required by Section 16(a) of the Exchange Act during the most recent
fiscal year, which ended September 30, 1998.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth certain information regarding
compensation paid by the Company during each of the last three fiscal years to
the Company's Chief Executive Officer and to each of the Company's four most
highly compensated executive officers who earned in excess of $100,000.
Summary Compensation Table
<TABLE>
<CAPTION>
Annual Compensation Long Term Compensation
------------------- ----------------------
Name and Other Annual Securities Underlying
Principal Position Year Salary $ Compensation $ Options/ SARs(#)
- ------------------ ---- -------- -------------- ----------------
<S> <C> <C> <C> <C>
Jonathan Rosenberg(1) 9/30/98 225,000 0 0
President, CEO 9/30/97 190,769 0 250,000
9/30/96 130,804 0 75,000
Sheldon R. Rose(1) 9/30/96 159,375 0 0
President, CEO
Irving Magram 9/30/98 245,387 0 0
Divisional President - Lew 9/30/97 50,000(2) 0 0
Magram
Warren H. Golden 9/30/98 245,387 0 0
Executive Vice President, COO 9/30/97 50,000(2) 0 0
Stephanie Sobel 9/30/98 193,025 0 0
Senior Vice President - 9/30/97 43,125(2) 0 0
Merchandising
Kenneth Grossman 9/30/98 183,502 0 350,000
Divisional President -
Brownstone
</TABLE>
- -------------
(1) Mr. Rose resigned as President and Chief Executive Officer of the
Company in November 1996. Mr. Rosenberg has served as President and
Chief Executive Officer of the Company since November 1996.
(2) Salaries for Irving Magram, Warren H. Golden, and Stephanie Sobel for
the fiscal year ending September 30, 1997 are included only for the
period from July 1, 1997, the effective date the Company acquired Lew
Magram, Ltd., through September 30, 1997. Prior to the acquisition of
Lew Magram Ltd on July 1, 1997, their annual salaries were as follows:
Irving Magram; $300,000; Warren H. Golden; $287,500; Stephanie Sobel;
$172,500.
36
<PAGE>
Option Grants in Last Fiscal Year
The following table sets forth information concerning stock options
granted to each of the executives named in the Summary Compensation Table for
the fiscal year ending September 30, 1998:
<TABLE>
<CAPTION>
Percentage of
Total of Potential Realizable Value
Number of Options at Assumed Annual Rates of
Shares Granted to Stock Price Appreciation
Underlying Employees Exercise for Option Term(1)
Options During Fiscal Price Per Expiration --------------------------
Name Granted Year Share Date 5% 10%
---- ---------- ------------- --------- ----------- --- ---
<S> <C> <C> <C> <C> <C> <C>
Kenneth Grossman(2) 350,000 50% 2.75 3/24/03 $266,000 $588,000
</TABLE>
- ------------
(1) The amounts shown in these columns represent the potential realizable
values using the options granted and the exercise price. The assumed
rates of stock price appreciation are set by the Securities and
Exchange Commission's executive compensation disclosure rules and are
not intended to forecast appreciation of the Common Stock.
(2) Of the options granted to Kenneth Grossman, 100,000 are exercisable
over four years period subject to Brownstone reaching certain earnings
criteria, and 250,000 options are exercisable over time, of which
100,000 are currently exercisable. Excludes 350,000 options granted to
Joan Grossman, Kenneth Grossman's wife and an employee of Brownstone,
which options are on the same terms as the options granted to Kenneth
Grossman.
37
<PAGE>
Fiscal Year-End Option Values
To date, no options have been exercised by the executives named in the
Summary Compensation Table. The following table sets forth certain information
concerning the number of shares covered by both exercisable and unexercisable
stock options as of September 30, 1998. Also reported are values of
"in-the-money" options that represent the positive spread between the respective
exercise prices of outstanding stock options and the fair market value of the
Company's Common Stock as of September 30, 1998.
<TABLE>
<CAPTION>
Number of Shares Subject to
Unexercised Options at Fiscal Value of In-the-Money
Year-End Options at Fiscal Year End(1)
---------------------------------- -----------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- ---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Jonathan Rosenberg 215,000 130,000 $18,750 $12,500
Kenneth Grossman 100,000 250,000 0 0
</TABLE>
- -------------
(1) Based on the closing bid price of the Company's Common Stock of
$1.125 per share on September 30, 1998.
Employment Agreements
Warren H. Golden has an employment agreement with the Company which
provides that Mr. Golden will be employed as the Company's Executive Vice
President and Chief Operating Officer and Lew Magram's Executive Vice President,
subject to annual renewals, at an annual salary of $235,000 subject to certain
periodic increases based on performance. The employment agreement, which
terminates in February, 2001, may only be earlier terminated by the Company for
cause as defined in the agreement.
Irving Magram has an employment agreement with Lew Magram which
provides that Mr. Magram will be employed as Divisional President of Lew Magram,
subject to annual renewals, at an annual salary of $235,000 subject to certain
periodic increases based on performance. The employment agreement, which
terminates in February, 2001, may only be earlier terminated by Lew Magram for
cause as defined in the agreement.
Stephanie Sobel has an employment agreement with Lew Magram which
provides that Ms. Sobel will be employed as the Senior Vice President of
Merchandising, subject to annual renewals, at an annual salary of $187,500
subject to certain periodic increases based on performance. The employment
agreement, which terminates in February, 2001, may only be earlier terminated by
Lew Magram for cause as defined in the agreement.
In accordance with their respective employment agreements, Messrs.
Golden and Magram and Ms. Sobel will also receive cash bonuses based on Lew
Magram meeting certain profitability criteria. The maximum aggregate cash
payment to Messrs. Golden and Magram and Ms. Sobel under this bonus arrangement
is $185,000 per year.
Kenneth S. Grossman has an employment agreement with Brownstone which
provides that Mr. Grossman is employed as Brownstone's Divisional President at
an annual salary of $200,000, plus certain other benefits, including an annual
bonus of up to $250,000 based on Brownstone meeting certain income criteria.
38
<PAGE>
Mr. Grossman's agreement also provides for Mr. Grossman to receive $10,000 per
year for merchandise consulting. The employment agreement, which terminates in
October 2002, may only be earlier terminated by Brownstone for cause as defined
in the agreement.
Each of the foregoing employment agreements contain a provision
prohibiting such employee from competing with the Company for one year after the
employee terminates his or her position with the Company or its subsidiaries
other than for cause, as defined in the respective employment agreement.
Robert M. Rubin, Chairman of the Board of the Company, has a financial
consulting agreement with the Company pursuant to which Mr. Rubin is paid
$150,000 per annum. The agreement terminates in December, 2003.
Stock Option Plans
1998 Stock Option Plan
The Company's 1998 Stock Option Plan (the "1998 Plan") was adopted by
the Board of Directors in February, 1998 and approved by the stockholders in
May, 1998. Under the 1998 Plan, the Company is authorized to issue options to
purchase up to 1,200,000 shares of Common Stock. All officers and other
employees of the Company and other persons who perform significant services for
or on behalf of the Company are eligible to participate in the 1998 Plan.
The Company may grant under the 1998 Plan both incentive stock options
("Incentive Stock Options") within the meaning of Section 422 of the Internal
Revenue Code of 1986, as amended (the "code"), and stock options that do not
qualify for incentive treatment under the Code ("Nonstatutory Options").
The Plan shall be administered by the Board of Directors of the
Company, if each member is a "disinterested" person 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
disinterested person.
Subject to the provisions of the 1998 Plan, the Committee has the
authority to construe and interpret the 1998 Plan, to prescribe, adopt, amend
and rescind rules and regulations relating to the administration of the 1998
Plan and to make all other determinations necessary or advisable for its
administration. Subject to the limitations of the 1998 Plan, the Committee also
selects from among the eligible persons those individuals who will 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).
The exercise price of each Incentive Stock Option under the Option Plan
will be determined by the Committee, but will be not less than 100% of the "Fair
Market Value" (as defined in the 1998 Plan) of Common Stock on the date of grant
(or 110% in the case of an employee who at the time owns more than 10% of the
total combined voting power of all classes of capital stock of the Company). The
Nonstatutory Option exercise price will be determined by the Committee, but will
not be less than 85% of the Common Stock on the date of grant.
In the discretion of the Committee, the exercise price of any option
granted under the 1998 Plan will be payable in full in cash, or by check
(subject to an limitations of applicable state corporations law) delivered at
the time of exercise. In the discretion of the Committee and upon receipt of all
regulatory approvals, an optionee
39
<PAGE>
may be permitted to deliver as payment in whole or in part of the exercise price
certificates for shares of Common Stock (valued for this purpose at its fair
market value on the day of exercise) or other property deemed appropriate by the
Committee. So-called cashless exercises as permitted under applicable rules and
regulations of the Securities and Exchange Commission and the Federal Reserve
Board also will be permitted in the discretion of the Committee.
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 the termination of employment for any reason other than death or
disability or twelve months following a termination of employment for disability
or death; provided, however, that 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.
An option granted under the 1998 Plan will 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 in the Code), and will be
exercisable during the optionee's lifetime only by the optionee or by his or her
guardian or legal representative. More particularly, 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 will not be subject
to execution, attachment or similar process.
If the outstanding shares of Common Stock are changed into, or under
the 1998 Plan, exchanged for cash or different number of kind of shares or
securities of the Company or 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 will be made by the Committee in
the number and kind of shares as to which options may be granted. In the event
of such change or exchange, other than for shares or securities or of another
corporation or by reason of reorganization, the Committee will also make a
corresponding adjustment in the number or kind of shares, and the exercise price
per share allocated to unexercised options or portions thereof, of options which
have been granted prior to such change. Any such adjustment, however, will be
made without change in the total price applicable to the unexercised portion of
the option but with a corresponding adjustment in the price for each share
(except for any change in the aggregate price resulting from rounding-off of
share quantities or prices).
Under the 1998 Plan, the Company has outstanding options to purchase an
aggregate of 700,000 shares of Common Stock exercisable at $2.75 per share, all
of which are held by employees of the Company. Options to purchase 200,000
shares of Common Stock become exercisable upon Brownstone meeting certain
minimum net income. The remaining outstanding options become exercisable over
four years.
1992 Stock Option Plan
The Company's 1992 Stock Option Plan ("1992 Plan") provides for the
issuance of up to 200,000 shares of Common Stock and is intended to qualify as
Incentive Stock Options. The terms of the 1992 Plan are substantially similar to
the 1998 Plan.
The Company has outstanding options to purchase an aggregate of 130,000
Stock Options, exercisable at $1.50 per share, all of which are held by
affiliates or employees of the Company at the time of grant.
40
<PAGE>
August 1996 Stock Option Plan
The Company also established a stock option plan providing for the
issuance of options to purchase up to 1,500,000 shares of Common Stock to its
directors, officers, key employees and consultants (the "August 1996 Plan"). To
date, the Company has granted directors, officers and key employees an aggregate
of 150,000 Nonstatutory Options at an exercise price of $2.00 per share.
Excluding the fact that options granted under the August 1996 Plan cannot
qualify as Incentive Stock Options, the terms of the August 1992 Plan are
substantially similar to the 1998 Plan.
November 1996 Stock Option Plan
Under the Company's November 1996 Incentive Stock Option Plan (the
"November 1996 Plan"), options to purchase up to 1,500,000 shares of Common
Stock may be granted to employees, officers and directors of the Company and
other persons who provide services to the Company. As of September 30, 1998,
1,060,000 of such options have been granted and are exercisable at an exercise
price of $1.00, of which options to purchase 620,000 shares of Common Stock
expired on June 17, 1998, 150,000 are exercisable at $2.375 and 50,000 are
exercisable at $1.00. The options to be granted under the Plan may be designated
as Incentive Stock Options or Nonstatutory Options. Other than the fact that
officers and directors who currently own more than 5% of the issued and
outstanding stock are not eligible to participate in the Plan, the terms of the
November 1996 Plan are substantially similar to the 1998 Plan.
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
February 1993, the Pension Plan was curtailed and no additional pension benefits
will accrue.
Magram's Profit Sharing and 401(k)
The Company's Lew Magram subsidiary has a profit sharing program
established on April 1, 1981. On July 1, 1993, Lew Magram amended the Plan to
include 401(k) provisions. All employees servicing either the Lew Magram or
Brownstone subsidiaries are invited to participate in the Plan after the
required waiting period and while they work the minimum hours required. Lew
Magram and Brownstone match employee 401(k) contribution on the basis of 25% of
the employee's first 5% of 401(k) withholdings. As of December 31, 1998, the
entire plan had assets of approximately $2.3 million. Company benefits vest on a
5-year schedule. Vesting and eligibility for matching requires the employee to
be employed as of the last day of each plan year.
The Company also has a 401(k) plan in effect for employees of the
Ecology Kids subsidiary, which was established on January 1, 1997. As of
December 31, 1998, the plan had assets of approximately $175,000.
Directors' Compensation and Committees
In May 1997, the Company issued to Howard Katz and Wesley C.
Fredericks, Jr. options to purchase
41
<PAGE>
up to 50,000 shares and 100,000 shares of Common Stock, respectively. The
options are exercisable at $2.38 per share and terminate in 2001. In June 1998,
the Company issued David Abel options to purchase 50,000 shares of Common Stock
at $3.125 per share which options terminate in May 2003. The options were
granted in connection with each of Messrs. Katz, Fredericks and Abel agreeing to
serve on the Company's Board of Directors. Mr. Fredericks resigned as a director
effective December 31, 1998. The Company has not paid and does not presently
propose to pay compensation to any director for acting in such capacity, except
for the grant of options described above and nominal sums for attending Board of
Directors meetings and reimbursement for reasonable out-of-pocket expenses in
attending those meetings.
The Company has three formal committees; the Audit Committee, which
consists of Jonathan Rosenberg, David Abel and one vacancy; the Compensation
Committee, which consists of Robert M. Rubin, Howard Katz and one vacancy; and
the Corporate Governance Compliance Committee, which consists of Warren H.
Golden and Robert M. Rubin. The Company does not currently have a Stock Option
Committee or a Nominating Committee.
The functions of the Audit Committee include: (i) recommending for
approval by the Board of Directors a firm of certified public accountants whose
duty it will be to audit the financial statements of the Company for the fiscal
year in which they are appointed, and (ii) to monitor the effectiveness of the
audit effort, the Company's internal financial and accounting organization and
controls and financial reporting. The Audit Committee will also consider various
capital and investment matters.
The Compensation Committee is responsible for establishing compensation
arrangements for officers and directors of the Company, reviewing benefit plans
and administering each of the Company's stock option plans.
The Corporate Governance Compliance Committee is responsible for
reviewing the Company on an ongoing basis regarding compliance with the
corporate governance standards applicable to the Company, including rules and
standards of The Nasdaq Stock Market, Inc.
The Board of Directors does not have a standing nominating committee.
Nominations for election to the Board of Directors may be made by the Board of
Directors, or by any shareholder entitled to vote for the election of directors.
Special meetings may be held from time to time to consider matters for
which approval of the Board of Directors is desirable or is required by law. The
Board of Directors met once during fiscal 1998 and acted on numerous matters by
written consent. The Audit, Compensation and Corporate Governance Committees did
not meet during the fiscal 1998.
Executives' Compensation Policies
Compensation of the Company's executives are intended to attract,
retain and award persons who are essential to the corporate enterprise. The
fundamental policy of the Company's executive compensation program is to offer
competitive compensation to executives that appropriately rewards the individual
executive's contribution to corporate performance. The Board of Directors
utilizes subjective criteria for evaluation of individual performance and relies
substantially on the executives in doing so. The Board focuses on two primary
components of the Company's executives compensation program, each of which is
intended to reflect individual
42
<PAGE>
and corporate performance: base salary compensation and long-term incentive
compensation.
Executives' base salaries are determined primarily by reference to
compensation package for similarly situated executives of companies of similar
size or in comparable lines of business with whom the Company expects to compete
for executive talent and with reference to the revenues, gross profits and other
financial criteria of the Company. The Board also assesses subjective
qualitative factors to discern a particular executive's relative value to the
corporate enterprise in establishing base salaries.
It is the Board's philosophy that significant stock ownership by
management creates a powerful incentive for executives to build long-term
shareholder value. Accordingly, the Board believes that an integral component of
executive compensation is the award of equity-based compensation, which is
intended to align executives' long-term interests with those of the Company's
shareholders. Awards of stock options to executives have historically been at
then-current market prices. The Board believes that option grants should be
considered on an annual basis.
43
<PAGE>
Performance Graph
Below is the line graph comparing the yearly percentage change in the
Company's Common Stockholders' return with the Nasdaq Stock Market (U.S.) Index
and the Nasdaq Non-Financial Index from the Company's initial public offering in
November 1993 through September 1998.
