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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-25488
THE L.L. KNICKERBOCKER CO., INC.
- -------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
CALIFORNIA 33-0230641
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
25800 COMMERCENTRE DRIVE
LAKE FOREST, CALIFORNIA 92630
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(Address of principal executive offices) (Zip Code)
ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE: (949) 595-7900
Indicate by mark whether the issuer: (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
The number of shares outstanding of the registrant's Common Stock, as of April
30, 1999 was 28,662,753.
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TABLE OF CONTENTS
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ITEM PAGE
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PART I
1. FINANCIAL INFORMATION................................................. 1
A. Condensed Consolidated Statements of Operations (unaudited)
for the three month periods ended March 31, 1999 and
March 31, 1998............................................ 1
B. Condensed Consolidated Statements of Comprehensive Income/
Loss (unaudited) for the three month periods ended
March 31, 1999 and March 31, 1998......................... 2
C. Condensed Consolidated Balance Sheets at March 31, 1999
(unaudited) and December 31, 1998......................... 3
D. Condensed Consolidated Statements of Cash Flows (unaudited)
for the three month periods ended March 31, 1999 and
March 31, 1998............................................ 5
E. Notes to Condensed Consolidated Financial Statements......... 7
2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS................................................ 12
A. General Business Description.................................. 12
B. Results of Operations......................................... 12
C. Liquidity and Capital Resources............................... 14
PART II
1. LEGAL PROCEEDINGS.................................................... 17
2. CHANGES IN SECURITIES AND USE OF PROCEEDS............................ 18
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................. 18
6. EXHIBITS AND REPORTS ON FORM 8-K..................................... 18
SIGNATURES........................................................... 19
</TABLE>
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
THE L.L. KNICKERBOCKER CO., INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
<TABLE>
<CAPTION>
Three months ended March 31,
--------------------------------
1999 1998
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<S> <C> <C>
Sales, net of returns $ 9,485,000 $ 11,482,000
Cost of sales 4,768,000 4,856,000
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Gross profit 4,717,000 6,626,000
Advertising expense 1,122,000 2,413,000
Selling expense 1,769,000 978,000
General and administrative expense 3,567,000 4,793,000
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Operating loss (1,741,000) (1,558,000)
Loss on equity method investments -- 553,000
Other (income) expense, net (118,000) 17,000
Interest expense (Note 4) 633,000 581,000
------------ ------------
Loss before minority interest and
income tax expense (2,256,000) (2,709,000)
Minority interest in loss of subsidiary -- (133,000)
Income tax expense 21,000 --
------------ ------------
Net loss $ (2,277,000) $ (2,576,000)
============ ============
Net loss per share:
Basic and diluted $ (0.09) $ (0.14)
============ ============
Shares used in computing net loss per share:
Basic and diluted 26,138,494 19,053,855
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
1
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THE L.L. KNICKERBOCKER CO., INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME / LOSS
(unaudited)
<TABLE>
<CAPTION>
Three months ended March 31,
-------------------------------
1999 1998
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<S> <C> <C>
Net Loss $(2,277,000) $(2,576,000)
Other comprehensive income (loss):
Foreign currency translation adjustments (204,000) 1,849,000
----------- -----------
Comprehensive loss $(2,481,000) $ (727,000)
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</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
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THE L.L. KNICKERBOCKER CO., INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
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<S> <C> <C>
ASSETS
Cash and cash equivalents $ 181,000 $ 199,000
Restricted cash 304,000 310,000
Accounts receivable 8,261,000 8,365,000
Inventories 11,666,000 10,989,000
Prepaid expenses and other current assets 2,437,000 2,745,000
Notes receivable 1,800,000 1,800,000
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Total current assets 24,649,000 24,408,000
Property and equipment, net 4,847,000 4,970,000
Receivable from stockholder 1,081,000 1,072,000
Investments 3,541,000 3,541,000
Other assets 1,251,000 1,342,000
Goodwill, net of accumulated amortization of
$1,509,000 and $1,395,000 as of March 31, 1999
and December 31, 1998, respectively 3,281,000 3,409,000
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$38,650,000 $38,742,000
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</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
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THE L.L. KNICKERBOCKER CO., INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
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<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 9,396,000 $ 9,461,000
Accrued expenses 3,868,000 3,080,000
Notes payable 5,829,000 4,324,000
Commissions and royalties payable 1,400,000 1,368,000
Interest payable 450,000 595,000
Income taxes payable 157,000 279,000
Current portion of long-term debt 159,000 215,000
Due to former shareholders of Krasner Group, Inc. 203,000 280,000
Deferred gain 1,642,000 1,642,000
Convertible debentures, net of discount of
$299,000 at March 31, 1999 and $491,000
at December 31, 1998 4,741,000 10,949,000
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Total current liabilities 27,845,000 32,193,000
Long-term debt, less current portion 493,000 541,000
Convertible debentures, net of discount of
$47,000 at March 31, 1999 and $110,000
at December 31, 1998 1,853,000 2,740,000
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Total long-term liabilities 2,346,000 3,281,000
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Stockholders' equity:
Common stock 38,513,000 30,757,000
Additional paid-in capital 6,028,000 6,112,000
Accumulated deficit (32,222,000) (29,945,000)
Accumulated other comprehensive loss (3,860,000) (3,656,000)
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Total stockholders' equity 8,459,000 3,268,000
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$ 38,650,000 $ 38,742,000
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</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
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THE L.L. KNICKERBOCKER CO., INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
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<CAPTION>
March 31, March 31,
1999 1998
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<S> <C> <C>
Cash flows from operating activities:
Net loss $(2,277,000) $(2,576,000)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 341,000 616,000
Equity in loss of investees -- 553,000
(Gain) loss on disposition of fixed assets (9,000) 18,000
Minority interest -- (133,000)
Amortization of debt discount 255,000 42,000
Changes in operating accounts:
Accounts receivable, net 104,000 (1,568,000)
Inventories (677,000) (1,440,000)
Prepaid expenses and other current assets 308,000 (1,316,000)
Other assets (39,000) 74,000
Accounts payable and accrued expenses 907,000 1,437,000
Commissions and royalties payable 32,000 (395,000)
Income taxes payable (122,000) (39,000)
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Net cash used in operating activities (1,177,000) (4,727,000)
Cash flows from investing activities:
Acquisitions of property and equipment (143,000) (273,000)
Proceeds from sales of property and equipment 9,000 21,000
Receivable from stockholder (9,000) 1,383,000
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Net cash (used in) provided by investing activities (143,000) 1,131,000
Cash flows from financing activities:
Net borrowings on line of credit 1,505,000 2,167,000
Payments on long-term debt (94,000) (74,000)
Borrowings on long-term debt -- 52,000
Proceeds from exercise of common stock purchase
warrants/options -- 75,000
Net borrowings on stockholder loan -- 687,000
----------- -----------
Net cash provided by financing activities 1,411,000 2,907,000
Effect of exchange rate changes on cash (115,000) 1,030,000
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Net increase (decrease) in cash and cash equivalents (24,000) 341,000
Cash and cash equivalents, beginning of period 509,000 342,000
----------- -----------
Cash and cash equivalents, end of period $ 485,000 $ 683,000
=========== ===========
Supplemental disclosures of cash flow information:
Cash paid for interest $ 215,000 $ 218,000
=========== ===========
Cash paid for income taxes $ 105,000 $ 32,000
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</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
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THE L.L. KNICKERBOCKER CO. INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(unaudited)
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITY:
During the three months ended March 31, 1999, $7,350,000 of convertible
debentures and $240,000 of accrued interest was converted to common stock.
During the three months ended March 31, 1999, the Company issued 151,220 shares
of common stock in payment of $77,000 of liability to former shareholders of
Krasner Group, Inc.
See accompanying notes to condensed consolidated financial statements.
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THE L.L. KNICKERBOCKER CO., INC.
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
NOTE 1: BASIS OF PRESENTATION
The information set forth in these consolidated financial statements is
unaudited except for the December 31, 1998 balance sheet. These statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information, the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements.
The accompanying condensed consolidated financial statements include the
accounts of The L.L. Knickerbocker Co., Inc.; its wholly-owned subsidiaries
Krasner Group, Inc., Harlyn International Co., Ltd., L.L. Knickerbocker (Thai)
Co., Ltd., and S.L.S. Trading Co., Ltd., and its majority-owned subsidiary
Georgetown Collection, Inc. All intercompany accounts and transactions have been
eliminated.
In the opinion of management, all adjustments, consisting only of normal
recurring accruals, necessary for a fair presentation have been included. The
results of operations for the three month period ended March 31, 1999 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 1999. For further information, refer to the financial statements
and notes thereto included in the Company's annual report on Form 10-K for the
year ended December 31, 1998.
Certain prior period balances have been reclassified to conform with current
presentation.
NOTE 2: EARNINGS PER SHARE
The Company computes income (loss) per share pursuant to Statement of Financial
Accounting Standards No. 128, "Earnings per Share" (SFAS 128), which requires
the dual presentation of basic and diluted earning per share. Shares issuable
upon the exercise of common stock warrants and options and shares issuable upon
the conversion of convertible debentures have been excluded from the three month
periods ended March 31, 1999 and 1998 per share calculations because their
effect is antidilutive.
NOTE 3: INVENTORIES
As of March 31, 1999 and December 31, 1998 inventories consisted of the
following:
<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998
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<S> <C> <C>
Finished goods $ 12,228,000 $ 11,710,000
Work-in-progress 666,000 663,000
Raw materials 1,630,000 1,532,000
Inventory reserves (2,612,000) (2,670,000)
------------ ------------
$ 11,912,000 $ 11,235,000
============ ============
</TABLE>
NOTE 4: CONVERTIBLE DEBENTURES
1998 Debentures - In June 1998, the Company issued Convertible Debentures (the
1998 Debentures) with a face value of $7,000,000 in a private placement to
institutional investors. This private placement yielded net proceeds to the
Company totaling $6,573,000 after deducting costs associated with issuing the
1998 Debentures. The 1998 Debentures accrue interest at the rate of 6% per
annum, payable upon conversion of
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the related debt. The 1998 Debentures are convertible at the option of the
holder into shares of the Company's common stock at the lower of $4.02 or a
graduated discounted price ranging from 97% to 90% of an average of the 7 lowest
trading days of the 30 consecutive trading days prior to conversion. The
discounted price of 90% applies if the investor does not convert prior to the
two-year anniversary of the closing date. Through March 31, 1999, the Company
issued a total of 4,174,043 shares of its common stock in connection with the
conversion of $1,960,000 of the principal amount of the 1998 Debentures, plus
interest accrued through the conversion date of $71,000.