[GRAPH OMITTED]
<TABLE>
<CAPTION>
Cumulative
Total
Return
--------------------------------------------------
11/4/93 9/94 9/95 9/96 9/97 9/98
<S> <C> <C> <C> <C> <C> <C>
DIPLOMAT DIRECT MARKETING CORPORATION 100 162 64 27 62 23
NASDAQ STOCK MARKET (U.S.) 100 99 136 162 222 227
NASDAQ NON-FINANCIAL 100 96 134 157 211 213
</TABLE>
44
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of February 26, 1999, except as
otherwise provided, information with respect to beneficial ownership of the
Common Stock by (i) each director, (ii) each executive officer named in the
Summary Compensation Table under "Management", (iii) the executive officers and
directors as a group and (iv) each person known to the Company who beneficially
owns 5% or more of the outstanding shares of the Common Stock. Unless otherwise
indicated, each of the stockholders has sole voting and investment power with
respect to the shares beneficially owned. Unless otherwise indicated, the
address of each person listed below is c/o Diplomat Direct Marketing
Corporation, 25 Kay Fries Drive, Stony Point, New York 10980.
<TABLE>
<CAPTION>
Name and Address Number (1) Percentage
- ---------------- ---------- ----------
<S> <C> <C>
The Rubin Family Irrevocable
Stock Trust U/A dated April 30, 1997(2)............... 9,285,735 54.0%
18 Pinetree Drive
Great Neck, New York 11024
Irving Magram(3)....................................... 933,302 7.2%
Jay Kaplowitz(4)....................................... 705,569 5.7%
101 East 52nd Street
New York, New York 10022
Warren H. Golden(5).................................... 468,536 3.7%
Stuart Leiderman(6).................................... 328,000 2.7%
Jonathan Rosenberg(7).................................. 277,500 2.2%
Stephanie Sobel(8)................................... 259,259 2.1%
Kenneth Grossman(9).................................. 200,000 1.6%
Howard Katz(10)........................................ 108,334 *
David Abel(11)......................................... 50,000 *
Robert M. Rubin(12).................................... 20,000 *
All officers and directors as a group (9 persons)...... 2,644,931 18.4%
</TABLE>
* less than one percent
- --------------
(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 and includes Shares of
Common Stock issuable upon conversion of outstanding preferred stock,
or subject to options, or warrants or exercisable or convertible within
sixty days. The percentage of stock outstanding for each
45
<PAGE>
stockholder is calculated by dividing (i) the number of shares of
Common Stock deemed to be beneficially held by such stockholder as of
February 26, 1999 by (ii) the sum of (A) the number of shares of Common
Stock outstanding as of February 26, 1999 plus (B) the number of shares
issuable upon exercise of options or warrants held by such stockholder
which were exercisable as of February 26, 1999 or which will become
exercisable within 60 days after February 26, 1999.
(2) Represents (i) 4,243,967 shares of Common Stock currently owned, (ii)
290,000 shares of Series B Preferred Stock which provide for certain
conversion rights and entitle it to 2,900,000 votes, (iii) 60,000
shares of Series C Preferred Stock which provide for certain conversion
rights and entitle it to 600,000 votes, (iv) 1,541,768 shares of Common
Stock issuable upon conversion of 46,253 shares of Series D Preferred
Stock. Robert M. Rubin, the Company's Chairman of the Board, is the
spouse of the Trust's co-trustee and parent of the Trust's
beneficiaries and may be deemed to be a beneficial owner of these
shares. Mr. Rubin disclaims beneficial ownership of these shares.
(3) Represents (i) 100,000 shares of Common Stock currently owned, and (ii)
833,302 shares of Common Stock issuable upon conversion of 24,999
shares of Series D Preferred Stock.
(4) Represents (i) 457,500 shares of Common Stock currently owned, (ii)
67,500 shares issuable upon exercise of currently exercisable options
granted pursuant to the August 1996 Plan, and (iii) 180,569 shares of
Common Stock issuable upon conversion of 5,417 shares of Series D
Preferred Stock.
(5) Represents (i) 66,667 shares of Common Stock currently owned, (ii)
351,869 shares of Common Stock issuable upon conversion of 10,556
shares of Series D Preferred Stock, and (iii) 50,000 shares of Common
Stock issueable upon exercise of options granted under the November
1996 Stock Option Plan. Excluding 150,000 shares of Common Stock
issuable upon exercise of options not currently exercisable and not
exercisable in the next sixty days.
(6) Represents (i) 268,000 shares of Common Stock currently owned, and (ii)
60,000 shares of Common Stock issuable upon exercise of currently
exercisable options granted under the November 1996 Plan. Mr. Leiderman
also has an additional 40,000 options under the November 1996 Option
Plan which are not currently exercisable and will not become
exercisable in the next sixty days.
(7) Represents (i) 65,000 shares of Common Stock issuable upon exercise of
currently exercisable options granted pursuant to the 1992 Stock Option
Plan, and (ii) 212,500 shares of Common Stock issuable upon the
exercise of currently exercisable options granted pursuant to the
November 1996 Plan. Mr. Rosenberg also has an additional 30,000 options
under the 1992 Stock Option Plan and 187,500 options under the November
1996 Option Plan which are not currently exercisable and will not
become exercisable in the next sixty days.
(8) Represents (i) 33,333 shares of Common Stock currently owned, (ii)
50,000 shares issuable upon exercise of currently exercisable options
granted pursuant to the November 1996 Plan, and (iii) 175,933 shares of
Common Stock issuable upon conversion of 5,278 shares of Series D
Preferred Stock. Ms. Sobel also has an additional 150,000 options under
the November 1996 Stock Option Plan which are not currently exercisable
and will not become exercisable in the next sixty days.
(9) Represents (i) 100,000 shares of Common Stock issuable upon exercise of
currently exercisable options granted under the 1998 Stock Option Plan,
and (ii) 100,000 shares of Common Stock issuable upon exercise of
currently exercisable options granted under the 1998 Stock Option Plan
to Joan Grossman, Kenneth Grossman's wife and an employee of the
Company. Each of Kenneth Grossman and Joan Grossman has (i) an
additional 150,000 options under the 1998 Stock Option Plan which are
not currently exercisable and will not become exercisable in the next
sixty days, and (ii) an additional 100,000 options
46
<PAGE>
under the 1998 Stock Option Plan which are not currently exercisable
and will become exercisable only upon Brownstone meeting certain
minimum earnings criteria which, at the present, have not been
achieved.
(10) Represents 108,334 shares of Common Stock issuable upon exercise of
currently exercisable options granted pursuant to the November 1996
Stock Option Plan. Mr. Katz also has an additional 16,666 options which
are not currently exercisable and will not become exercisable within
the next sixty days.
(11) Represents 50,000 shares of Common Stock issuable upon exercise of
currently exercisable options granted pursuant to the November 1996
stock option plan.
(12) Represents 20,000 shares of Common Stock issuable upon exercise of
currently exercisable options granted pursuant to the 1992 Stock Option
Plan.
47
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Financing Transactions
In January 1994, the Company entered into a three year financial
consulting agreement with Robert M. Rubin, Chairman of the Board 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 agreement was renewed to terminate on
December 31, 2003 at an annual compensation of $150,000.
In May 1997 the Company issued 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 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 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. Based on the market price
for the ten days prior to January 11, 1999, the Series C Preferred Stock would
be convertible into 425,238 shares of Common Stock.
As of September 30, 1996, Mr. Rubin 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 Stock 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. Based on the market price for the ten days prior to January 11, 1999,
the Series B Preferred Stock would be convertible into 2,055,316 shares of
Common Stock.
In March 1997, the Company issued 52,217 shares of Common Stock to Mr.
Rubin in lieu of the dividend payments due under the Series B and Series C
Preferred Stock, as well as for an adjustment in consulting fees, for the period
from January 1, 1997 through March 31, 1997.
On September 9, 1996, the Company entered into an arrangement with
Gersten, Savage, Kaplowitz & Fredericks, LLP ("GSKF") which provided that GSKF
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 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. Of such securities, 157,500 shares of Common Stock and 67,500 options
were issued to Wesley C. Fredericks who has since then become a Director of the
Company. Mr. Fredericks resigned from the Board on December 31, 1998.
48
<PAGE>
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.
Options to acquire 620,000 shares were granted to certain employees of
Biobottoms Inc., which the Company subsequently sold, and expired in July, 1998.
The Company's principal working capital credit facility is provided by
Congress Financial Corporation ("Congress"). The lines of credit between
Congress and the Company are personally guaranteed by Mr. Rubin up to an
aggregate amount of approximately $1,000,000.
In May 1997, the Company issued 200,000 shares of Common Stock to Mr.
Rubin in consideration of Mr. Rubin extending loans to the Company as well as
extending a personal guarantee to Congress on behalf of the Company.
Acquisition Transactions
In December 1992, Loshell Realty Corporation ("Loshell"), owner of the
real estate and buildings housing the Company's executive offices and the
warehouse and distribution facilities for Ecology Kids 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 1,000 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 were 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 6.375%) and
$698,000 with respect to a subordinated mortgage note originally due July 1995,
but extended to January 1998, bearing interest at an initial rate of 11.5% per
annum. The Company is currently negotiating the refinance of the mortgages. 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.
In February 1996, Mr. Rubin loaned the Company $2,353,500 to be used as
part of the acquisition price of Biobottoms, Inc. which the Company sold in
April 1998. 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. Mr. Rubin converted the Series A
Preferred Stock in November 1998.
In September 1997, Robert Rubin and Jay Kaplowitz advanced an aggregate
of $2,205,000 for the financing of Jean Grayson's Brownstone Studio, Inc. prior
to the purchase by the Company, as well as for working capital for the Company.
In October 1997, in part to raise capital for the Company's acquisition
of substantially all of the assets of Brownstone out of bankruptcy, the Company
completed a private offering of its securities which raised
49
<PAGE>
$3,630,000 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. As a result, the
Company issued an aggregate of 3,630 shares of Series E Preferred Stock and
2,608,750 shares of Common Stock. Robert Rubin and Jay Kaplowitz purchased an
aggregate of 220.5 of the units for $2,205,000, the proceeds of which repaid the
$2,205,000 advance by Messrs. Rubin and Kaplowitz made in September 1997.
In May 1997, Robert Rubin and Jay Kaplowitz acquired all of the
outstanding senior convertible preferred stock of Lew Magram Ltd., which was
convertible into one-half of the outstanding common stock of Lew Magram Ltd.
after giving effect to the conversion. The purpose for the investment was to
provide Lew Magram Ltd. with sufficient working capital to maintain operations
until the Company and Lew Magram Ltd. could reach an agreement for the
acquisition by the Company of Lew Magram. In December 1997, the Company entered
into an Agreement and Plan of Merger with Lew Magram Ltd., Robert Rubin, Jay
Kaplowitz, Irving Magram, Warren Golden and Stephanie Sobel, all of the
shareholders of Lew Magram Ltd. ("Merger"). Simultaneous with the closing of the
Merger on February 19, 1998, Lew Magram Ltd. merged with Magram Acquisition
Corp. resulting in Lew Magram becoming a wholly owned subsidiary of the Company.
Prior to the closing Messrs. Magram and Golden and Ms. Sobel owned all of the
outstanding common stock of Lew Magram Ltd. and Messrs. Rubin and Kaplowitz
owned all of the outstanding senior convertible preferred stock of Lew Magram
Ltd. At the closing of the Merger, the Company issued 95,000 shares of the
Series D Preferred Stock to each of the Lew Magram Ltd. shareholders of which
Mr. Rubin received 46,253 shares, Mr. Magram received 24,999 shares (excluding
2,497 shares sold to third parties who converted the shares to Common Stock),
Mr. Kaplowitz received 5,417 shares, Mr. Golden received 10,556 shares, and Ms.
Sobel received 5,278 shares. In addition, Mr. Magram, Mr. Golden and Ms. Sobel
received 100,000, 66,667 and 33,333 shares of the Company's Common Stock,
respectively, excluding 50,000 shares of the Company's Common Stock issued to
their counsel at the closing. Each share of the Company's Series D Preferred
Stock is convertible into 33 1/3 shares of the Company's Common Stock. Each of
the Lew Magram Ltd. shareholders have agreed to indemnify the Company for any
material breach of the representations made by Lew Magram Ltd. in the Merger
Agreement limited to $9,500,000 and which claims for indemnification must be
brought within one year of the closing date of the Merger. Messrs. Rubin and
Kaplowitz assigned to the Company their rights to any claim either of them may
have for breach of any warranty made by Lew Magram Ltd. in the May 1997 Senior
Convertible Preferred Stock Purchase Agreement in return for a release of their
indemnification obligations under the Merger Agreement.
50
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
(a) Page
Financial Statements: Number
<S> <C>
Diplomat Direct Marketing Corporation and Subsidiaries
Reports of Independent Certified Public Accountants..................................................F - 2
Consolidated Balance Sheets as of September 30, 1998 and 1997........................................F - 4
Consolidated Statements of Operations
for the fiscal years ended September 30, 1998, 1997 and 1996....................................F - 5
Consolidated Statements of Changes in Stockholders' Equity
for the fiscal years ended September 30, 1998, 1997 and 1996....................................F - 6
Consolidated Statements of Cash Flows
for the fiscal years ended September 30, 1998, 1997 and 1996....................................F - 7
Notes to Consolidated Financial Statements...........................................................F - 8
Lew Magram Ltd.
Reports of Independent Certified Public Accountants.................................................F - 36
Statements of Operations
for the fiscal years ended June 30, 1997 and January 4, 1997...................................F - 38
Statements of Cash Flows
for the fiscal years ended June 30, 1997 and January 4, 1997...................................F - 39
Notes to FinancialStatements........................................................................F - 40
</TABLE>
(b) Reports on Form 8-K.
On July 22, 1998, the Company filed a report dated July 15, 1998 on
Form 8-K, Item 4, covering a change in principal independent accountants.
(c) Exhibits.
3a. Certificate of Incorporation, as amended(1)
3b By-laws, amended(1)
51
<PAGE>
3c Amendment to Certificate of Incorporation(1)
3d Amendment to Certificate of Incorporation(7)
3e Certificate of Designation of Series B and Series C Preferred Stock(5)
3f Amended and Restated Certificate of Designation of Series D Preferred
Stock(8)
3g Certificate of Designation of Series E Preferred Stock(9)
4a Form of Common Stock Certificate(1)
10a 1992 Stock Option Plan(1)
10b August 1996 Stock Option Plan(11)
10c November 1996 Stock Option Plan(5)
10d License Agreement by and between Diplomat Juvenile Corporation, Wesley
Howell and Steve Pressed(1)
10e Loshell Realty mortgages with Union State Bank and Stoney Point
Technical Park, Inc. and related Mortgage Notes, including Sheldon Rose
guarantee of Union State Bank(1)
10f First Amendment to Exclusive Distributorship Agreement by and between
Ambrose & Montgomery, Inc. and Diplomat Corporation(2)
10g Collateral Assignment of Trademarks and Trademark Licenses (Security
Agreement) by and between Congress Financial Corporation and Diplomat
Corporation(2)
10h Second Amendment to Exclusive Distributorship Agreement between Ambrose
Montgomery, Inc. and Diplomat Corporation(3)
10i Amendments No. 1, No. 2 and No. 3 to Loan and Security Agreement by and
between Congress Financial Corporation and Diplomat Corporation(4)
10j Security Agreement (Rights in Agreement and Plan of Merger) dated
February 9, 1996 between Biobottoms, Inc., Diplomat Corporation and
Congress Financial Corporation(4)
10k Asset Purchase Agreement dated as of September 24, 1997 by and among
Diplomat Corporation and Jean Grayson's Brownstone Studio, Inc. and
Wilroy Inc.(7)
10l Bill of Sale provided by Jean Grayson's Brownstone Studio, Inc. and
Wilroy, Inc.(7)
10m Assignment and Assumption Agreement dated October 30, 1997 between
Brownstone Holdings, Inc., Jean Grayson's Brownstone Studio, Inc. and
Wilroy, Inc.(7)
10n Loan and Security Agreement by and among Congress Financial Corporation
and Jean Grayson's Brownstone Studio, Inc. dated February 28, 1997, as
amended September 17, 1997(7)
10o Junior Participation Agreement between Congress Financial Corporation,
Robert M. Rubin and Jay M. Kaplowitz dated September 17, 1997(7)
10p Agreement and Plan of Merger dated December 23, 1997, by and between
Diplomat Corporation, Lew Magram, et al(6)
10q Employment Agreement between Warren H. Golden and Diplomat Corporation
dated February 2, 1998(8)
10r Employment Agreement between Irving Magram and Lew Magram Ltd. dated
February 2, 1998(8)
10s Employment Agreement between Stephanie Sobel and Lew Magram, Ltd. dated
February 2, 1998(8)
10t Lease Agreement between Franklin Associates and Lew Magram, Ltd dated
May 15, 1992(8)
10u Loan and Security Agreement by and between Congress Financial
Corporation and Lew Magram Ltd. dated August 13, 1996(8)
10v Employment Agreement between Kenneth Grossman and Brownstone Holdings,
Inc. dated October 30, 1997*
52
<PAGE>
10w Employment Agreement between Joan Grossman and Brownstone Holdings,
Inc. dated October 30, 1997*
10x Debenture Purchase Agreement between Sirrom Capital Corporation,
Diplomat Direct Marketing Corporation, et al, and forms of exhibits(10)
10y 1998 Stock Option Plan(12)
22 Subsidiaries of the Registrant*
27 Financial Data Schedule*
* Filed herewith
(1) Incorporated by reference to Diplomat Corporation Registration
Statement No. 33-66910 NY.