The 1998 Debentures were subject to an agreement whereby after approval by the
shareholders of the Company of the issuance of the 1998 Debentures and the
creation of a class of Preferred Stock of the Company, the 1998 Debentures would
be exchanged for shares of newly created Preferred Stock of the Company, the
terms of which would be substantially similar to that of the 1998 Debentures.
However, the 1998 Debenture Holders chose not to exchange the 1998 Debentures
for Preferred Stock, citing a "material adverse effect," which was the decline
in the price of the Company's common stock. Under the terms of the related
agreements the 1998 Debentures matured on December 28, 1998. The Company was
unable to repay the 1998 Debenture Holders as of December 31, 1998 and is in
default of the 1998 Debenture Agreement. Although the company is attempting to
negotiate an extension of the maturity date, under the terms of the 1998
Debentures the face amount of the Debentures, aggregating $5,040,000, is due and
payable by the Company.
The conversion of the securities at a maximum of 90% of the closing price of the
Company's common stock resulted in the 1998 Debentures being issued at a
discount (the conversion discount). The Company is recognizing the conversion
discount as non-cash interest expense over the estimated term of the 1998
Debentures (two years) with a corresponding increase to the original principal
amount of the 1998 Debentures. Upon conversion of the 1998 Debentures any
portion of the conversion discount not previously recognized is recorded as
interest expense on the conversion date. In connection with the issuance of the
1998 Debentures, the Company issued to the investors warrants to purchase
261,194 shares of common stock. The warrants vest as of the grant date with an
exercise price of $4.72 per share, which was equivalent to 135% of the fair
market value of the Company's common stock at the date of grant and are valid
for five years from the date of the grant. The warrants have an ascribed value
of $470,000 (determined utilizing the Black-Scholes option-pricing model), which
was recorded as debt discount (the warrant discount) and additional paid-in
capital. The Company recognized the warrant discount as noncash interest expense
over the approximate seven-month term of the securities in 1998. During the
three months ended March 31, 1999, a total of $274,000 of noncash interest
expense was recorded relating to the 1998 Debentures, including $126,000
relating to the additional conversion discount recorded upon conversion.
1997 Debentures - In September 1997, the Company issued Convertible Debentures
(the 1997 Debentures) with a face value of $5,000,000 in a private placement to
an institutional investor. This private placement yielded net proceeds to the
Company totaling $4,675,000 after deducting costs associated with issuing the
1997 Debentures.The 1997 Debentures accrue interest at the rate of 6% per annum,
payable upon conversion of the related debt or at debt maturity of September 7,
2000. The 1997 Debentures are convertible at the option of the holder into
shares of the Company's common stock at a graduated discounted price ranging
from 97% to 90% of an average of the 7 lowest trading days of the 30 consecutive
trading days prior to conversion. The discounted price of 90% applies if the
investor does not convert prior to the two-year anniversary of the closing date.
As of March 31, 1999, the Company issued a total of 3,312,330 shares of its
common stock in connection with the conversion of $3,100,000 of the principal
amount of the 1997 Debentures, plus interest accrued through the conversion date
of $190,000.
The conversion of the notes at a maximum of 90% of the closing price of the
Company's common stock resulted in the 1997 Debentures being issued at a
discount (the conversion discount). The conversion discount is being recognized
by the Company as noncash interest expense over the estimated term of the 1997
Debentures (two years) with a corresponding increase to the original principal
amount of the 1997 Debentures. Upon conversion of the 1997 Debentures, any
portion of the conversion discount not previously recognized is recorded as
interest expense on the conversion date. During the three months
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ended March 31, 1999 and 1998, a total of $123,000 and $42,000, respectively, of
noncash interest expense was recorded relating to the 1997 Debentures, including
$35,000 in the three months ended March 31, 1999 relating to the additional
conversion discount recorded upon conversion (none in 1998).
1996 Debentures - In September 1996, the Company issued Convertible Debentures
(the 1996 Debentures) with a face value of $15,500,000 in a private placement to
institutional investors. This private placement yielded net proceeds to the
Company totaling $14,730,000 after deducting costs associated with issuing the
1996 Debentures. The Debentures accrued interest of the rate of 7% per year,
payable quarterly. The Debentures were convertible at the option of the holder
into shares of the Company's common stock at a price equal to 85% of the closing
price of the Company's common stock at the date of conversion, subject to a
minimum and maximum conversion price of $5.25 and $12.00 per share, at any time
through the second anniversary of the original date of issuance. In January
1997, the Company reached agreement with the debenture holders to tender all
outstanding Debentures to the Company in exchange for new convertible Debentures
(the New Debentures). Under the terms of the agreement, New Debentures were
issued with a face value of 117.5% of the face value of the tendered debentures.