(2) Incorporated by reference to Diplomat Corporation Annual Report on Form
10KSB for the year ended January 1, 1994.
(3) Incorporated by reference to Diplomat Corporation Registration No.
33-95986.
(4) Incorporated by reference to Diplomat Corporation Annual Report on Form
10KSB for the year ended December 31, 1995.
(5) Incorporated by reference to Diplomat Corporation Annual Report on Form
10KSB for the year ended September 30, 1996.
(6) Incorporated by reference to Diplomat Corporation Annual Report on Form
10KSB for the year ended September 30, 1997.
(7) Incorporated by reference to Diplomat Corporation report on Form 8-K
dated November 14, 1997.
(8) Incorporated by reference to Diplomat Corporation report on Form 8-K
dated March 6, 1998.
(9) Incorporated by reference to Diplomat Corporation Annual Report on Form
10KSB/A2 for the year ended September 30, 1997 filed March 3, 1998.
(10) Incorporated by reference to Diplomat Direct Marketing Corporation
10-QSB for the quarter ended June 30, 1998.
(11) Incorporated by reference to Diplomat Corporation Registration
Statement on Form S-8 filed August 30, 1996.
(12) Incorporated by reference to Diplomat Corporation Proxy Statement on
Schedule 14A filed April 29, 1998.
53
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Index to Financial Statements
<TABLE>
<S> <C>
Diplomat Direct Marketing Corporation and Subsidiaries:
Reports of independent certified public accountants F-2 - F-3
Consolidated financial statements:
Balance sheets F-4
Statements of operations F-5
Statements of changes in stockholders' equity F-6
Statements of cash flows F-7
Notes to consolidated financial statements F-8 - F-35
Lew Magram Ltd.:
(Predecessor company, information prior to date of acquisition by
Diplomat Direct Marketing Corporation)
Reports of independent certified public accountants F-36 - F-37
Financial statements:
Statements of operations F-38
Statements of cash flows F-39
Notes to financial statements F-40 - F-44
</TABLE>
F-1
<PAGE>
Report of Independent Certified Public Accountants
To the Board of Directors and Stockholders
Diplomat Direct Marketing Corporation
We have audited the accompanying consolidated balance sheet of Diplomat Direct
Marketing Corporation and Subsidiaries as of September 30, 1998, and the related
consolidated statements of operations, changes in stockholders' equity and cash
flows for the year then ended. 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 audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Diplomat Direct
Marketing Corporation and Subsidiaries as of September 30, 1998, and the results
of their operations and their cash flows for the year then ended, in conformity
with generally accepted accounting principles.
BDO SEIDMAN, LLP
New York, New York
January 30, 1999
F-2
<PAGE>
Report of Independent Certified Public Accountants
To the Board of Directors and Stockholders
Diplomat Direct Marketing Corporation
Stony Point, New York
We have audited the accompanying consolidated balance sheet of Diplomat Direct
Marketing Corporation and Subsidiaries as of September 30, 1997, and the related
consolidated statements of operations, changes in stockholders' equity and cash
flows for the year ended September 30, 1997 and the nine months ended September
30, 1996. 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 consolidated financial statements referred to above, as
restated for the adjustments disclosed in Note 3(b), present fairly, in all
material respects, the financial position of Diplomat Direct Marketing
Corporation and Subsidiaries as of September 30, 1997, and the results of their
operations and their cash flows for the year ended September 30, 1997 and the
nine months ended September 30, 1996, in conformity with generally accepted
accounting principles.
Feldman Sherb Ehrlich & Co., P.C.
Certified Public Accountants
New York, New York
January 13, 1998, except for Note 3(a),
which is of February 19, 1998, and Note 3(b),
which is as of January 30, 1999
F-3
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Consolidated Balance Sheets
<TABLE>
<CAPTION>
September 30, 1998 1997
------------- -------------
<S> <C> <C>
Assets
Current:
Cash and cash equivalents $ 322,778 $ 59,750
Accounts receivable, net of allowance of $204,196 and $147,001 1,921,209 1,585,840
Inventories 11,066,380 6,354,619
Net assets held for sale - 3,254,010
Prepaid catalogs 8,051,651 1,534,830
Prepaid expenses 1,379,567 1,143,848
Other current assets 837,946 482,738
------------- -------------
Total current assets 23,579,531 14,415,635
------------- -------------
Property and equipment, net 4,176,903 3,092,736
------------- -------------
Other assets:
Goodwill, net of amortization of $669,435 and $199,000 14,587,358 9,945,930
Customer list, net of amortization of $900,000 and $125,000 7,100,000 4,875,000
Note receivable 870,000 -
Other 645,091 683,586
------------- -------------
Total other assets 23,202,449 15,504,516
------------- -------------
$ 50,958,883 $33,012,887
============= =============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses $ 18,469,136 $12,366,083
Loans payable - officers 225,000 235,000
Loans payable - Congress Financial Corp. 5,504,371 3,083,896
Open prepaid orders 1,211,165 335,948
Outstanding merchandise credit 1,892,148 945,313
Current maturities of long-term debt 939,816 823,918
------------- -------------
Total current liabilities 28,241,636 17,790,158
------------- -------------
Long-term debt, less current maturities 6,383,585 1,154,645
------------- -------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value - shares authorized 1,000,000;
issued and outstanding 546,133 and 545,000 (Liquidation value
of $16,380,000) 5,461 5,450
Common stock, $.0001 par value - shares authorized 50,000,000;
issued and outstanding 11,162,372 and 8,304,150 1,112 829
Additional paid-in capital 25,835,445 22,144,478
Accumulated deficit (9,508,356) (8,082,673)
------------- -------------
Total stockholders' equity 16,333,662 14,068,084
------------- -------------
$ 50,958,883 $33,012,887
============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Consolidated Statements of Operations
<TABLE>
<CAPTION>
Nine months ended
Year ended September 30, September 30, 1996
---------------------------------------- -------------------
1998 1997 1996
--------------- --------------- ---------------
<S> <C> <C> <C>
Net sales $74,585,592 $17,468,066 $7,448,778
Cost of goods sold 34,433,297 8,724,030 7,392,265
--------------- --------------- ---------------
Gross profit 40,152,295 8,744,036 56,513
Selling, general and administrative expenses 37,537,372 7,060,658 3,672,133
Restructuring and reorganization costs - - 1,738,975
--------------- --------------- ---------------
Operating income (loss) 2,614,923 1,683,378 (5,354,595)
Interest expense (1,355,324) (421,233) (702,474)
--------------- --------------- ---------------
Income (loss) before income tax 1,259,599 1,262,145 (6,057,069)
(expense) benefit
Income tax (expense) benefit - 140,000 (17,353)
--------------- --------------- ---------------
Income (loss) from continuing
operations 1,259,599 1,402,145 (6,074,422)
Loss on discontinued operations (net of $453,000
gain on sale assets in 1998) ( 2,322,392) (295,633) (1,150,478)
--------------- --------------- ---------------
Net income (loss) (1,062,793) 1,106,512 (7,224,900)
Preferred stock dividends (362,890) (288,892) -
--------------- --------------- ---------------
Net income (loss) to common stockholders $(1,425,683) $ 817,620 $(7,224,900)
Per common share:
Net income (loss) from continuing
operations--basic and diluted $ .08 $ .19 $ (1.34)
Net income (loss) from
discontinued operations (.21) (.05) (.25)
=============== =============== ===============
Net income (loss)--basic and diluted $ (.13) $ .14 $ (1.59)
=============== =============== ===============
Average number of shares used in computation 10,717,628 5,892,454 4,549,525
=============== =============== ===============
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity
Years ended September 30, 1998 and 1997 and nine months ended September 30, 1996
<TABLE>
<CAPTION>
Common stock Preferred stock
--------------- ---------------- ---------------- --------------- Additional
Shares Amount Shares Amount paid-in capital
---------- ------- ---------- ------------ ---------------
<S> <C> <C> <C> <C> <C>
Balance, December 30, 1995 4,493,525 $ 458 - $ - $5,201,441
Exercise of options, issuance
of 500,000 shares of common
stock par .0001 500,000 50 - - 474,950
Issuance of common stock 550,000 55 - - 399,945
Issuance of preferred stock - - 450,000 4,500 4,095,500
Net loss - - - - -
---------- ------- ---------- ------------ ----------
Balance, September 30, 1996 5,543,525 563 450,000 4,500 10,171,836
Private placements 1,250,000 125 - - 2,174,875
Exercise of warrants 500,000 50 - - 499,950
Issuance of shares 708,408 63 - - 515,747
Preferred and common stock issued
for Magram acquisition 250,000 24 95,000 950 8,690,694
Common stock issued for
Preferred stock dividend 52,217 4 - - 91,376
Net income - - - - -
Preferred stock dividends - - - - -
---------- ------- ---------- ------------ ----------
Balance, September 30, 1997 8,304,150 829 545,000 5,450 22,144,478
Private placements 2,722,500 272 3,630 36 3,619,711
Exercise of options 35,000 2 - - 64,341
Common stock issued for Brownstone
acquisition 17,500 1 - - 6,898
Net loss - - - - -
Conversion of Series D
preferred 83,222 8 (2,497) (25) 17
Preferred stock dividends - - - - -
---------- ------- ---------- ------------ ----------
Balance, September 30, 1998 11,162,372 $1,112 546,133 $ 5,461 $25,835,445
========== ======= ========== ============ ===========
<CAPTION>
Accumulated
deficit Total
----------- ------------
<S> <C> <C>
Balance, December 30, 1995 $(1,675,393) $ 3,526,506
Exercise of options, issuance
of 500,000 shares of common
stock par .0001 - 475,000
Issuance of common stock - 400,000
Issuance of preferred stock - 4,100,000
Net loss (7,224,900) (7,224,900)
----------- ------------
Balance, September 30, 1996 (8,900,293) 1,276,606
Private placements - 2,175,000
Exercise of warrants - 500,000
Issuance of shares - 515,810
Preferred and common stock issued
for Magram acquisition - 8,691,668
Common stock issued for
Preferred stock dividend - 91,380
Net income 1,106,512 1,106,512
Preferred stock dividends (288,892) (288,892)
----------- ------------
Balance, September 30, 1997 (8,082,673) 14,068,084
Private placements - 3,620,019
Exercise of options - 64,343
Common stock issued for Brownstone
acquisition - 6,899
Net loss (1,062,793) (1,062,793)
Conversion of Series D
preferred - -
Preferred stock dividends (362,890) (362,890)
----------- ------------
Balance, September 30, 1998 $(9,508,356) $16,333,662
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Nine months
ended
Year ended September 30, September 30,
------------ ------------------- -------------
1998 1997 1996
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)
Adjustments to reconcile net income (loss) to net
cash used in operating activities: (1,062,793) $ 1,106,512 $(7,224,900)
Amortization 1,245,435 375,333 -
Depreciation 765,107 384,857 211,237
Issuance of stock for expenses - 91,380 400,000
Gain on sale of Biobottoms (453,000) - -
Changes in assets and liabilities:
(Increase) decrease in accounts receivable 264,631 297,154 (282,507)
(Increase) decrease in inventories (1,897,761) (3,076,019) 2,551,187
(Increase) decrease in prepaid expenses (235,719) 512,723 1,041,372
(Increase) decrease in prepaid catalogs (6,516,821) (1,982,124) (641,132)
(Increase) decrease in current assets (355,208) (205,824) 702,866
(Increase) decrease in other assets (38,495) (92,373) 500,202
Increase (decrease) in accounts payable and
accrued expenses (5,057,623) (1,998,570) 2,054,897
Increase (decrease) in outstanding
merchandise credits 946,835 748,083 -
Increase (decrease) in prepaid orders 575,217 22,130 -
----------- ------------ ------------
Net cash used in operating activities (11,820,195) (3,816,738) (686,778)
----------- ------------ ------------
Cash flows from investing activities:
Proceeds from sale of Biobottoms 3,707,010 - -
Cash paid for Biobottoms, Inc. (net of cash acquired) - - (2,899,211)
Cash acquired in Magram acquisition - 2,051,007 -
Purchase of trademark - (75,000) -
Purchase of property and equipment (2,049,274) (189,780) (211,096)
Note Receivable (870,000) - -
------------ ------------ ------------
Net cash provided by (used in) investing
activities 787,736 1,786,227 (3,110,307)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds of loans 5,228,940 - 450,000
Revolving credit loans 2,745,075 (735,145) 583,650
Preferred stock dividends paid (362,890) (288,892) -
Issuance of preferred and common stock 3,684,362 3,190,809 475,000
Borrowings from stockholder - 1,435,000 2,620,000
Repayment of long-term debt and loan payables - 1,580,769 (393,678)
------------ ------------ ------------
Net cash provided by financing activities 11,295,487 2,021,003 3,734,972
------------ ------------ ------------
Net decrease in cash and cash equivalents 263,028 (9,508) (62,113)
Cash and cash equivalents, beginning of period 59,750 69,258 131,371
------------ ------------ ------------
Cash and cash equivalents, end of period 322,778 $ 59,750 $ 69,258
============ ============ ============
Supplemental disclosures of cash flow information: Cash paid during the
period for:
Interest 1,500,676 764,000 $ 706,000
Income taxes - - -
========== ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
1. Summary of Significant
Accounting Policies (a) The consolidated financial
statements include the accounts of
Diplomat Direct Marketing
Corporation (the "Company") and its
wholly-owned subsidiaries. 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 ten years for
machinery, furniture and equipment.
(d) The Company follows Statement of
Financial Accounting Standards
("SFAS") No. 109 for income taxes.
Pursuant to SFAS No. 109, deferred
tax assets and liabilities are
determined based on differences
between the financial reporting and
tax bases 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
consolidated financial statements
and the reported amounts of
revenues and expenses during the
reporting period. Actual results
could differ from those estimates.
(g) Computation of Earnings Per Common
Share.
Basic earnings per share has been
computed using the weighted average
number of shares of common stock
outstanding. Diluted earnings per
share includes the assumed
excercise of stock options using
the treasury stock method that
could potentially dilute earnings
per share. In all periods
presented, there were no
differences between basic and
diluted income (loss) per common
share because the assumed exercise
of stock options was anti-dilutive.
The assumed exercise of stock
options could potentially dilute
basic earnings per share amounts in
the future.
F-8
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
(h) Long-lived assets, primarily
property and equipment, goodwill
and customer lists are
periodically reviewed by
management to determine if there
has been a permanent impairment in
their value by evaluating various
factors, including current and
projected operating results. Based
on this assessment, management
concluded that at September 30,
1998 and 1997, the Company's
long-lived assets were fully
realizable.
(i) 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.
Long-term debt has been recorded
at its face value which
approximates its fair value based
on its term and interest rate.
(j) The Company accounts for stock
transactions with employees 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.
(k) Direct response advertising costs,
consisting primarily of catalog
preparation, printing and postage
expenditures, are amortized over
the period in which related
revenues are expected to be
realized, generally three to six
months. Advertising costs,
principally the amortization of
such prepaid catalog costs
attributable to continuing
operations, included in the
accompanying statement of
operations were $20,974,673 for
the year ended September 30,
1998, $3,102,588 for the year
ended September 30, 1997 and
none for the nine months ended
September 30, 1996. Included in
other current assets at
September 30, 1998 is $8,051,651
and at September 30, 1997
$1,534,830 of prepaid catalog
costs.
(l) Revenue is recognized at the time
merchandise is shipped to
customers. Proceeds received for
merchandise not yet shipped are
reflected as "prepaid orders", a
current liability.
(m) The Company issues merchandise
credits for certain returns of
merchandise sold with substantial
discounts. Unused credits are
periodically written off into
income.
(n) New Accounting Standards
Statement of Financial Accounting
Standards No. 130, "Reporting
Comprehensive Income," established
standards for reporting and
display of comprehensive income,
its components and accumulated
balances. Comprehensive income is
defined to include all changes in
equity except those resulting from
investments by owners and
distributions to owners. Among
other disclosures, SFAS No. 130
requires that all items that are
required to be recognized under
current accounting standards as
components of comprehensive income
be reported in a financial
statement that is displayed with
the same prominence as other
financial statements.
Statement of Financial Accounting
Standards No. 131, "Disclosures
about Segments of an Enterprise
and Related Information," which
supersedes SFAS No. 14,
"Financial Reporting for Segments
of a Business Enterprise,"
establishes standards for the way
that public enterprises report
information about operating
segments in annual financial
statements and requires reporting
of selected information about
operating segments in interim
financial statements issued to the
public. It also establishes
standards for disclosures
regarding products and services,
geographic areas and major
customers. SFAS No. 131 defines
operating segments as components
of enterprises about which
separate financial information is
available that is evaluated
regularly by Management in
deciding how to allocate resources
and in assessing performance.
Both SFAS Nos. 130 and 131 are
effective for financial statements
for periods beginning after
December 15, 1997 and require
comparative information for
earlier years to be restated. The
adoption of these standards is not
expected to have a material effect
on the Company's financial
position or results of operations.
The Company is currently reviewing
SFAS No. 131 and has of yet
been unable to fully evaluate the
impact, if any, it may have on
future financial statement
disclosures.
Statement of Financial Accounting
Standards No. 133 "Accounting
for Derivative Instruments and
Hedging Activities" establishes
accounting and reporting standards
for Derivative Instruments. The
Company has not in the past nor
does it anticipate that it will
engage in transactions involving
Derivative Instruments which will
impact the Financial Statements.
F-9
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
2. Business The Company is engaged in two continuing
lines of business and, accordingly, its
operations are classified into two business
segments: mail order catalog retail
operations, and the manufacturing,
marketing and distribution of infants'
accessories principally to mass merchants.
In 1998, the Company sold its Biobottoms
subsidiary. The operations of that company
have been accounted for as a discontinued
operations, see note 5.
On November 12, 1996, the Company changed
its reporting period to September 30.
Effective October 1, 1996, the Company's
subsidiaries report their results of
operations on a fifty-two/fifty-three week
ending on the Saturday closest to September
30.
3. Acquisition of (a) On February 19, 1998, the Company
Magram (through its wholly-owned
subsidiary, Magram Acquisition
Corp.) closed on 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 catalogue sales of women's
clothing. For accounting purposes,
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 $.01 par value, Series D,
convertible preferred stock. The
Series D preferred stock is
convertible into 3,166,667 shares
of the Company's common stock
(which assumes a market value of
$4.00 per share). The preferred
stock does not pay any dividends,
but participates with common in any
Company distributions. The
preferred stock has a liquidation
preference of $100 per share. An
additional 250,000 shares of common
stock were also given as
consideration to the sellers. 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
certain selling stockholders of
Magram who are also principal
stockholders of the Company.
F-10
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
The net fair market value of
identifiable assets acquired was
approximately $6.9 million, and
included customer lists valued at
$5 million. The customer lists are
being amortized over a period of
10 years. Cost in excess of net
assets acquired amounted to
approximately $10 million and is
being amortized over 25 years.
(b) In January 1999, the Company, based
upon historical information
developed in conjunction with the
preparation of its September 30,
1998 financial statements,
determined that certain liabilities
of Magram were understated as of
July 1, 1997, and also at September
30, 1997. Such liabilities included
reserves for customer merchandise
returns and credits and unrecorded
liabilities for purchased
merchandise. Consequently, the
accompanying consolidated financial
statements have been restated to
reflect the above adjustments. The
effect of such restatement on the
Company's consolidated balance
sheet and statement of operations
as at and for the year ended
September 30, 1997 is as follows:
<TABLE>
<CAPTION>
(000's omitted)
As Reclassifications As
reported Adjustments (a) restated
--------- ------------- ----------------- ---------
<S> <C> <C> <C> <C>
Current assets $17,066 $ - $(2,651) $14,415
Property and
equipment 3,465 - (372) 3,093
Goodwill 10,879 2,515 (3,448) 9,946
Other assets 5,604 - (45) 5,559
------- --------- ------- -------
Total $37,014 $2,515 $(6,516) $33,013
======= ========= ======= =======
Current
liabilities $21,490 $2,736 $(6,436) $17,790
Long-term debt 1,235 - (80) 1,155
Stockholders'
equity 14,289 (221) - 14,068
------- --------- ------- -------
Total $37,014 $2,515 $(6,516) $33,013
======= ========= ======= =======
</TABLE>
F-11
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
<TABLE>
<CAPTION>
(000's omitted)
As Adjustments Reclassifications As
reported (a) restated
--------- ------------- ----------------- ---------
<S> <C> <C> <C> <C>
Net sales $35,147 $(297) $(17,382) $17,468
Cost of goods sold 16,665 (76) (7,865) 8,724
-------- --------- -------- -------
Gross profit $18,482 $(221) $ (9,517) $ 8,744
======== ========= ======== =======
Operating income $ 1,761 $(221) $ 143 $ 1,683
======== ========= ======== =======
Net income $ 1,328 $(221) $ - $ 1,107
======== ========= ======== =======
Net income to
common
shareholders $ 964 $(221) $ 74 $ 817
======== ========= ======== =======
Net income per
share $ .16 .14
======== ========= ======== =======
</TABLE>
--------------
(a) Reflects the discontinued
Biobottoms assets and liabilities.
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:
<TABLE>
<CAPTION>
Year Nine months
ended ended
September 30, September 30,
1997 1996
------------- -------------
(unaudited)
<S> <C> <C>
Net sales $55,382,211 $43,772,271
Net loss (7,415,554) (8,397,091)
Net loss per common share (1.20) (1.74)
=========== ===========
</TABLE>
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-12
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
4. Acquisition of
Brownstone 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 for the assumption of
approximately $10,000,000 in liabilities and
an option to the owners of Jean Grayson's
Brownstone Studios, Inc. to purchase 200,000
shares of Diplomat common stock at $3.9375
(market value) for a period of three years.
The acquisition was accounted for as a
purchase accordingly, the operating results
include the operations of Brownstone for the
period November 1, 1997 through October 3,
1998. The purchase price was allocated to
assets acquired based on their estimated
fair value, including customer lists valued
at $3,000,000 which will be amortized on a
straight line basis over ten years. This
treatment results in approximately
$4,000,000 in cost in excess of net assets
acquired which will be amortized on a
straight line basis over twenty five years.
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. Since Brownstone was in bankruptcy
prior to its acquisition in October 1997,
presentation of financial information as if
it had been acquired on October 1, 1996 was
not available and would not be meaningful.
5. Acquisition and Sale of (a) Acquisition of Biobottoms, Inc
Biobottoms, Inc. and
Related Financing 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.
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'
stockholders, each in the amount
of $750,000 ("Acquisition Notes").
The notes bore interest at 1% over
the prime rate as defined in the
agreements. 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'
stockholders, which required that
the Company cure the default on
the notes within 270 days, or be
subject to enforcement action. On
February 25, 1997, the former
F-13
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
Biobottoms' stockholders agreed
not to initiate enforcement action
under this or subsequent defaults
until not earlier than December
31, 1997. In connection with
obtaining this agreement, Diplomat
agreed to pay the Biobottoms'
stockholders 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 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' stockholders paid
$1,500,000 in full satisfaction of
all amounts due under the
acquisition notes, and also
amended its consulting agreement
with the former stockholders 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 were converted
into 1,000,000 common shares of
the Company during November 1996.
The acquisition of Biobottoms had
been accounted for as a purchase
and, accordingly, its results of
operations are included with the
Company's beginning February 9,
1996.
F-14
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
(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 paid in full on May 4, 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 were
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.
F-15
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
(c) Sale of Biobottoms
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
carryforwards 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.
Following is a summary of net assets and the results of operations of
Biobottoms:
September 30, 1997
Assets-current 5,904,579
Property and Equipment 372,757
Other 3,493,295
Liabilities-current (6,435,512)
Long-Term (81,109)
---------
Net assets to be disposed of 3,254,010
=========
Periods Ended 1998 1997 1996
- --------------- ---- ---- ----
Sales $7,539,651 $17,591,784 $11,774,023
---------- ----------- -----------
Cost of Sales 5,105,464 8,074,679 5,942,323
Operating Expenses 5,027,458 9,589,738 6,900,075
Interest 182,121 223,000 82,103
---------- ----------- -----------
10,315,043 17,887,417 12,924,501
---------- ----------- -----------
Net Loss (2,775,392) (295,633) (1,150,478)
========== =========== ===========
6. Restructuring of During the quarter ended
Operations 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.
F-16
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
As a result of the actions taken, the
Company incurred restructuring charges of
approximately $1,739,000. 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.
7. Conversion of Effective September 30, 1996, a significant
Stockholder Debt and stockholder and member of the Company's
Issuance of Series B & Board of Directors converted $3,500,285 of
C Preferred Stock 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 B and 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 $.80 per share, the
estimated fair value of such shares at the
time of issuance.
In September 1997, this significant
stockholder loaned the Company an
additional $1.2 million, with interest at
9%.
F-17
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
8. Inventories
Inventories consist of the following:
<TABLE>
<CAPTION>
September 30, 1998 1997
------------- ------------- -------------
<S> <C> <C>
Raw materials and packaging $ 371,573 $ 375,510
Work-in-process 54,892 365,333
Finished goods 10,639,915 5,613,776
------------- -------------
$11,066,380 $6,354,619
============= =============
9. Property and Equipment
Property and equipment consist of the following:
<CAPTION>
September 30, 1998 1997
------------- ------------- -------------
<S> <C> <C>
Land $ 420,000 $ 420,000
Building 1,517,600 1,517,600
Equipment 5,757,682 6,132,117
------------- -------------
7,695,282 8,069,717
Less: Accumulated depreciation (3,518,379) (4,976,981)
------------- -------------
$4,176,903 $3,092,736
============= =============
<CAPTION>
September 30, 1998 1997
------------- ------------- -------------
<S> <C> <C>
10. Other Assets
Noncurrent deferred tax asset $581,535 $581,535
Other 63,556 102,051
------------- -------------
$645,091 $683,586
============= =============
</TABLE>
F-18
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
11. Revolving Credit
Agreements (a) In April 1994, the Company entered
into an agreement with Congress
Financial Corporation which has been
extended to July 2000, providing the
Company with a maximum $3,000,000
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 percent (2%) 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 was
increased during the fiscal year
ending September 30, 1997 to
($250,000) and $1,500,000,
respectively. The Company has
received waivers for its failure to
comply with the reporting and
financial requirements of the
Agreement through September 30,
1998, and is currently negotiating
revised financial covenants to
reflect the current corporate
structure.
(b) 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.
F-19
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
(c) As of October 30, 1997, Brownstone
entered into a loan agreement which
expires in February 2000 with
Congress providing Brownstone with
a maximum $5,500,000 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. The
Company has received waivers for
its failure to comply with the
reporting and financial
requirements through September 30,
1998
(d) Prior to the acquisition of Magram,
Magram had entered into a loan
agreement, dated as of August 13,
1996, which expires in July 1999,
with Congress providing Magram with
a maximum of $5,000,000 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
guaranteed by a principal
shareholder and director up to an
aggregate maximum amount of
$1,000,000.
F-20
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
12. Long-term Debt
Long-term debt consists of the following:
<TABLE>
<CAPTION>
September 30, 1998 1997
------------- ---------- -----------
<S> <C> <C>
12% subordinated debenture due
June 2003 (a) $5,000,000 $ -
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
building and is guaranteed by a
former stockholder. 911,877 952,806
Note payable - bank, payable in
monthly installments of $7,201
which includes interest at 12%.
The note is collateralized by
land and buildings and is
cosigned by a former stockholder (b) 544,811 564,540
Equipment loans - payable in
monthly installments 775,983 450,851
Other 90,730 10,366
---------- -----------
7,323,401 1,978,563
Less: Current maturities 939,816 823,918
---------- -----------
Long-term debt $6,383,585 $1,154,645
========== ===========
</TABLE>
------------
(a) On June 29, 1998, the Company
issued $5,000,000 principal
amount of its 12% subordinated
secured debentures to Sirrom
Capital Corporation, d/b/a Tandem
Capital ("Tandem Debentures").
The debentures are due June 29,
2003, and bear interest at 12%,
payable quarterly. The Tandem
Debentures are secured by all of
the personal property of the
Company and its subsidiaries and
includes
F-21
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
certain restrictive covenants,
including restrictions on
dividends and distributions,
additional debt financing and
transaction with the Company and
its subsidiaries. The Company also
issued warrants in connection with
the issuance of the Tandem
Debentures. The Company issued
warrants to purchase up to 208,300
shares of its common stock
exercisable at $2.35 for five
years. The value of the warrants
is immaterial and no original
issue discount has been recorded.
An additional 416,600 warrants
will be issued on February 28,
1999 if the debenture is still
outstanding at an exercise price
equal to 80% of the average
closing bid price for the twenty
days prior to their issuance. An
additional 200,000 warrants will
be issued on each anniversary that
the debenture is outstanding at an
exercise price equal to 80% of the
average closing bid price for the
twenty days prior to their
issuance. The exercise price is to
be adjusted downward if the
Company's common stock price is
below this exercise price to an
exercise price equal to the
greater of 80% of the market price
or $2.00 per share.
(b) Full payment of this mortgage was
due on January 26, 1997. The lender
agreed to extend the mortgage to
March 1999. The Company is in the
process of refinancing the
mortgage.
The maturities of long-term debt are as
follows:
<TABLE>
<S> <C>
1999 $939,816
2000 367,743
2001 237,945
2002 166,217
2003 5,120,216
Thereafter 491,464
----------
$7,323,401
==========
</TABLE>
F-22
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
13. Stockholders' Equity (a) On December 31, 1992, the Board of
Directors adopted a stock option
plan which allows for the grant of
options 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
cancelled during either of the
years presented.
(b) On November 4, 1998, 581,175
warrants to purchase shares of the
Company's common stock at $3.50 per
share issued in connection with the
Company's initial public offering
of its common stock expired.
(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, which
were exercised during 1997. The
warrants expiring July 18, 1996
were not exercised.
(d) In September 1996, the Company
issued 500,000 common shares at
$.95 per share to previously
unrelated investors from the
exercise of warrants. Net proceeds
to the Company were $475,000.
(e) In May 1997, pursuant to an
agreement in 1996, the Company
issued to a principal shareholder
and officer an aggregate of 550,000
shares of common stock valued at
$400,000 ($.75 per share)in
consideration of his 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
during 1996.
F-23
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
(f) In March 1997, the Company approved
the issuance of 52,217 shares of
common stock to a principal
shareholder and officer in lieu of
the dividend payments due under the
Series B and Series C preferred
stock.
(g) On September 9, 1996, the Company
entered into an agreement with
Gersten, Savage, Kaplowitz &
Fredericks, LLP ("GSK&F") which
provided that GSK&F will provide
certain legal and consulting
services to the Company over an
extended prior of time. In 1997 as
compensation for its services,
certain individual members of GSK&F
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.
(h) 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.
Options to purchase 620,000 shares
expired on June 17, 1998 and
150,000 options were granted with
an exercise price of $2.375.
(i) In May 1997, the Company issued an
aggregate of 150,000 options
pursuant to the November 1996 Plan,
50,000 of which were issued to
Howard Katz, a director of the
Company, and 100,000 of which were
issued to Mr. Fredericks in
connection with his agreement to
become a member of the Company's
Board of Directors. Such options
are exercisable at $1.875 per
share.
F-24
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
(j) In May 1997, the Company authorized
the issuance of 200,000 shares of
common stock to a principal
shareholder and officer in
consideration of his extending
loans to the Company, as well as
extending a personal guarantee to
Congress on behalf of the Company.
(k) Between May and July 1997, the
Company issued an aggregate of
100,000 and 58,408 shares of common
stock in connection with the
acquisitions of Magram and
Biobottoms. The shares were
recorded at fair market value with
a corresponding increase in
goodwill. During the same period
options to acquire 200,000 shares
of common stock were issued to six
consultants. Of the 200,000
options, 50,000 are exercisable at
$1.75 per share and 150,000 are
exercisable at $1.875 per share.
(l) From May 1997 through September
1997, the Company sold 1,250,000
shares of its common stock in a
private placement of its securities
in which it raised $2,500,000. In
addition to these shares, the
Company issued to European
Community Capital a placement
agent's warrant exercisable to
purchase up to 200,000 shares of
common stock at $3.3125 per share.
The Company issued an option to a
principal of the common stock at
$3.3125 per share. The Company
issued an option to a principal of
the placement agent to purchase up
to 100,000 shares of common stock
at $2.00 per share.
(m) In September 1997, a principal
shareholder and officer made an
additional loan to the Company in
the amount of $1,200,000.
(n) In October 1997, in part to raise
capital for the Company's
acquisition out of bankruptcy of
the assets of Brownstone, the
Company completed a private
offering of its securities which
raised $3,620,000 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. As a result,
the Company issued an
aggregate of 3,630 shares of Series
E preferred stock and 2,722,500
shares of common stock.
F-25
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
(o) On June 29, 1998, the Company
completed the sale of subordinated
debentures to Tandem Capital in the
amount of $5,000,000 to be used for
working capital. In connection with
the transaction, the Company issued
warrants to purchase 208,300 shares
of common stock.
At September 30, 1998 the components of the Preferred Stock were:
<TABLE>
<CAPTION>
Shares Par Value
-------------------------------------------------------------------
Issued Outstanding Per Share Total Liquidation
------ ----------- ---------- ----- Value
-----------
<S> <C> <C> <C> <C> <C>
Series A(d) 100,000 100,000 $.01 1000 $ -
Series B(a) 290,000 290,000 .01 2900 2,900,280
Series C(a) 60,000 60,000 .01 600 600,000
Series D(b) 95,000 92,503 .01 950 9,250,300
Series E(c) 3,630 3,630 .01 36 3,630,000
-----------
$16,380,580
------------
------------
</TABLE>
- ---------------------
(a) Convertible into common into common stock at 75% of "current market price"
with a dividend of 9% of liquidation value and 10 votes per share.
(b) Shares issued in connection with the Magram aquisition (see Note 2(a)).
(c) Redeemable at the option of the Company with a dividend based on
liquidation value of 6% increased to 12% if not redeemed by October 2000.
(d) Converted into 1,000,000 shares of common stock in November 1998.