The New Debentures bear interest at 7% per year, payable quarterly. The New
Debentures were convertible at the option of the holder into shares of the
Company's common stock at $8.00 per share. The New Debentures matured on January
31, 1999.
Through December 31, 1998, the Company issued a total of 1,940,674 shares of its
common stock in connection with the conversion of $12,799,000 of the original
principal amount of the Debentures, plus interest accrued through the conversion
date of $268,000. During the three months ended March 31, 1999, the Company
issued 586,650 shares of its common stock in connection with the conversion of
the remaining $4,600,000 principal amount of the New Debentures, plus interest
accrued through January 31, 1999 of $93,000.
NOTE 5: BANK FINANCING
The Company has available to use for working capital purposes and to post
letters of credit, a line of credit totaling $15,000,000, subject to certain
limits. The line of credit encompasses The L.L. Knickerbocker Co., Inc. (LLK),
Georgetown Collection, Inc. (GCI) and Krasner Group, Inc. (TKG) and expires in
July 1999. Certain credit limits are established for each company. The credit
limits are $5,000,000 for LLK, $7,000,000 for GCI and $3,000,000 for TKG.
Borrowing availability is determined by an advance rate on eligible accounts
receivable and inventory. The line of credit includes sublimits for letters of
credit and bankers acceptances aggregating $7,000,000, $5,000,000 and $3,000,000
for GCI, LLK and TKG, respectively. Borrowings bear interest at the bank's base
rate (7.75% at March 31, 1999) plus 2% for GCI and TKG borrowings, and plus 1%
for LLK borrowings or, at the Company's option, an adjusted LIBOR rate. In
addition, the Company is charged an Unused Line fee of .25% of the unused
portion of the revolving loans.
At March 31, 1999, the Company had $5,829,000 of cash borrowings outstanding and
no outstanding letters of credit. Borrowings are collateralized by substantially
all assets of the Company. The line of credit agreement contains, among other
things, restrictive financial covenants, which require the Company to maintain
certain leverage and current ratios (computed annually and quarterly), an
interest coverage ratio (computed annually) and to achieve certain levels of
annual income. The agreement also limits GCI annual capital expenditures and
prohibits the payment of dividends. At March 31, 1999, the Company was not in
compliance with certain of these covenants. As a result of noncompliance under
the terms of the line of credit agreement, the lender has the right to demand
immediate repayment of the outstanding balance. Absent the rights of the lender
due to noncompliance, available borrowings under the line of credit aggregated
approximately $850,000 at March 31, 1999.
S.L.S. and Harlyn have available lines of credit aggregating 66,000,000 Thai
baht (approximately $1,746,000 at March 31, 1999). Outstanding borrowings bear
interest at rates ranging from 8.5% to 10.5%. One such line of credit was
secured by restricted cash of approximately $300,000 at March 31, 1999 and
December 31, 1998.
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NOTE 6: LITIGATION
Plaintiff Michael Elam filed an action in Orange County Superior Court (Case No.
759883) on or about February 16, 1996, against Louis L. Knickerbocker, Tamara
Knickerbocker and the Company alleging causes of action for conversion, breach
of fiduciary duty, fraud, debitatus assumpsit, intentional interference with
contract, constructive trust, breach of oral agreement, specific performance,
money had and received, open book account and spoliation of evidence. The
plaintiff sought money damages and/or shares of stock of the Company ranging
between $500,000 and $35,000,000 as a result of prior business affiliations with
Mr. Knickerbocker, alleging that the Company is liable as a successor-in-
interest for the debts of Mr. Knickerbocker's prior companies, and that Mr.
Knickerbocker was obligated to allow the plaintiff to participate in the Company
when it was created. The defendants are vigorously opposing the lawsuit. A
motion for summary judgment filed in August 1998 eliminated those causes of
action claiming an interest in the Company's predecessor, Knickerbocker
Creations, Ltd. On April 21, 1999, the Company reached a settlement with the
plaintiff to settle the litigation in exchange for shares of Pure Energy
Corporation held by the Company with a carrying value of $168,000. This amount
is included in accrued liabilities at March 31, 1999 and December 31, 1998.
The Company's predecessor, Knickerbocker Creations, Ltd., filed an action in the
Los Angeles Superior Court in 1991 (Case No. 060405) against Excess, Inc.,
Beverly Johnson and Alan Johnson. The suit seeks repayment of $157,000, together
with pre-judgment interest and lost profits, as a result of defendants' failure
to manufacture and ship various clothing goods. A cross-complaint was filed by
Beverly Johnson against Knickerbocker Creations, Ltd. and Louis Knickerbocker
for $25,000 for commissions allegedly owed to her. The Company became involved
in the case in the fall of 1998 when a motion to substitute The L.L.
Knickerbocker Company, Inc. as plaintiff and cross-defendant for Knickerbocker
Creations, Ltd., an inactive corporation, was granted by the court. The matter
is currently set for trial on April 5, 1999.