14. Concentrations of Financial instruments that potentially
Credit Risk 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.
15. Net Sales Two customers of Ecology Kids accounted for
the following percentage of net sales from
continuing operations. No customer exceeded
10% of net sales in 1998.
<TABLE>
<CAPTION>
Percentage of net
sales
-----------------
<S> <C> <C>
Year ended September 30, 1997 12 8
Nine months ended September 30, 1996 11 40
==== ====
</TABLE>
F-26
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
16. Commitments and (a) Sales Tax Audit
Contingencies
In November 1997, Magram was
served with a proposed assessment
related to a sales tax audit
aggregating approximately $2.4
million (including penalties and
interest). This matter was settled
for $350,000 and has been accrued
at October 3, 1998. The liability
was recorded as of the
acquisition date of Magram.
(b) Merchandise Credits
Because of Magram's policy of
periodically writing off into
income unused merchandise credits
issued with the return of sale
merchandise, it may be liable for
future claims on such amounts
previously written off. The
amounts written off into income
for 1997 and 1998 were $742,000
and $3,398,000 respectively.
(c) Employment Agreements
In connection with the Magram
acquisition, the Company entered
into three-year employment
agreements with three former
principals of Magram to serve in
executive capacities with the
acquired company. Aggregate
minimum annual compensation under
these agreements is $657,000 for
the first two years and $692,000
for the third year.s wir 132
F-27
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
(d) Leases
The Company rents real and
personal property under long-term
lease agreements which expire at
various dates through December
2004. Although the lease on the
facility used in the Magram and
Brownston operations will expire
in August 1999, the Company
intends to exercise its option to
extend to 2004. Future minimum
rentals under noncancellable
operating leases are as follows:
<TABLE>
<CAPTION>
Fiscal year ending Amount
-----------------------------------------------
<S> <C>
1999 $ 654,756
2000 663,996
2001 674,780
2002 543,736
2003 465,000
Thereafter 465,000
-----------
$ 3,467,268
===========
</TABLE>
Rent expense amounted to
approximately $890,000, $823,277
and $226,000 for the years ended
September 30, 1998 and 1997 and
the nine months ended September
30, 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 seeking $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
has $1,000,000 of insurance
coverage which could be applied to
any liability posed by this
matter.
F-28
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
In February 1997, Francine Nichols,
a former consultant of the Company,
commenced an action against the
Company in the Supreme Court of the
State of New York, New York County,
to recover approximately $240,000
allegedly due under a consulting
agreement between Ms. Nichols and
the Company. In March 1998, Paul
Russo filed a complaint against the
Company alleging that he is
entitled to the Unit Purchase
Option. The Company disputes each
claim and intends to vigorously
defend against them and believes
that it will prevail.
17. Income Taxes The following analyzes the deferred tax
assets at September 30, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
------- ------
<S> <C> <C>
Net operating loss carryforward $ 3,485,000 $ 2,915,000
Depreciation 100,000 102,000
Inventory 1,016,000 1,016,000
Other items 164,000 164,000
----------- -----------
4,765,000 4,197,000
Less: Valuation allowance (3,403,000) (2,835,000)
---------- -----------
Deferred tax asset $ 1,362,000 $ 1,362,000
=========== ===========
</TABLE>
F-29
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
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 $2,835,000 at September 30,
1997, which represents a decrease of
$212,000 over the amount reported at
September 30, 1996. The current portion of
the deferred tax asset amounts to
$780,464, and is included with other
current assets. The long-term portion
amounts to $581,536 and is included with
other assets. The increase in the
deferred tax assets in 1998 was fully
reserved.
As of September 30, 1998, the Company has
net operating loss carryforwards for
Federal income tax purposes of
approximately $7,300,000 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
Year ended September 30, ended
------------------------- September 30,
1998 1997 1996
--------- --------- -------------
<S> <C> <C> <C>
Income tax benefit computed
at statutory rate $ 568,000 $ 376,000 $ (2,456,000)
Tax benefit of net operating
loss carryforward - (376,000) -
State tax benefit, net of
Federal tax benefit - 1,567 (313,000)
Adjustment to valuation
allowance (568,000) (212,000) 2,769,000
--------- --------- -------------
Income tax (benefit) as
reported $ - $(210,433)(1) $ -
========= ========= =============
</TABLE>
(1) Includes amounts attributable to discontinued operations.
F-30
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
18. Business Segment Summarized financial information by business
Information segment for the year ended:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- ---------
<S> <C> <C> <C>
Net sales:
Specialty catalog retail operations $67,921,661 $10,575,342 -
Mass merchant manufacturing and
distribution 6,663,931 6,892,724 $ 7,448,778
------------ ----------- -----------
$74,585,592 $17,468,066 $7,448,778
============ =========== ===========
Operating income:
Specialty catalog retail operations $ 2,611,731 $ 246,944 -
Mass merchant manufacturing and
distribution 414,850 1,436,434 $(5,354,595)
Diplomat Corporate (411,658)
------------ ----------- -----------
$ 2,614,923 $ 1,683,378 $(5,354,595)
============ =========== ===========
Total assets:
Specialty catalog retail operations $43,319,650 $27,597,554 -
Mass merchant manufacturing and
distribution 4,666,520 5,415,333 $ 7,762,190
Diplomat Corporate 2,972,713
------------ ----------- -----------
$50,958,883 $33,012,887 $ 7,762,190
============ =========== ===========
Depreciation and amortization:
Specialty catalog retail operations $ 1,904,052 $ 530,481 -
Mass merchant manufacturing and
distribution 106,490 105,124 $ 85,682
------------ ----------- -----------
$ 2,010,542 $ 635,605 $ 85,682
============ =========== ===========
Capital expenditures:
Specialty catalog retail operations $ 978,391 $ 176,206 -
Mass merchant manufacturing and
distribution 7,558 20,138 $ 8,463
------------ ----------- -----------
$ 985,949 $ 196,344 $ 8,463
============ =========== ===========
</TABLE>
F-31
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
19. Stock Option Plans The Company's 1992 Stock Option Plan ("1992
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 Code of
1986, as amended ("Code").
The 1992 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 1992 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 1992 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 outstanding an aggregate of
130,000 stock options, exercisable at $1.50
per share, all of which are held by
affiliates or employees of the Company at
the time of grant.
August 1996 Stock Option Plan
The Company also established a nonqualified
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 (the "August 1996 Plan"). To
date, the Company has granted directors,
officers and key employees an aggregate of
150,000 incentive and nonqualified stock
options, at an exercise price of $2.00 per
share and 500,000 nonqualified stock options
issued and exercised by a consultant. Future
grants could have an adverse effect on the
market price of the Company's securities.
F-32
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
November 1996 Stock Option Plan
Under the Company's November 1996
Incentive Stock Option Plan (the "November
1996 Plan"), 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. 1,060,000 of such options have
been granted at an exercise price of
$1.00, of which 620,000 options expired on
June 17, 1998, 150,000 are exercisable at
$2.375 and 50,000 are exercisable at
$1.00. The options to be granted under the
November 1996 Plan are designated as
incentive stock options or nonincentive
stock options by the Board of Directors
which also have discretion as to the
persons to be granted options, the number
of shares subject to the options and terms
of the option agreements. Only employees,
including officers and part-time employees
of the Company, and nonemployee 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
November 1996 Plan.
The November 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.
F-33
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
1998 Stock Option Plan
The Company's 1998 Stock Option Plan (the
"1998 Plan") was adopted by the Board of
Directors in February, 1998 and approved
by the stockholders in May, 1998. Under
the 1998 Plan, the Company is authorized
to issue options to purchase up to
1,200,000 shares of common stock. All
officers and other employees of the
Company and other persons who perform
significant services for or on behalf of
the Company are eligible to participate in
the 1998 Plan.
The Company may grant under the 1998 Plan
both incentive stock options ("Incentive
Stock Options") within the meaning of
Section 422 of the Internal Revenue Code
of 1986, as amended (the "code"), and
stock options that do not qualify for
incentive treatment under the Code
("Nonstatutory Options").
The Plan shall be administered by the
Board of Directors of the Company (the
"board"), if each member is a
"disinterested" person 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 disinterested person.
Subject to the provisions of the 1998
Plan, the Committee has the authority to
construe and interpret the 1998 Plan, to
prescribe, adopt, amend and rescind rules
and regulations relating to the
administrations of the 1998 Plan and to
make all other determinations necessary or
advisable for its administration. Subject
to the limitations of the 1998 Plan, the
Committee also selects from among the
eligible persons those individuals who
will 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).
F-34
<PAGE>
Diplomat Direct Marketing Corporation
and Subsidiaries
Notes to Consolidated Financial Statements
The exercise price of each Incentive Stock
Option under the Option Plan will be
determined by the Committee, but will not
be less than 100% of the "Fair Market
Value" (as defined in the 1998 Plan) of
common stock on the date of grant (or 110%
in the case of an employee who at the time
owns more than 10% of the total combined
voting power of all classes of capital
stock of the Company). The Nonstatutory
Option exercise price will be determined
by the Committee, but will not be less
than 85% of the common stock on the date
of grant.
Under the 1998 Plan, the Company has
outstanding options to purchase an
aggregate of 700,000 shares of common
stock exercisable at $2.75 per share, all
of which are held by employees of the
Company. Options to purchase 200,000
shares of common stock become exercisable
upon Brownstone meeting certain minimum
net income. These options will be
recorded, when and if, the net income
assessments are met. The remaining
outstanding options become exercisable
over four years.
The following table is a summary of stock
option information for 1996 through 1998:
Option Price Range Average
Shares Per Share Price
------ ----------- -------
Outstanding 1/1/96 130,000 $1.50 $1.50
Granted 650,000 $.95 to $2.50 $1.34
Exercised 500,000 $.95 $ .95
Forfeited 0 0 0
- ------------------------------------------------------------------------------
Outstanding 10/1/96 280,000 $1.50 - $2.50 $2.04
Granted 1,485,000 $1.00 - $3.125 $1.21
Exercised 0 0 0
Forfeited 0 0 0
- ------------------------------------------------------------------------------
Outstanding 10/1/97 1,765,000 $1.00 to $3.125 $1.67
Granted 750,000 $1.00 to $2.75 $2.63
Exercised 35,000 $1.75 to $1.85 $1.84
Forfeited 620,000 $1.00 $1.00
- ------------------------------------------------------------------------------
Outstanding 9/30/98 1,860,000 $1.00 to $3.125 $2.05
==============================================================================
Exercisable at year-end
9/30/96 130,000 $1.50 $1.50
9/30/97 527,000 $1.00 - $3.125 $1.61
9/30/98 831,000 $1.00 - $3.125 $2.02
Available for future grants
1992 Aug 1996 Nov 1996 1998
Plan Plan Plan Plan
---- ---- ---- ----
9/30/98 70,000 850,000 710,000 500,000
The following table summarizes information about stock options outstanding at
September 30, 1998.
Range of Exercise prices: $1.00 - $3.125
Outstanding options
Number outstanding at
September 30, 1998 1,860,000
Weighted average remaining
contractual life (years) 3.5
Weighted average
exercise price $2.05
Exercisable options
Number outstanding at
September 30, 1998 831,000
Weighted average
exercise price $2.02
In fiscal 1997, the Company adopted the
disclosure provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation".
For disclosure purposes, the fair value of
options is estimated on the date of grant
using the Black-Scholes option pricing
model with the following weighted average
assumptions used for stock options granted
during the years ended September 30, 1998
and 1997 and nine months ended September
30, 1996: annual dividends of $-0-;
expected volatility of 46.10% in 1988 and
94.99% in 1997; risk-free interest rate of
7% and expected life of five years. The
weighted average fair value of stock
options granted during the years ended
September 30, 1998 and 1997 and nine
months ended September 30, 1996 was $1.51,
$1.17 and $1.48, respectively. If the
Company had recognized compensation cost
for stock options in accordance with SFAS
No. 123, the Company's pro forma net loss
and net loss per share would have been
$2,257,683 and $ .21 per share and
$550,088 and $.09 per share for the years
ended September 30, 1998 and 1997 and
$8,298,400 and $1.82 per share for the
nine months ended September 30, 1996.
F-35
<PAGE>
Report of Independent Certified Public Accountants
To the Board of Directors and Stockholders
Lew Magram Ltd.
We have audited the accompanying statements of operations and cash flows of Lew
Magram Ltd. for the year ended January 4, 1997. 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 audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the results of operations and cash flows of Lew Magram
for the year ended January 4, 1997, in conformity with generally accepted
accounting principles.
New York, New York
May 16, 1997 except
for Note 2 which is
as of February 19, 1998
BDO SEIDMAN LLP
F-36
<PAGE>
Report of Independent Certified Public Accountants
To the Board of Directors and Stockholders
Lew Magram Ltd.
We have audited the accompanying statements of operations and cash flows of Lew
Magram Ltd. for the six months ended June 30, 1997. 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 audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the results of operations and cash flows of Lew Magram
for the six months ended June 30, 1997, in conformity with generally accepted
accounting principles.
New York, New York
January 30, 1999
FELDMAN SHERB EHRLICH & CO. P.C.
Certified Public Accountants
F-37
<PAGE>
Lew Magram Ltd.
Statements of Operations
<TABLE>
<CAPTION>
Six months ended Year ended
June 30, 1997 January 4, 1997
---------------- ---------------
<S> <C> <C>
Net sales $19,642,703 $51,926,603
Cost of goods sold 11,960,210 25,111,912
------------ -----------
Gross profit 7,682,493 26,814,691
Selling, general and administrative expenses 14,670,290 28,296,249
------------ -----------
Operating loss (6,987,797) (1,481,558)
Other income (expense) (218,636) 691,553
------------ -----------
Loss before income taxes (7,206,433) (790,005)
Income taxes (70,000) -
------------ -----------
Net loss $ (7,276,433) $ (790,005)
============ ===========
</TABLE>
See accompanying notes to financial statements.
F-38
<PAGE>
Lew Magram Ltd.
Statements of Cash Flows
<TABLE>
<CAPTION>
Six months ended Year ended
June 30, 1997 January 4, 1997
---------------- ---------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(7,276,433) $ (790,005)
----------- -----------
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation and amortization 303,547 546,030
Unrealized gain in marketable securities - (12,000)
Decrease(increase) in:
Accounts receivable (10,977) 83,216
Inventories 938,598 (67,018)
Prepaid expenses and other current assets 6,363 (991,238)
Other assets - 34,937
Increase (decrease) in:
Accounts payable (469,981) 804,867
Accrued expenses 5,278,391 638,927
----------- -----------
Total adjustments 6,045,941 1,037,721
----------- -----------
Net cash provided by (used in) operating activities (1,230,492) 247,716
----------- -----------
Cash flows from investing activities:
Capital expenditures (87,175) (543,950)
----------- -----------
Cash flows from financing activities:
Increase in long-term debt 1,369,084 325,547
Issuance of preferred stock 2,000,000 -
Dividends on preferred stock (24,466) -
Payments under capital leases (199,121) 138,606
Redemption of stockholder (77,619) 46,774
----------- -----------
Net cash provided by financing activities 3,067,878 510,927
----------- -----------
Net increase in cash 1,750,211 214,693
Cash, beginning of period 285,796 71,104
----------- -----------
Cash, end of period $ 2,036,007 $ 285,797
=========== ===========
</TABLE>
See accompanying notes to financial statements.
F-39
<PAGE>
Lew Magram Ltd.
Notes to Financial Statements
1. Summary of Accounting Description of Business
Policies
The Company is a mail order ladies apparel
retailer.
Inventories
Inventories consisting of finished goods are
valued at the lower of cost (first-in,
first-out) or market.
Catalogue and Advertising Expenses
The Company expenses the production costs of
advertising the first time the advertising
takes place, except for direct-response
advertising, which is capitalized and
amortized over its expected period of future
benefits.
Direct-response advertising consists
primarily of mail order catalogues that
include order forms for the Company's
products. The capitalized costs of the
catalogue are amortized over the shipping
season of the products appearing in the
catalogues, which does not exceed 6 months.
The Company began a production development
program that extends the useful lives of
certain production costs over many catalogue
seasons. These costs are being amortized on
a straight-line basis over 18 months, the
estimated useful life, and consist of
photography, modeling and color separation
costs.
Property, Equipment and Depreciation
Depreciation and amortization are computed
by both accelerated and straight-line
methods based on the estimated useful lives
of the assets.
F-40
<PAGE>
Lew Magram Ltd.
Notes to Financial Statements
Revenue Recognition
Revenue is recognized at the time
merchandise is shipped to customers.
Proceeds received for merchandise not yet
shipped are reflected as "open prepaid
orders," a current liability. In addition,
the Company passes on the cost of parcel
shipments directly to the customer as part
of the postal and handling charge, which
is customary in the direct mail industry.
This is reflected as a reduction of
operating expenses.
The Company also derives revenue through
the rental of their customer mailing list,
which is reflected in other income.
Merchandise Credits
The Company issues merchandise credits for
certain returns of merchandise sold with
substantial discounts. Unused credits are
periodically written off into income.