The Company brought claims against State Street Bank and Trust Company ("State
Street") in federal district court in Boston, Massachusetts (Civil Action No.
97-12573-NO, U.S. District Court, D. MA) for conversion, breach of contract,
unjust enrichment, a declaratory judgment and violation of Massachusetts General
Laws, c. 93A arising from State Street's wrongful retention of 72,188 shares of
the Company's common stock after the Company's obligations to State Street under
a Settlement Agreement of the prior indebtedness of Georgetown Collection, Inc.,
a subsidiary acquired in 1996, had been paid in full. The stock retained by
State Street had an original value of $617,000. State Street denies liability
and brought a counterclaim against the Company for breach of contract and
specific performance seeking $102,000 in damages, plus attorneys fees and costs.
Discovery is substantially complete, and the final pre-trial conference is
scheduled on June 1, 1999. The company is currently negotiating with State
Street to settle the above matter.
Finance Authority of Maine, Costal Enterprises, Inc, and the Southern Maine
Economic Development District brought claims in federal district court in
Portland, Maine (Civil Action No.98-2235-8, U.S. District Court, D. Maine) for
breach of contract, indemnification and specific performance arising from the
Company's performance under certain settlement documents following the
acquisition of the subsidiary, Georgetown Collection, Inc., in 1996. The
plaintiffs are seeking an order requiring the Company to purchase 63,030 shares
of the Company's stock previously transferred to plaintiffs for $11.50 per
share, plus interest and attorneys fees. The Company answered and denied
liability on plaintiffs' claims. The plaintiffs moved for summary judgment, and
the motion is currently under advisement. No discovery has been conducted and
the current scheduling order provides for a trial date in September 1999.
A former shareholder of GCI alleges that the Company is liable for a $750,000
note payable to the former shareholder. No accrual for potential loss related to
this note has been recorded as of March 31, 1999, as the Company believes that
the note payable was settled in connection with the acquisition of GCI and that
the Company is not liable for this amount.
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The Company is involved in certain other legal and administrative proceedings
and threatened legal and administrative proceedings arising in the normal course
of its business. While the outcome of such proceedings and threatened
proceedings cannot be predicted with certainty, in the opinion of management,
the ultimate resolution of these matters individually or in the aggregate will
not have a material adverse effect on the Company.
NOTE 7: SUBSEQUENT EVENTS
In April 1999, the Company issued 870,235 shares of its common stock in
connection with the conversion of $100,000 and $175,000 of the principal amount
of the 1997 Debentures and 1998 Debentures, respectively, plus interest accrued
through the conversion date.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion includes the operations of The L.L. Knickerbocker Co.,
Inc. and subsidiaries for each of the periods discussed.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1999 AND 1998
NET SALES
Net sales decreased to $9,485,000 for the three months ended March 31, 1999 from
$11,482,000 for the three months ended March 31, 1998, a decrease of $1,997,000,
or 17.4%. The $1,997,000 decrease in net sales was comprised of decreases of
$3,971,000 in the Company's non-celebrity, direct response and catalog-driven
collectible doll programs and $671,000 in the Company's fine jewelry program,
offset by increases in net sales of $1,839,000 in the Company's celebrity-driven
collectible doll program and $806,000 in the Company's fashion jewelry program.
The decrease in non-celebrity collectible doll revenues was primarily attributed
to the continuation of the planned reduction in direct response advertising
spending which began in the second half of 1998. The Company is curtailing
direct response advertising spending until the direct response brands reach
targeted profitability goals, previously unmet in the past twelve months. The
decrease in net sales from the Company's fine jewelry program was primarily
attributed to short term liquidity problems experienced in Asia, which limited
the Company's ability to fulfill backlogged orders in the quarter. The increase
in net sales from celebrity-driven collectible doll programs is due primarily to
increased sales to the Company's largest home shopping industry customer and
from the Company's expansion of its retail base of customers, an area of focus
by the Company since the second half of 1998. The Company continues to assess
the potential of sales expansion of existing products through new distribution
channels, as well as continuing to develop new product categories.
GROSS PROFIT
Gross profit decreased to $4,717,000 for the three months ended March 31, 1999
from $6,626,000 for the three months ended March 31, 1998, a decrease of
$1,909,000, or 28.8%. As a percentage of net sales, gross profit for the quarter
decreased to 49.7% in 1999 from 57.7% in 1998. The decrease in the gross profit
percentage in 1999 from 1998 is due primarily to a change in the sales mix of
products sold directly to the consumer via print advertisements and catalogs,
versus products sold by the Company at wholesale prices. In 1999, 22.7% of the
Company's sales were directly to the consumer through catalogs and print
advertisements, referred to as direct response sales, versus 53.0% in 1998.
Direct response sales, as opposed to wholesale, business to business sales,
generate higher margins to the Company as the products are sold at retail prices
to individual consumers. Therefore, the Company's gross profit percentage will
vary depending on the relationship of direct response sales to total sales for
the Company during the year. Correspondingly, should the majority of the
Company's sales come from fine jewelry sales in any period, the gross profit
percentage of the Company will be lower due to lower historical margins
associated with jewelry production and sales.