Income Taxes
The Company elected, with the consent of
its stockholders, to be taxed as an S
corporation under the provisions of the
Internal Revenue Code and New York State
Franchise Tax Law. The stockholder is
required to report the Company's taxable
income or loss in their personal income
tax returns; accordingly, such income
taxes are not reflected in the financial
statements. The financial statements
include a provision for New York City and
New Jersey income taxes since New York
City and New Jersey do not recognize S
corporation status. New York State imposes
a corporate level tax based upon the
differential between corporate and
individual tax rates, which has been
provided for.
During the year ended July 1, 1995, the
Company adopted SFAS No. 109, "Accounting
for Income Taxes". SFAS No. 109 is an
asset and liability approach that requires
the recognition of deferred tax assets and
liabilities for the expected future tax
consequences of events that have been
recognized in the Company's financial
statements or tax returns. Deferred
income taxes are immaterial and not
recorded by the Company.
F-41
<PAGE>
Lew Magram Ltd.
Notes to Financial Statements
In connection with the transactions
discussed in Note 2, the Company's S
corporation status was automatically
terminated when the Company issued preferred
stock (see note 4(a)), and the Company will
now be taxed as a C corporation. The change
in status will not materially affect the
Company.
Fiscal Year
The Company's fiscal year is comprised of
52-53 weeks ending on the Saturday closest
to December 31.
2. Acquisition by On February 19, 1998, Diplomat Direct
Diplomat Marketing Corporation ("DDMC") completed the
Direct Marketing acquisition of Lew Magram, Ltd. The
Corporation acquisition was effected as of July 1, 1997,
the date that DDMC 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 DDMC's $.10 par value, Series D
convertible preferred stock and 250,000
shares of DDMC's common stock. The Series D
preferred stock is convertible into
3,166,667 shares of DDMC's common stock. The
fair market value of the consideration was
approximately $8.7 million and acquisition
costs were approximately $646,000. DDMC
recorded the carryover basis for a certain
selling stockholder of Magram who is also a
principal stockholder of DDMC.
F-42
<PAGE>
Lew Magram Ltd.
Notes to Financial Statements
3. Rent Expense Rent expense amounted to approximately
$280,000 and $563,000 for the six months
ended June 30, 1997 and the year ended
January 4, 1997, respectively.
4. Contingencies Because of the Company's policy of
periodically writing off into income unused
merchandise credits issued (approximately
$264,110 and $796,000 for the six
months ended June 30, 1997 and the year
ended January 4, 1997, respectively),
without expiration dates in connection with
the return of sale merchandise, it may be
liable for future claims on such amounts
previously written off.
F-43
<PAGE>
Lew Magram Ltd.
Notes to Financial Statements
5. Other (a) On May 16, 1997, the Company issued
2,000 shares of preferred stock to
two individuals for $2,000,000. The
preferred stock has been designated
as senior convertible preferred
stock with $.01 par value. The
preferred stock has a $1,000 per
share liquidation value and a 9.5%
cumulative dividend.
(b) In connection with the transaction
discussed above, the Company
amended its certificate of
intercompany whereby the Company is
authorized to issue 2,000 shares of
$.01 par value common stock and
2,000 shares of $.01 par value
preferred stock.
F-44
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
Registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
DIPLOMAT DIRECT MARKETING CORPORATION
Dated: March 2, 1999 By: /s/ JONATHAN ROSENBERG
-----------------------
Jonathan Rosenberg
President and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Jonathan Rosenberg and Warren H. Golden,
and each of them, each with full power to act without the other, his true and
lawful attorneys-in-fact and agents, each with full power of substitution and
resubstitution, for such person and in his name, place and stead, in any and all
capacities, to sign or all further amendments to this Annual Report on Form 10-K
and to file the same, with all exhibits thereto, and other documents in
connections therewith, with the Securities and Exchange Commission, granting
unto each of said attorneys-in-fact and agents full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully as to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that each of said
attorneys-in-facts and agents, or his substitutes, may lawfully do or cause to
be done by virtue hereof.
Pursuant to the requirements of the Act, this Registration Statement
has been signed by the following persons in the capacities and on the dates
indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ JONATHAN ROSENBERG Chief Executive Officer, President and March 2, 1999
- ---------------------- Director
Jonathan Rosenberg
/s/ STUART A. LEIDERMAN Executive Vice President and Director March 2, 1999
- -----------------------
Stuart A. Leiderman
/s/ WARREN H. GOLDEN Executive Vice President, Chief March 2, 1999
- ------------------------- Operating Officer and Director
Warren H. Golden
/s/ IRWIN ORINGER Chief Accounting Officer March 2, 1999
- -------------------------
Irwin Oringer
/s/ ROBERT M. RUBIN Chairman of the Board March 2, 1999
- -------------------------
Robert M. Rubin
- ------------------------- Director February __, 1999
Howard B. Katz
- ------------------------- Director February __, 1999
David Abel
</TABLE>
<PAGE>
EXHIBIT INDEX
3a. Certificate of Incorporation, as amended(1)
3b By-laws, amended(1)
3c Amendment to Certificate of Incorporation(1)
3d Amendment to Certificate of Incorporation(7)
3e Certificate of Designation of Series B and Series C Preferred Stock(5)
3f Amended and Restated Certificate of Designation of Series D Preferred
Stock(8)
3g Certificate of Designation of Series E Preferred Stock(9)
4a Form of Common Stock Certificate(1)
10a 1992 Stock Option Plan(1)
10b August 1996 Stock Option Plan(11)
10c November 1996 Stock Option Plan(5)
10d License Agreement by and between Diplomat Juvenile Corporation, Wesley
Howell and Steve Pressed(1)
10e Loshell Realty mortgages with Union State Bank and Stoney Point
Technical Park, Inc. and related Mortgage Notes, including Sheldon Rose
guarantee of Union State Bank(1)
10f First Amendment to Exclusive Distributorship Agreement by and between
Ambrose & Montgomery, Inc. and Diplomat Corporation(2)
10g Collateral Assignment of Trademarks and Trademark Licenses (Security
Agreement) by and between Congress Financial Corporation and Diplomat
Corporation(2)
10h Second Amendment to Exclusive Distributorship Agreement between Ambrose
Montgomery, Inc. and Diplomat Corporation(3)
10i Amendments No. 1, No. 2 and No. 3 to Loan and Security Agreement by and
between Congress Financial Corporation and Diplomat Corporation(4)
10j Security Agreement (Rights in Agreement and Plan of Merger) dated
February 9, 1996 between Biobottoms, Inc., Diplomat Corporation and
Congress Financial Corporation(4)
10k Asset Purchase Agreement dated as of September 24, 1997 by and among
Diplomat Corporation and Jean Grayson's Brownstone Studio, Inc. and
Wilroy Inc.(7)
10l Bill of Sale provided by Jean Grayson's Brownstone Studio, Inc. and
Wilroy, Inc.(7)
10m Assignment and Assumption Agreement dated October 30, 1997 between
Brownstone Holdings, Inc., Jean Grayson's Brownstone Studio, Inc. and
Wilroy, Inc.(7)
10n Loan and Security Agreement by and among Congress Financial Corporation
and Jean Grayson's Brownstone Studio, Inc. dated February 28, 1997, as
amended September 17, 1997(7)
10o Junior Participation Agreement between Congress Financial Corporation,
Robert M. Rubin and Jay M. Kaplowitz dated September 17, 1997(7)
10p Agreement and Plan of Merger dated December 23, 1997, by and between
Diplomat Corporation, Lew Magram, et al(6)
10q Employment Agreement between Warren H. Golden and Diplomat Corporation
dated February 2, 1998(8)
10r Employment Agreement between Irving Magram and Lew Magram Ltd. dated
February 2,
<PAGE>
1998(8)
10s Employment Agreement between Stephanie Sobel and Lew Magram, Ltd. dated
February 2, 1998(8)
10t Lease Agreement between Franklin Associates and Lew Magram, Ltd dated
May 15, 1992(8)
10u Loan and Security Agreement by and between Congress Financial
Corporation and Lew Magram Ltd. dated August 13, 1996(8)
10v Employment Agreement between Kenneth Grossman and Brownstone Holdings,
Inc. dated October 30, 1997*
10w Employment Agreement between Joan Grossman and Brownstone Holdings,
Inc. dated October 30, 1997*
10x Debenture Purchase Agreement between Sirrom Capital Corporation,
Diplomat Direct Marketing Corporation, et al, and forms of exhibits(10)
10y 1998 Stock Option Plan(12)
22 Subsidiaries of the Registrant*
27 Financial Data Schedule*
* Filed herewith
(1) Incorporated by reference to Diplomat Corporation Registration
Statement No. 33-66910 NY.
(2) Incorporated by reference to Diplomat Corporation Annual Report on Form
10KSB for the year ended January 1, 1994.
(3) Incorporated by reference to Diplomat Corporation Registration No.
33-95986.
(4) Incorporated by reference to Diplomat Corporation Annual Report on Form
10KSB for the year ended December 31, 1995.
(5) Incorporated by reference to Diplomat Corporation Annual Report on Form
10KSB for the year ended September 30, 1996.
(6) Incorporated by reference to Diplomat Corporation Annual Report on Form
10KSB for the year ended September 30, 1997.
(7) Incorporated by reference to Diplomat Corporation report on Form 8-K
dated November 14, 1997.
(8) Incorporated by reference to Diplomat Corporation report on Form 8-K
dated March 6, 1998.
(9) Incorporated by reference to Diplomat Corporation Annual Report on Form
10KSB/A2 for the year ended September 30, 1997 filed March 3, 1998.
(10) Incorporated by reference to Diplomat Direct Marketing Corporation
10-QSB for the quarter ended June 30, 1998.
(11) Incorporated by reference to Diplomat Corporation Registration
Statement on Form S-8 filed August 30, 1996.
(12) Incorporated by reference to Diplomat Corporation Proxy Statement on
Schedule 14A filed April 29, 1998.
<PAGE>
Exhibit 10v - Employment Agreement with Kenneth Grossman
BROWNSTONE HOLDINGS, INC.
EMPLOYMENT AGREEMENT
EMPLOYMENT AGREEMENT is effective as of the 30th day of
October, 1997 by and between BROWNSTONE HOLDINGS, INC., a Delaware corporation
(hereinafter referred to as "Employer"), a wholly-owned subsidiary of Diplomat
Corporation, a Delaware corporation ("Diplomat") and KENNETH S. GROSSMAN,
(hereinafter referred to as "Employee");
W I T N E S S E T H:
WHEREAS, Employer desires to employ Employee as Divisional
President of the Employer; and
WHEREAS, Employee is willing to be employed as Divisional
President of the Employer in the manner provided for herein, and to perform
the duties of Divisional President of Employer upon the terms and conditions
herein set forth;
NOW, THEREFORE, in consideration of the promises and mutual
covenants herein set forth it is agreed as follows:
1. Employment of Employee. Employer hereby employs Employee
as Divisional President of the Employer.
2. Term. The term of this Agreement shall commence on the 30th
day of October (the "Commencement Date") and expire five (5) years from such
date. Each 12 month period from the Commencement Date forward during the term
hereof shall be referred to as an "Annual Period." During the term hereof,
Employee shall devote substantially all of his business time and efforts to
Employer and its subsidiaries and affiliates.
3. Duties. Employee hereby agrees that, throughout the period
of his employment hereunder, he shall devote substantially all of his business
time, attention, knowledge and skills, faithfully, diligently and to the best of
his ability, in furtherance of the business of Employer, shall perform the
duties assigned to him by the officers of Diplomat consistent with the following
duties: responsible for (i) buying and merchandising for Brownstone catalogs and
(ii) creative control over Brownstone catalogs, and shall observe and carry out
such rules and regulations, policies and directions as Employer may from time to
time establish consistent with his position. During the term of this Agreement,
Employee shall do such traveling as may be reasonably required of him in the
performance of his duties on behalf of Employer. Employee shall be available to
confer and consult with and advise the officers and directors of Employer and
Diplomat at such times that may be reasonably required by Employer and Diplomat.
Employee shall report directly and solely to the Chief Executive Officer and
Chief Operating Officer of Employer.
<PAGE>
4. Compensation.
(a) Employee shall be paid a minimum of $200,000 for
each Annual Period. Employee shall be paid periodically in accordance with the
policies of the Employer during the term of this Agreement, but not less
frequently than bi-weekly. Employee is eligible for an annual bonus, if any,
which will be determined and paid in accordance with policies set from time to
time by the Board of Diplomat.
1
<PAGE>
(b) Employee shall be entitled to participate in and
receive the benefits of all pension, profit-sharing, deferred compensation,
retirement, hospitalization, insurance, medical or dental or other benefit
plan or arrangement generally available to executive employees of Employer as
may now or hereafter exist. Employee shall also be entitled to participate in
or receive all other benefits and perquisites generally available to senior
executives of Employer that may be in effect from time to time during the
Employee's employment hereunder. Employer shall be under no obligation to
institute or continue the existence of any such employee plan, benefit or
perquisite.
5. Expenses. Employer shall reimburse Employee, promptly
upon presentation of receipts or vouchers thereof, for all expenses reasonably
incurred by him, including parking expenses in connection with the performance
of his duties hereunder and the business of Employer, all in accordance with
policies of Employer from time to time in effect. Employer shall continue to
make loan payments on, and shall continue to pay the cost of maintenance, fuel
and insurance, for, the automobile currently in place for the benefit of
Employee, through and until all loan payments on the automobile are made.
Thereafter, the automobile shall be transferred to Employee for $1 and, at
Employee's option, shall be entitled to have all maintenance, fuel and
insurance paid through the term of this Agreement or have leased for him
another automobile in accordance with Employer's benefit plan, if any, for
senior executives. Employee shall be provided a corporate credit card in
accordance with Employer's policy, if any.
6. Vacation. Employee shall be entitled to receive three (3)
weeks paid vacation time after each year of employment upon dates agreed upon by
Employer. Upon separation of employment, for any reason, vacation time accrued
and not used shall be paid at the salary rate of Employee in effect at the time
of employment separation.
7. Employee's Representations. Employee is free to enter
into this Employment Agreement and to perform each of the provisions contained
herein. Employee represents and warrants that Employee is not restricted or
prohibited, contractually or otherwise, from entering into and performing this
Employment Agreement, and that Employee's execution and performance of this
Employment Agreement is not a violation or breach of any agreement between
Employee and any other person or entity.
<PAGE>
8. Nondisclosure of Confidential Information; Ownership of
Intellectual Property Rights; Non Competition; Covenant Not to Compete.
(a) Nondisclosure of Confidential Information. During
the term of this Employment Agreement and at all times thereafter, Employee
will keep confidential and will not directly or indirectly divulge to anyone
nor use or otherwise appropriate for Employee's own benefit, or on behalf of
any other person, firm, partnership or corporation by whom Employee might
subsequently be employed or otherwise associated or affiliated with, any
Confidential Information (as defined herein). For this purpose, "Confidential
Information" means any and all trade secrets or other confidential information
of any kind, nature or description concerning any matters affecting or
relating to the business of Employer or any affiliate of Employer which
derives economic value, actual or potential, from not being generally known to
the public or the trade or to other persons who can obtain economic value from
its disclosure or use and which is subject to efforts by Employer that are
reasonable under the circumstances to maintain its secrecy. Confidential
Information does not include information which (a) is or becomes generally
available to the public or the trade other than as a result of a disclosure by
Employee or any of his agents or representatives, or (b) was within Employee's
possession prior to its being furnished to Employee by Employer, Jean
Grayson's Brownstone Studio, Inc. or Wilroy, Inc.; provided that the source of
such information in the case of either clause (a) or (b) was not bound by a
confidentiality agreement or other contractual obligation of confidentiality
with respect to such information or did not otherwise acquire or disclose such
information wrongfully.
2
<PAGE>
(b) Employer Intellectual Property Rights. All
intellectual property rights, whether or not patentable or copyrightable,
which (i) are made or developed with the equipment, supplies, facilities,
product formulations, trade secrets, time or other assets of Employer; (ii)
relate to the business, including anticipated research or development, of
Employer that are developed during the term of this Employment Agreement or
previously with Jean Grayson's Brownstone Studio, Inc. or Wilroy, Inc., or
(iii) result from work performed by Employee for Employer, are and shall
remain the sole property of Employer, and upon request made by Employer,
Employee shall assign any and all rights, including copyrights, patents and
patent rights, trade mark and trade dress rights, Employee may have therein to
Employer.
(c) Employer Materials. All reports and analysis,
designs, drawings, contracts, contractual arrangements, specifications,
computer software, computer hardware and other equipment, computer printouts,
computer disks, documents, memoranda, notebooks, correspondence, files, lists
and other records, and the like, and all photocopies or other reproductions
thereof, affecting or relating to the business of Employer which Employee
shall prepare, use, construct, observe, possess or control ("Employee
Materials"), shall be and remain the sole property of Employer. Upon
termination of this Employment Agreement, Employee shall deliver promptly to
Employer all such Employer Materials.
(d) Certain Restrictions on Business Activities.