ADVERTISING EXPENSE
Advertising expense decreased to $1,122,000 for the three months ended March 31,
1999 from $2,413,000 for the three months ended March 31, 1998, a decrease of
$1,291,000, or 53.5%. The $1,291,000 decrease in advertising expense is due
primarily to the Company's continuation of its planned reduction in unprofitable
direct response advertising spending which began in the second half of 1998.
Included in advertising expense are advertisement printing costs, catalog-
printing costs, media space in magazines, and advertisement creative and
development costs.
12
<PAGE> 15
SELLING EXPENSE
Selling expense increased to $1,769,000 for the three months ended March 31,
1999 from $978,000 for the three months ended March 31, 1998, an increase of
$791,000, or 80.9%. As a percentage of net sales, selling expense increased from
8.5% in 1998 to 18.7% in 1999. The increase in selling expense is due primarily
to increases in trade show and commission expenses related to the Company's
expansion of its products into the retail distribution channel and higher
variable royalty expense attributable to higher revenues in 1999 for the
Company's celebrity-driven collectible doll and fashion jewelry programs.
Selling expense includes royalty expense, commission expense, trade show
expenses, and other sales promotion expenses.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense decreased to $3,567,000 for the three months
ended March 31, 1999 from $4,793,000 for the three months ended March 31, 1998,
a decrease of $1,226,000, or 25.6%. The percentage of revenues represented by
these expenses decreased from 41.7% in 1998 to 37.6% in 1999. The dollar
decrease in general and administrative expenses, as well as the decrease as a
percentage of revenues, was due primarily to the Company's aggressive
consolidation efforts which began in the fourth quarter of 1998 combined with
the Company's continued focus on lowering operating costs.
LOSS ON EQUITY METHOD INVESTMENTS
Loss on equity method investments decreased to $0 for the three months ended
March 31, 1999 from $553,000 for the three months ended March 31, 1998. The
major components of the 1998 loss from equity method investments stem from the
Company's 50% interest in Arkenol Asia, LLC and its interest in Pure Energy
Corporation (PEC), both development-stage corporations. Under the equity method
of accounting, the Company recorded loss on equity method investments equal to
the investees' net loss multiplied by the Company's ownership percentage.
Effective April 1, 1998, the Company discontinued the application of the equity
method to its investment in PEC due to the Company's lack of significant
influence over the operations of PEC. Additionally, during the year ended
December 31, 1998, the Company wrote off its investment in Arkenol Asia LLC due
to the inactivity of the joint venture.
OTHER (INCOME) EXPENSE
Other income increased to $118,000 for the three months ended March 31, 1999
from expense of $17,000 for the three months ended March 31, 1998, a change of
$135,000. The change is primarily attributable to $66,000 of foreign currency
gains from transactions of the Company's Thailand operations in the three months
ended March 31, 1999 compared to foreign currency transaction losses of $32,000
in the comparable 1998 period, due to fluctuations in the Thai baht.
INTEREST EXPENSE
Interest expense increased to $633,000 for the three months ended March 31, 1999
from $581,000 for the three months ended March 31, 1998, an increase of $52,000,
or 9.0%. The increase in interest expense relates primarily to the issuance of
$7,000,000 face value of convertible debentures in June 1998. This increase is
offset by decreases due to the maturity of the 1996 Debentures on January 31,
1999, and the conversion to common stock of $3,100,000 face value of the 1997
Debentures during 1998 and the first quarter of 1999. Included in interest
expense for the three months ended March 31, 1999 and 1998, is noncash interest
related to convertible debentures of $403,000 and $206,000, respectively. The
remaining balance of interest expense includes interest on borrowings from
working capital lines of credit and mortgages on buildings owned by the Company.
13
<PAGE> 16
NET LOSS
As a result of the foregoing factors, net loss decreased to $2,277,000 for the
three months ended March 31, 1999 from net loss of $2,576,000 for the three
months ended March 31, 1998, a decrease in net loss of $299,000
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations from internally generated cash flow,
short-term borrowings and equity financings. As of March 31, 1999 the Company
had negative working capital of $3,196,000. Working capital decreased from
$13,159,000 at March 31, 1998. Through the first quarter of 1999, the Company
has continued to invest most of its available funds generated from operations
and raised in its convertible debenture financing by capitalizing subsidiaries,
purchasing inventory for seasonal needs and developing new product categories.
The Company has available to use for working capital purposes and to post
letters of credit, a line of credit totaling $15,000,000, subject to certain
limits. The line of credit encompasses The L.L. Knickerbocker Co., Inc. (LLK),
Georgetown Collection, Inc. (GCI) and Krasner Group, Inc. (TKG) and expires in
July 1999. Certain credit limits are established for each company. The credit
limits are $5,000,000 for LLK, $7,000,000 for GCI and $3,000,000 for TKG.