During the term of this Employment Agreement, Employee agrees that:
(i) Business Activities. He will not, directly or
indirectly, own an interest in, operate, join, control or participate in, or
be connected as an officer, employee, agent, independent contractor, partner,
shareholder or principal of any corporation, partnership, proprietorship,
firm, association, person or other entity providing services and/or products
or a combination thereof which directly or indirectly compete with Employer's
business, and he will not undertake planning for or organization of any
business activity competitive with Employer's business or combine or conspire
with other employees or representatives of Employer's business for the purpose
of organizing any such competitive business activity, except the purchase of
less than four percent (4%) of the stock of a publicly traded company which is
not affiliated with Employer.
(ii) Solicitation of Customers, Etc. He will not,
directly or indirectly, either for himself or for any other person, firm or
corporation, divert or take away or attempt to divert or take away and, if the
Employee's termination of employment results for Cause (as defined herein) or
the Employee's voluntary termination of employment, for six (6) months after
the term of this Employment Agreement, call on or solicit or attempt to call
on or solicit in an attempt to so divert or take away any of Employer's
customers or distributors, including but not limited to, those upon whom
Employee called or whom Employee solicited or serviced or with whom Employee
became acquainted while engaged as an employee in Employer's, Jean Grayson's
Brownstone Studio, Inc.'s or Wilroy, Inc.'s business.
(iii) Solicitation of Employees, Etc. He will not,
directly or indirectly or by action in concert with others, induce or
influence (or seek to induce or influence) any person who is engaged (as an
employee, agent, independent contractor or otherwise) by Employer to terminate
his or her employment or engagement.
(e) Covenant Not to Compete.
(i) Obligations of Employee. Employee acknowledges
that, as a key management employee, Employee will be involved, on a high
level, in the development, implementation and management of the business
strategies and plans of Employer, which shall also consist of such other
business, units, divisions, subsidiaries or other entities of Employer as
Employer shall determine in its sole discretion from time to time (the
"Business"). By virtue of Employee's unique and sensitive position and special
background, employment of Employee by a competitor of Employer represents a
serious competitive danger to Employer and the Business,
3
<PAGE>
and the use of Employee's talent and knowledge and information about Employer
or the Business can and would constitute a valuable competitive advantage over
Employer and the Business. In view of the foregoing, Employee covenants and
agrees that, if Employee's employment with Employer is terminated other than
by Employer without Cause (as defined herein) at any time, for a period of
eighteen (18) months after the date of such termination, Employee will not
engage or be engaged, in any capacity, directly or indirectly, including but
not limited as employee, agent, consultant, manager, executive, owner or
stockholder (except as a passive investor holding less than a four percent
(4%) equity interest in any enterprise the securities of which are publicly
traded) in any business entity doing business in the United States engaged in
competition with any business conducted by Employer on the date of
termination. This Covenant Not to Compete shall survive the termination or
expiration of the other provisions of this Employment Agreement. If any court
determines that this Covenant Not to Compete, or any part thereof, is
unenforceable because of the duration or geographic scope of such provision,
such court shall have the power to reduce the duration or scope of such
provision, as the case may be, and, in its reduced form, such provision shall
then be enforceable.
(ii) Injunctive Relief. Employee acknowledges that
the violation of the covenants contained in this Section 8(e) would be
detrimental and cause irreparable injury to Employer and its affiliates which
could not be compensated by money damages. Employee agrees that an injunction
from a court of competent jurisdiction is the appropriate remedy for these
provisions, and consents to the entry of an appropriate judgment enjoining
Employee from violating these provisions in the event there is a finding of
their breach.
(f) Severability. Employee agrees, in the event that any
provision of this Section 8 or any word, phrase, clause, sentence or other
portion thereof shall be held to be unenforceable or invalid for any reason,
such provision or portion thereof shall be modified or deleted in such a
manner so as to make this Section 8 as modified legal and enforceable to the
fullest extent permitted under applicable laws. The validity and
enforceability of the remaining provisions or portions thereof shall not be
affected thereby and shall remain valid and enforceable to the fullest extent
permitted under applicable laws. A waiver of any breach of the provisions of
this Section 8 shall not be construed as a waiver of any subsequent breach of
the same or any other provision.
9. Termination.
(a) Termination by Employer.
(i) Employer may terminate this Agreement upon
written notice for Cause. For purposes hereof, "Cause" shall mean only (A)
action wilfully taken with the intention of being to the material detriment of
Employer or Diplomat, including engaging in conduct that constitutes activity
in competition with Employer or Diplomat; (B) the conviction of Employee for
the commission of a felony; (C) the habitual abuse of alcohol or controlled
substances; and/or (D) material breach of this Agreement, including, but not
limited to, Employee's duties under Section 3 hereof. Notwithstanding anything
to the contrary in this Section 9(a)(i), Employer may not terminate Employee's
employment under this Agreement for Cause unless Employee shall have first
received notice from the Board advising Employee of the specific acts or
omissions alleged to constitute Cause, and such acts or omissions continue
after Employee shall have had a reasonable opportunity (at least 20 days from
the date Employee receives the notice from the Board) to correct the acts or
omissions so complained of.
(ii) In the event that during the term of his
employment with Employer, Employee shall become Disabled (as that term is
defined herein), Employer may terminate this Agreement and Employee's
employment hereunder at any time upon 10 days' written notice to Employee and
Employee shall be entitled to receive disability payments during the
succeeding 12-month period at a rate equal to one-half of the rate of the base
salary as provided in Section 4(a) to which he was theretofore entitled,
payable in equal installments no less frequently than monthly plus all
employee benefits under Section 4(b). For the purposes of this Agreement,
Employee shall be deemed to have become Disabled when by reason of his
physical or mental incapacity, Employee shall not be able to perform his
duties hereunder for a period of six consecutive months or for an aggregate of
180
4
<PAGE>
days in any consecutive period of twelve months. Any proceeds of disability
insurance policies or plans maintained by Employer for the benefit of Employee
shall be paid to Employee up to an amount equal to the amount paid under the
first sentence of this Section 9(a)(ii).
(iii) This Employment Agreement and Employer's
obligations hereunder shall terminate upon Employee's death. Upon termination
for death, Employer shall continue to pay the compensation payments pursuant
to Section 4(a), plus the bonus under Section 10, pro-rated through the date
of termination, to the surviving spouse of Employee (or if there is none to
Employee's estate) for the succeeding three (3) months.
(b) Termination by Employee. Employee shall have the
right to terminate his employment under this Agreement upon 20 days' notice to
Employer given within 90 days following the occurrence of any of the following
events:
(A) Employer acts to materially reduce
Employee's duties and responsibilities hereunder. Employee's duties and
responsibilities shall not be deemed materially reduced for purposes hereof
solely by virtue of the fact that Employer is (or substantially all of its
assets are) sold to, or is combined with, another entity, provided that
Employee shall continue to have the same duties and responsibilities with
respect to Employer's business, and Employee shall report directly to the
corporate designee of the entity (or individual) that acquires Employer or its
assets;
(B) Any reduction in Employee's rate of base
compensation, or a material reduction in Employee's other benefits;
(C) A failure by Employer to obtain the
assumption of this Agreement by any successor; or
(D) A material breach of this Agreement by
Employer, which is not cured within twenty (20) days of written notice of such
breach by Employer.
If Employer shall terminate Employee's employment other than due to his death or
disability or for Cause (as defined in Section 9(a)(i) of this Agreement), or if
Employee shall terminate this Agreement under Section 9(b), Employee shall
receive solely, as liquidated damages, all amounts provided for by Section 4 and
all additional employee benefits under Sections 4 and 5 throughout the remaining
term of this Agreement regardless of the amount of compensation he may earn with
respect to any other employment he may obtain. In the event of Employee's death
or disability, Employee shall be entitled to reimbursed expenses under Section 5
incurred prior to the date of death or disability.
10. Bonus. Employee shall be entitled to an amount equal to
ten percent (10%) of Earnings before income taxes of Employer up to a maximum of
$250,000 per Annual Period ("Bonus") payable within 90 days after the end of
Employer's fiscal year. For the purpose of this Section 10 "Earnings" for any
fiscal year shall mean (i) the revenues of Employer, less returns, (ii) less
direct costs of Employer (including, but not limited to, the cost of merchandise
sold, employees dedicated solely to Employer, catalog production cost,
Employer's financing costs, and direct costs of sales of Employer's
merchandise), and (iii) less combined selling, general and administrative costs
and overhead of Diplomat allocated in accordance with Diplomat's policy as may
be modified from time to time, all as determined under U.S. Generally Accepted
Accounting Principles, consistently applied. Within 90 days after the end of
Employer's fiscal year, Employee shall receive a guaranteed payment of $10,000
per year for merchandise consulting to Lew Magram Ltd., which amount shall not
reduce any bonus earned under the first sentence of this Section 10.
5
<PAGE>
11. Excise Tax. In the event that any payment or benefit
received or to be received by Employee in connection with a termination of his
employment with Employer would constitute a "parachute payment" within the
meaning of Code Section 280G or any similar or successor provision to 280G
and/or would be subject to any excise tax imposed by Code Section 4999 or any
similar or successor provision then Employer shall assume all liability for the
payment of any such tax and Employer shall immediately reimburse Employee on a
"grossed-up" basis for any income taxes attributable to Employee by reason of
such Employer payment and reimbursements.
12. Arbitration. Any controversies between Employer and
Employee involving the construction or application of any of the terms,
provisions or conditions of this Agreement, save and except for any breaches
arising out of Sections 8 hereof, shall on the written request of either party
served on the other be submitted to arbitration. Such arbitration shall comply
with and be governed by the rules of the American Arbitration Association. An
arbitration demand must be made within one (1) year of the date on which the
party demanding arbitration first had notice of the existence of the claim to be
arbitrated, or the right to arbitration along with such claim shall be
considered to have been waived. An arbitrator shall be selected according to the
procedures of the American Arbitration Association. The cost of arbitration
shall be born by the losing party or in such proportions as the arbitrator shall
decide. The arbitrator shall have no authority to add to, subtract from or
otherwise modify the provisions of this Agreement, or to award punitive damages
to either party.
13. Attorneys' Fees and Costs. If any action at law or in
equity is necessary to enforce or interpret the terms of this Agreement, the
prevailing party shall be entitled to reasonable attorney's fees, costs and
necessary disbursements in addition to any other relief to which he may be
entitled.
14. Entire Agreement. This Agreement contains the entire
agreement between the parties with respect to the transactions contemplated
herein and supersedes, effective as of the date hereof any prior agreement or
understanding between Employer and Employee with respect to Employee's
employment by Employer. The unenforceability of any provision of this Agreement
shall not affect the enforceability of any other provision. This Agreement may
not be amended except by an agreement in writing signed by the Employee and the
Employer, or any waiver, change, discharge or modification as sought. Waiver of
or failure to exercise any rights provided by this Agreement and in any respect
shall not be deemed a waiver of any further or future rights.
15. Assignment. This Agreement shall not be assigned to other
parties, provided, however, this Agreement may be assigned by Employer to an
entity that acquires substantially all of the assets of Employer.
16. Governing Law. This Agreement and all the amendments
hereof, and waivers and consents with respect thereto shall be governed by the
internal laws of the State of New York.
17. Notices. All notices, responses, demands or other
communications under this Agreement shall be in writing and shall be deemed to
have been given when (a) delivered by hand; (b) sent by telefax, (with receipt
confirmed), provided that a copy is mailed by registered or certified mail,
return receipt requested, on such date; or (c) received by the addressee as sent
by express delivery service (receipt requested) in each case to the appropriate
addresses and telefax numbers as the party may designate to itself by notice to
the other parties:
(i) if to the Employer:
Diplomat Corporation
25 Key Fries Drive
Stony Point, New York 10980
Attention: Jonathan Rosenberg
Telefax: (914) 786-8727
Telephone: (914) 786-5552
6
<PAGE>
With a copy to:
Gersten, Savage, Kaplowitz & Fredericks, LLP
101 East 52nd Street
New York, New York 10022
Attention: Jay M. Kaplowitz, Esq.
Telefax: (212) 980-5192
Telephone: (212) 752-9700
(ii) if to the Employee:
Kenneth S. Grossman
7 Rosemont Place
Great Neck, New York 11023
Telefax: (516) 466-6252
Telephone: (516) 466-6239
With a copy to:
Warshaw Burstein Cohen Schlesinger & Kuh, LLP
555 Fifth Avenue
New York, New York 10017
Attention: Frederick R. Cummings, Jr., Esq.
Telefax: (212) 972-9150
Telephone: (212) 984-7700
18. Severability of Agreement. Should any part of this
Agreement for any reason be declared invalid by a court of competent
jurisdiction, such decision shall not affect the validity of any remaining
portion, which remaining provisions shall remain in full force and effect as if
this Agreement had been executed with the invalid portion thereof eliminated,
and it is hereby declared the intention of the parties that they would have
executed the remaining portions of this Agreement without including any such
part, parts or portions which may, for any reason, be hereafter declared
invalid.
19. Guarantee. Diplomat guarantees the obligations of Employer
under this Agreement.
[Signatures on following page]
IN WITNESS WHEREOF, the undersigned have executed this
agreement as of the day and year first above written.
BROWNSTONE HOLDINGS, INC.
By: /s/ JONATHAN ROSENBERG
------------------------------
Jonathan Rosenberg, President
7
<PAGE>
/S/ KENNETH GROSSMAN
------------------------------
Kenneth Grossman
As to Section 19
DIPLOMAT CORPORATION
By: /S/ JONATHAN ROSENBERG
------------------------------
Jonathan Rosenberg, President
8
<PAGE>
Exhibit 10w - Employment Agreement with Joan Grossman
BROWNSTONE HOLDINGS, INC.
EMPLOYMENT AGREEMENT
EMPLOYMENT AGREEMENT is effective as of the 30th day of
October, 1997 by and between BROWNSTONE HOLDINGS, INC., a Delaware corporation
(hereinafter referred to as "Employer"), a wholly-owned subsidiary of Diplomat
Corporation, a Delaware corporation ("Diplomat") and JOAN GROSSMAN, (hereinafter
referred to as "Employee");
W I T N E S S E T H:
WHEREAS, Employer desires to employ Employee as Director of
Product Development of the Employer; and
WHEREAS, Employee is willing to be employed as Director of
Product Development of the Employer in the manner provided for herein, and to
perform the duties of Director of Product Development of Employer upon the terms
and conditions herein set forth;
NOW, THEREFORE, in consideration of the promises and mutual
covenants herein set forth it is agreed as follows:
1. Employment of Employee. Employer hereby employs Employee
as Director of Product Development of the Employer.
2. Term. The term of this Agreement shall commence as of the
30th day of October, 1997 (the "Commencement Date") and expire five (5) years
from such date. Each 12 month period from the Commencement Date forward during
the term hereof shall be referred to as an "Annual Period." During the term
hereof, Employee shall devote substantially all of her business time and efforts
to Employer and its subsidiaries and affiliates.
3. Duties. Employee hereby agrees that, throughout the period
of her employment hereunder, she shall devote substantially all of her business
time, attention, knowledge and skills, faithfully, diligently and to the best of
her ability, in furtherance of the business of Employer, shall perform the
duties assigned to her by the officers of Diplomat consistent with her position,
and shall observe and carry out such rules and regulations, policies and
directions as Employer may from time to time establish and consistent with her
position. During the term of this Agreement, Employee shall do such traveling as
may be reasonably required of her in the performance of her duties on behalf of
Employer. Employee shall be available to confer and consult with and advise the
officers and directors of Employer and Diplomat at such times that may be
reasonably required by Employer and Diplomat. Employee shall report directly and
solely to the Chief Executive Officer and Chief Operating Officer of Employer.
4. Compensation.
(a) Employee shall be paid a minimum of $172,500
for each Annual Period. Employee shall be paid periodically in accordance with
the policies of the Employer during the term of this Agreement, but not less
frequently than bi-weekly. Employee is eligible for an annual bonus, if any,
which will be determined and paid in accordance with policies set from time to
time by the Board of Diplomat.
1
<PAGE>
(b) Employee shall be entitled to participate
in and receive the benefits of all pension, profit-sharing, deferred
compensation, retirement, hospitalization, insurance, medical or dental or other
benefit plan or arrangement generally available to executive employees of
Employer as may now or hereafter exist. Employee shall also be entitled to
participate in or receive all other benefits and perquisites generally available
to senior executives of Employer that may be in effect from time to time during
the Employee's employment hereunder. Employer shall be under no obligation to
institute or continue the existence of any such employee plan, benefit or
perquisite.
5. Expenses. Employer shall reimburse Employee, promptly upon
presentation of receipts or vouchers thereof, for all expenses reasonably
incurred by her, including parking expenses, in connection with the performance
of her duties hereunder and the business of Employer, all in accordance with
policies of Employer from time to time in effect. Employer shall continue
automobile lease payments and shall continue to pay the cost of maintenance fuel
and insurance for the automobile through the lease term on the automobile lease
currently in place for the benefit of Employee. Thereafter, Employer shall
furnish Employee an automobile in accordance with Employer's benefit plan, if
any, for senior executives. Employee shall be provided a corporate credit card
in accordance with Employer's policy, if any.
6. Vacation. Employee shall be entitled to receive three (3)
weeks paid vacation time after each year of employment upon dates agreed upon by
Employer. Upon separation of employment, for any reason, vacation time accrued
and not used shall be paid at the salary rate of Employee in effect at the time
of employment separation.
7. Employee's Representations. Employee is free to enter into
this Employment Agreement and to perform each of the provisions contained
herein. Employee represents and warrants that Employee is not restricted or
prohibited, contractually or otherwise, from entering into and performing this
Employment Agreement, and that Employee's execution and performance of this
Employment Agreement is not a violation or breach of any agreement between
Employee and any other person or entity.
8. Nondisclosure of Confidential Information; Ownership of
Intellectual Property Rights; Non Competition; Covenant Not to Compete.
(a) Nondisclosure of Confidential Information.
During the term of this Employment Agreement and at all times thereafter,
Employee will keep confidential and will not directly or indirectly divulge to
anyone nor use or otherwise appropriate for Employee's own benefit, or on behalf
of any other person, firm, partnership or corporation by whom Employee might
subsequently be employed or otherwise associated or affiliated with, any
Confidential Information (as defined herein). For this purpose, "Confidential
Information" means any and all trade secrets or other confidential information
of any kind, nature or description concerning any matters affecting or relating
to the business of Employer or any affiliate of Employer which derives economic
value, actual or potential, from not being generally known to the public or the
trade or to other persons who can obtain economic value from its disclosure or
use and which is subject to efforts by Employer that are reasonable under the
circumstances to maintain its secrecy. Confidential Information does not include
information which (a) is or becomes generally available to the public or the
trade other than as a result of a disclosure by Employee or any of her agent or
representatives, or (b) was within Employee's possession prior to its being
furnished to Employee by Employer, Jean Grayson's Brownstone Studio, Inc., or
Wilroy, Inc.; provided that the source of such information in the case of either
clause (a) or (b) was not bound by a confidentiality agreement or other
contractual obligation of confidentiality with respect to such information or
did not otherwise acquire or disclose such information wrongfully.
2
<PAGE>
(b) Employer Intellectual Property Rights.
All intellectual property rights, whether or not patentable or copyrightable,
which (i) are made or developed with the equipment, supplies, facilities,
product formulations, trade secrets, time or other assets of Employer; (ii)
relate to the business, including anticipated research or development, of
Employer that are developed during the term of this Employment Agreement or
previously with Jean Grayson's Brownstone Studio, Inc. or Wilroy, Inc., or (iii)
result from work performed by Employee for Employer, are and shall remain the
sole property of Employer, and upon request made by Employer, Employee shall
assign any and all rights, including copyrights, patents and patent rights,
trade mark and trade dress rights, Employee may have therein to Employer.
(c) Employer Materials. All reports and
analysis, designs, drawings, contracts, contractual arrangements,
specifications, computer software, computer hardware and other equipment,
computer printouts, computer disks, documents, memoranda, notebooks,
correspondence, files, lists and other records, and the like, and all
photocopies or other reproductions thereof, affecting or relating to the
business of Employer which Employee shall prepare, use, construct, observe,
possess or control ("Employee Materials"), shall be and remain the sole property
of Employer. Upon termination of this Employment Agreement, Employee shall
deliver promptly to Employer all such Employer Materials.
(d) Certain Restrictions on Business
Activities. During the term of this Employment Agreement, Employee agrees that:
(i) Business Activities. She will not,
directly or indirectly, own an interest in, operate, join, control or
participate in, or be connected as an officer, employee, agent, independent
contractor, partner, shareholder or principal of any corporation, partnership,
proprietorship, firm, association, person or other entity providing services
and/or products or a combination thereof which directly or indirectly compete
with Employer's business, and she will not undertake planning for or
organization of any business activity competitive with Employer's business or
combine or conspire with other employees or representatives of Employer's
business for the purpose of organizing any such competitive business activity,
except the purchase of less than four percent (4%) of the stock of a publicly
traded company which is not affiliated with Employer.
(ii) Solicitation of Customers, Etc. She
will not, directly or indirectly, either for herself or for any other person,
firm or corporation, divert or take away or attempt to divert or take away and,
if the Employee's termination of employment results for Cause (as defined
herein) or the Employee's voluntary termination of employment, for six (6)
months after the term of this Employment Agreement call on or solicit or attempt
to call on or solicit in an attempt to so divert or take away any of Employer's
customers or distributors, including but not limited to, those upon whom
Employee called or whom Employee solicited or serviced or with whom Employee
became acquainted while engaged as an employee in Employer's, Jean Grayson's
Brownstone Studio, Inc.'s, or Wilroy, Inc.'s business.
(iii) Solicitation of Employees, Etc.
She will not, directly or indirectly or by action in concert with others, induce
or influence (or seek to induce or influence) any person who is engaged (as an
employee, agent, independent contractor or otherwise) by Employer to terminate
his or her employment or engagement.
(e) Covenant Not to Compete.
(i) Obligations of Employee. Employee
acknowledges that, as a key management employee, Employee will be involved, on a
high level, in the development, implementation and management of the business
strategies and plans of Employer, which shall also consist of such other
business, units, divisions, subsidiaries or other entities of Employer as
Employer shall determine in its sole discretion from time to time (the
"Business"). By virtue of Employee's unique and sensitive position and special
background, employment
3
<PAGE>
of Employee by a competitor of Employer represents a serious competitive danger
to Employer and the Business, and the use of Employee's talent and knowledge and
information about Employer or the Business can and would constitute a valuable
competitive advantage over Employer and the Business. In view of the foregoing,
Employee covenants and agrees that, if Employee's employment with Employer is
terminated other than by Employer without Cause (as defined herein) at any time,
for a period of eighteen (18) months after the date of such termination,
Employee will not engage or be engaged, in any capacity, directly or indirectly,
including but not limited as employee, agent, consultant, manager, executive,
owner or stockholder (except as a passive investor holding less than a four
percent (4%) equity interest in any enterprise the securities of which are
publicly traded) in any business entity doing business in the United States
engaged in competition with any business conducted by Employer on the date of
termination. This Covenant Not to Compete shall survive the termination or
expiration of the other provisions of this Employment Agreement. If any court
determines that this Covenant Not to Compete, or any part thereof, is
unenforceable because of the duration or geographic scope of such provision,
such court shall have the power to reduce the duration or scope of such
provision, as the case may be, and, in its reduced form, such provision shall
then be enforceable.
(ii) Injunctive Relief. Employee
acknowledges that the violation of the covenants contained in this Section 8(e)
would be detrimental and cause irreparable injury to Employer and its affiliates
which could not be compensated by money damages. Employee agrees that an
injunction from a court of competent jurisdiction is the appropriate remedy for
these provisions, and consents to the entry of an appropriate judgment enjoining
Employee from violating these provisions in the event there is a finding of
their breach.
(f) Severability. Employee agrees, in the event
that any provision of this Section 8 or any word, phrase, clause, sentence or
other portion thereof shall be held to be unenforceable or invalid for any
reason, such provision or portion thereof shall be modified or deleted in such a
manner so as to make this Section 8 as modified legal and enforceable to the
fullest extent permitted under applicable laws. The validity and enforceability
of the remaining provisions or portions thereof shall not be affected thereby
and shall remain valid and enforceable to the fullest extent permitted under
applicable laws. A waiver of any breach of the provisions of this Section 8
shall not be construed as a waiver of any subsequent breach of the same or any
other provision.
10. Termination.
(a) Termination by Employer.
(i) Employer may terminate this
Agreement upon written notice for Cause. For purposes hereof, "Cause" shall mean
only (A) action wilfully taken with the intention of being to the material
detriment of Employer or Diplomat including engaging by the Employee in conduct
that constitutes activity in competition with Employer or Diplomat; (B) the
conviction of Employee for the commission of a felony; (C) the habitual abuse of
alcohol or controlled substances; and/or (D) material breach of this Agreement,
including, but not limited to, Employee's duties under Section 3 hereof.
Notwithstanding anything to the contrary in this Section 9(a)(i), Employer may
not terminate Employee's employment under this Agreement for Cause unless
Employee shall have first received notice from the Board advising Employee of
the specific acts or omissions alleged to constitute Cause, and such acts or
omissions continue after Employee shall have had a reasonable opportunity (at
least 20 days from the date Employee receives the notice from the Board) to
correct the acts or omissions so complained of.
(ii) In the event that during the term of
her employment with Employer, Employee shall become Disabled (as that term is
defined herein), Employer may terminate this Agreement and Employee's employment
hereunder at any time upon 10 days' written notice to Employee and Employee
shall be entitled to receive disability payments during the succeeding 12-month
period at a rate equal to one-half of the rate of the base salary as provided in
Section 4(a) to which she was theretofore entitled, payable in equal
installments no
4
<PAGE>
less frequently than monthly plus all employee benefits under Section 4(b). For
the purposes of this Agreement, Employee shall be deemed to have become Disabled
when by reason of his physical or mental incapacity, Employee shall not be able
to perform his duties hereunder for a period of six consecutive months or for an
aggregate of 180 days in any consecutive period of twelve months. Any proceeds
of disability insurance policies or plans maintained by Employer for the benefit
of Employee shall be paid to Employee up to an amount equal to the amount paid
under the first sentence of this Section 9(a)(ii).
(iii) This Employment Agreement and
Employer's obligations hereunder shall terminate upon Employee's death. Upon
termination for death, Employer shall continue to pay the compensation payments
pursuant to Section 4(a) to the surviving spouse of Employee (or if there is
none to Employee's estate) for the succeeding three (3) months.
(b) Termination by Employee. Employee shall
have the right to terminate her employment under this Agreement upon 20 days'
notice to Employer given within 90 days following the occurrence of any of the
following events:
(A) Employer acts to
materially reduce Employee's duties and responsibilities hereunder. Employee's
duties and responsibilities shall not be deemed materially reduced for purposes
hereof solely by virtue of the fact that Employer is (or substantially all of
its assets are) sold to, or is combined with, another entity, provided that
Employee shall continue to have the same duties and responsibilities with
respect to Employer's business, and Employee shall report directly to the
corporate designee of the entity (or individual) that acquires Employer or its
assets;
(B) Any reduction in Employee's rate
of base compensation, or a material reduction in Employee's other benefits;
(C) A failure by Employer to obtain
the assumption of this Agreement by any successor; or
(D) A material breach of this
Agreement by Employer, which is not cured within twenty (20) days of written
notice of such breach by Employer.
If Employer shall terminate Employee's employment other than due to her death or
disability or for Cause (as defined in Section 9(a)(i) of this Agreement), or if
Employee shall terminate this Agreement under Section 9(b), Employee shall
receive solely, as liquidated damages, all amounts provided for by Section 4 and
all additional employee benefits under Sections 4 and 5 throughout the remaining
term of this Agreement regardless of the amount of compensation she may earn
with respect to any other employment she may obtain. In the event of Employee's
death or disability, Employee shall be entitled to be reimbursed expenses under
Section 5 incurred prior to the date of death or disability.
10. [Reserved]
11. Excise Tax. In the event that any payment or benefit
received or to be received by Employee in connection with a termination of his
employment with Employer would constitute a "parachute payment" within the
meaning of Code Section 280G or any similar or successor provision to 280G
and/or would be subject to any excise tax imposed by Code Section 4999 or any
similar or successor provision then Employer shall assume all liability for the
payment of any such tax and Employer shall immediately reimburse Employee on a
"grossed-up" basis for any income taxes attributable to Employee by reason of
such Employer payment and reimbursements.
5
<PAGE>
12. Arbitration. Any controversies between Employer and
Employee involving the construction or application of any of the terms,
provisions or conditions of this Agreement, save and except for any breaches
arising out of Sections 8 hereof, shall on the written request of either party
served on the other be submitted to arbitration. Such arbitration shall comply
with and be governed by the rules of the American Arbitration Association. An
arbitration demand must be made within one (1) year of the date on which the
party demanding arbitration first had notice of the existence of the claim to be
arbitrated, or the right to arbitration along with such claim shall be
considered to have been waived. An arbitrator shall be selected according to the
procedures of the American Arbitration Association. The cost of arbitration
shall be born by the losing party or in such proportions as the arbitrator shall
decide. The arbitrator shall have no authority to add to, subtract from or
otherwise modify the provisions of this Agreement, or to award punitive damages
to either party.
13. Attorneys' Fees and Costs. If any action at law or in
equity is necessary to enforce or interpret the terms of this Agreement, the
prevailing party shall be entitled to reasonable attorney's fees, costs and
necessary disbursements in addition to any other relief to which he may be
entitled.
14. Entire Agreement. This Agreement contains the entire
agreement between the parties with respect to the transactions contemplated
herein and supersedes, effective as of the date hereof any prior agreement or
understanding between Employer and Employee with respect to Employee's
employment by Employer. The unenforceability of any provision of this Agreement
shall not affect the enforceability of any other provision. This Agreement may
not be amended except by an agreement in writing signed by the Employee and the
Employer, or any waiver, change, discharge or modification as sought. Waiver of
or failure to exercise any rights provided by this Agreement and in any respect
shall not be deemed a waiver of any further or future rights.
15. Assignment. This Agreement shall not be assigned to other
parties, provided, however, this Agreement may be assigned by Employer to an
entity that acquires substantially all of the assets of the Employer.
16. Governing Law. This Agreement and all the amendments
hereof, and waivers and consents with respect thereto shall be governed by the
internal laws of the State of New York.
17. Notices. All notices, responses, demands or other
communications under this Agreement shall be in writing and shall be deemed to
have been given when (a) delivered by hand; (b) sent by telefax, (with receipt
confirmed), provided that a copy is mailed by registered or certified mail,
return receipt requested, on such date; or (c) received by the addressee as sent
by express delivery service (receipt requested) in each case to the appropriate
addresses and telefax numbers as the party may designate to itself by notice to
the other parties:
(i) if to the Employer:
Diplomat Corporation
25 Key Fries Drive
Stony Point, New York 10980
Attention: Jonathan Rosenberg
Telefax: (914) 786-8727
Telephone: (914) 786-5552
With a copy to:
Gersten, Savage, Kaplowitz
&Fredericks, LLP
101 East 52nd Street
New York, New York 10022
6
<PAGE>
Attention: Jay M. Kaplowitz, Esq.
Telefax: (212) 980-5192
Telephone: (212) 752-9700
(ii) if to the Employee:
Joan Grossman
7 Rosemont Place
Great Neck, New York 11023
Telefax: (516) 466-6252
Telephone: (516) 466-6239
With a copy to:
Warshaw Burstein Cohen Schlesinger
& Kuh, LLP
555 Fifth Avenue
New York, New York 10017
Attention: Frederick R. Cummings,
Jr., Esq.
Telefax: (212) 972-9150
Telephone: (212) 984-7700
18. Severability of Agreement. Should any part of this
Agreement for any reason be declared invalid by a court of competent
jurisdiction, such decision shall not affect the validity of any remaining
portion, which remaining provisions shall remain in full force and effect as if
this Agreement had been executed with the invalid portion thereof eliminated,
and it is hereby declared the intention of the parties that they would have
executed the remaining portions of this Agreement without including any such
part, parts or portions which may, for any reason, be hereafter declared
invalid.
19. Guarantee. Diplomat guarantees the obligations of Employer
under this Agreement.
[Signatures on following page]
IN WITNESS WHEREOF, the undersigned have executed this
agreement as of the day and year first above written.
BROWNSTONE HOLDINGS, INC.
By: /s/ JONATHAN ROSENBERG
---------------------------------
Jonathan Rosenberg, President
/S/ JOAN GROSSMAN
---------------------------------
Joan Grossman
As to Section 19
7
<PAGE>
DIPLOMAT CORPORATION
By: /s/ JONATHAN ROSENBERG
---------------------------------
Jonathan Rosenberg, President
8
<PAGE>
Exhibit 22 - List of Subsidiaries
Lew Magram Ltd., a New York Corporation
Ecology Kids, Inc., a Delaware corporation
Brownstone Holdings, Inc., a Delaware corporation
Diplomat Holdings, Inc., a California corporation
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AND CONSOLIDATED STATEMENTS OF OPERATIONS INCLUDED
IN THE REGISTRANT'S FORM 10-K FOR THE YEAR ENDED SEPTEMBER 30, 1998 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-01-1997
<PERIOD-END> SEP-30-1998
<CASH> 322,778
<SECURITIES> 0
<RECEIVABLES> 2,125,405
<ALLOWANCES> 204,196
<INVENTORY> 11,066,380
<CURRENT-ASSETS> 23,579,531
<PP&E> 7,695,282
<DEPRECIATION> 3,518,379
<TOTAL-ASSETS> 50,958,883
<CURRENT-LIABILITIES> 28,039,133
<BONDS> 6,383,585
0
16,113,107
<COMMON> 1,100
<OTHER-SE> 9,930,314
<TOTAL-LIABILITY-AND-EQUITY> 50,958,883
<SALES> 74,585,592
<TOTAL-REVENUES> 74,585,592
<CGS> 34,433,297
<TOTAL-COSTS> 37,537,372
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,355,324
<INCOME-PRETAX> 1,259,599
<INCOME-TAX> 0
<INCOME-CONTINUING> 1,259,599
<DISCONTINUED> (2,322,392)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,062,793)
<EPS-PRIMARY> (.13)
<EPS-DILUTED> (.13)
</TABLE>