Borrowing availability is determined by an advance rate on eligible accounts
receivable and inventory. The line of credit includes sublimits for letters of
credit and bankers acceptances aggregating $7,000,000, $5,000,000 and $3,000,000
for GCI, LLK and TKG, respectively. Borrowings bear interest at the bank's base
rate (7.75% at March 31, 1999) plus 2% for GCI and TKG borrowings and plus 1%
for LLK borrowings or, at the Company's option, an adjusted LIBOR rate. In
addition, the Company is charged an Unused Line fee of .25% of the unused
portion of the revolving loans. The Company, due to its consolidation efforts,
is in the process of reallocating borrowing limits among the remaining
operational subsidiaries.
At March 31, 1999, the Company had $5,829,000 of cash borrowings outstanding.
Borrowings are collateralized by substantially all assets of the Company. The
line of credit agreement contains, among other things, restrictive financial
covenants, which require the Company to maintain certain leverage and current
ratios (computed annually and quarterly), an interest coverage ratio (computed
annually) and to achieve certain levels of annual income. The agreement also
limits GCI annual capital expenditures and prohibits the payment of dividends.
At March 31, 1999, the Company was not in compliance with certain of these
covenants. As a result of noncompliance under the terms of the line of credit
agreement, the lender has the right to demand immediate repayment of the
outstanding balance. Absent the rights of the lender due to non-compliance,
available borrowings under the line of credit aggregated approximately $850,000
at March 31, 1999. The two-year term of the line of credit is expiring in July
1999, which, at expiration will need to either be paid off in full or renewed.
The Company currently does not have sufficient funds to pay off the line of
credit should the facility not be renewed. The Company believes that the
facility will be renewed, but no assurances can be made that the Company will be
successful in renewing the line of credit. The Company is in the process of
expanding distribution and product categories and is limited in its ability to
borrow on the $15,000,000 credit facility based upon current levels of inventory
and receivables. As a result of the limitations on the usage of the $15,000,000
credit facility, the Company has looked to outside financing to supplement the
credit facility, completing a $7,000,000 convertible debenture offering in a
private placement to institutional investors in June 1998 (the 1998 Debentures).
The 1998 Debentures were subject to an agreement whereby after approval by the
shareholders of the Company of the issuance of the 1998 Debentures and the
creation of a class of Preferred Stock of the Company, the 1998 Debentures
14
<PAGE> 17
would be exchanged for shares of newly created Preferred Stock of the Company,
the terms of which would be substantially similar to that of the 1998
Debentures. The Preferred Stock would be convertible into shares of common stock
of the Company at the lower of $4.02 or a graduated discounted price ranging
from 97% to 90% of an average of the 7 lowest trading days of the 30 consecutive
trading days prior to conversion. The discounted price of 90% would have applied
if the investor did not convert prior to the two-year anniversary of the closing
date. Citing the decline in the Company's stock price, the holders of the 1998
Debentures chose not to complete the exchange into Preferred Stock. As a result,
under the terms of the agreements related to the 1998 Debentures (the
Agreements), the 1998 Debentures matured on December 28, 1998. The Company has
received a demand for payment from one of the holders of the 1998 Debentures and
currently does not have sufficient funds to pay off the balance. The Company is
negotiating with the holders of the 1998 Debentures to extend the note, but no
assurances can be made that the Company will be successful in the negotiations.
As a result, the Company has reflected the 1998 Debentures as a current
liability in the accompanying financial statements.
Cash flow used in operations was $1,177,000 in the three months ended March 31,
1999 compared to $4,727,000 in the comparable 1998 period. This $3,550,000
decrease in cash used in operations was due primarily to a $299,000 decrease in
net loss offset by a $275,000 decrease in depreciation and amortization and a
$553,000 decrease in equity in loss of investees; a $233,000 decrease in
accounts payable net of inventories, a $1,008,000 decrease in prepaid expenses
and other current assets and a $1,672,000 decrease in accounts receivable.
Cash flow used in investing activities was $143,000 for the three months ended
March 31, 1999, primarily related to acquisitions of property and equipment.
Cash flow provided by financing activities was $1,411,000 in the first quarter
of 1999 due primarily to borrowings on the $15,000,000 credit facility. The
current ratio for the Company increased from .76 at December 31, 1998 to .89 at
March 31, 1999.
The Company believes it will be necessary to raise additional funds from
additional debt or equity financing or asset sales, to sustain its operations.
The Company is in the process of obtaining necessary operational financing and
believes it will be successful in its efforts to obtain the financing. There can
be no assurance that the Company will be successful in raising such funds on
terms acceptable to it, or at all. Additionally, the Company is in the process
of negotiating a reduction in outstanding liabilities with its trade creditors.
The Company's future success is dependent upon raising additional financing to
provide for the necessary operations of the Company and to repay existing
financing, as necessary. If the Company is unable to obtain additional
financing, there would be a material adverse effect on the Company's business,
financial position and results of operations.
SEASONALITY AND QUARTERLY RESULTS
The Company's business is subject to seasonal fluctuations. The Company's direct
response and catalog brands have historically experienced greater sales in the
latter portion of the year. Because of the seasonality of the Company's
business, results for any quarter are not necessarily indicative of the results
that may be achieved for the full fiscal year.
YEAR 2000 READINESS DISCLOSURE
The Company has undertaken a Year 2000 Compliance Project ("Y2K Project") that
is designed to ensure that the Company can effectively conduct business beyond
January 1, 2000, and that disruption from December 31, 1999 to January 1, 2000
is minimized. Although no assurances can be given regarding the result of the
Year 2000 event itself, major components of the Company's Y2K Project are
expected to be completed by the end of the third quarter of fiscal 1999.
The Company's Y2K Plan addresses reporting compliance and legal concerns and
contains various phases, including evaluation of systems, planning for system
fixes, implementation of system fixes, development of contingency plans, and
testing of system fixes. The Company has completed the evaluation phase related
15
<PAGE> 18
to internal systems and is in the process of evaluating the state of readiness
of its major suppliers and customers. The planning phase for fixing internal
systems is completed, and currently the Company is implementing and testing
system fixes. The Company's main accounting system software, including general
ledger, accounts receivable and accounts payable modules, and related hardware
have been upgraded. Such software has been certified as Y2K compliant, and the
related hardware and operating system software has been warranted as Y2K
compliant. The components of the Company's LAN-based software and hardware that
require upgrading should be upgraded and tested through the first three quarters
of fiscal 1999.
The Company outsources its fulfillment and warehousing functions related to its
direct response businesses to an independent provider of such services. The
independent provider has warranted that it is actively taking steps so that its
hardware, software and data feeds, and other machinery and equipment, which
consider and process date-related information, will continue to function
properly after January 1, 2000. The independent provider has, among other
things, (i) taken an inventory of its hardware, software, and data feeds, and
applicable machinery and equipment, (ii) has adopted a testing and remediation
plan, (iii) is currently in progress regarding such testing and remediation for
application software, operating system software, embedded chips and firmware.
The Company is assessing the state of readiness of its major suppliers and
customers through written inquiry and evaluation of responses. The Company
intends to follow up with those suppliers or customers that indicate material
problems. Alternate suppliers or service providers will be identified for those
whose responses indicate an unusually high risk of a Y2K problem. The Company's
evaluation of business processes that are not related to information systems,
and the development of contingency plans where such evaluation identifies a high
risk of a Y2K problem should be completed by the third quarter of fiscal 1999.
The main risks of the Company's Y2K Project are the uncertainties as to whether
the Company's suppliers can continue to perform their services for the Company
uninterrupted by the Y2K event, and whether the Company's customers can continue
to operate their business uninterrupted by the Y2K event. Although the state of
readiness of the Company's suppliers and customers will be monitored and
evaluated, and contingency plans will be developed, no assurances can be given
as to the eventual state of readiness of the Company's suppliers and/or
customers. Nor can any assurance be given as to eventual effectiveness of the
Company's contingency plans.
When the Company's systems were upgraded as part of its Y2K Project, other
improvements to the Company's system were made. The cost of the Company's Y2K
Project, including such system upgrades, is estimated to be approximately
$10,000 through December 31, 1998 with $5,000 expected to be incurred in fiscal
1999.
FORWARD-LOOKING STATEMENTS
When used in this document, the words "believes", "anticipates", "expects" and
similar expressions are intended to identify in certain circumstances
forward-looking statements. Such statements are subject to a number of risks and
uncertainties that could cause actual results to differ materially from those
projected, including risks related to the dependence on sales to QVC; the
acceptance in the marketplace of new products; the ability to source raw
materials at prices favorable to the Company; currency fluctuations; and other
risks outlined in the Company's previously filed public documents, copies of
which may be obtained without cost from the Company. Given these uncertainties,
prospective investors are cautioned not to place undue reliance on such
statements. The Company also undertakes no obligation to update these
forward-looking statements.
16
<PAGE> 19
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Plaintiff Michael Elam filed an action in Orange County Superior Court (Case No.
759883) on or about February 16, 1996, against Louis L. Knickerbocker, Tamara
Knickerbocker and the Company alleging causes of action for conversion, breach
of fiduciary duty, fraud, debitatus assumpsit, intentional interference with
contract, constructive trust, breach of oral agreement, specific performance,
money had and received, open book account and spoliation of evidence. The
plaintiff is seeking money damages and/or shares of stock of the Company ranging
between $500,000 and $35,000,000 as a result of prior business affiliations with
Mr. Knickerbocker, alleging that the Company is liable as a
successor-in-interest for the debts of Mr. Knickerbocker's prior companies, and
that Mr. Knickerbocker was obligated to allow the plaintiff to participate in
the Company when it was created. The defendants are vigorously opposing the
lawsuit. A motion for summary judgment filed in August 1998 eliminated those
causes of action claiming an interest in the Company's predecessor,
Knickerbocker Creations, Ltd. On April 21, 1999, the Company reached a
settlement with the plaintiff to settle the litigation in exchange for shares of
Pure Energy Corporation held by the Company with a carrying value of $168,000.
This amount is included in accrued liabilities at March 31, 1999 and December
31, 1998.
The Company's predecessor, Knickerbocker Creations, Ltd., filed an action in the
Los Angeles Superior Court in 1991 (Case No. 060405) against Excess, Inc.,
Beverly Johnson and Alan Johnson. The suit seeks repayment of $157,000, together
with pre-judgment interest and lost profits, as a result of defendants' failure
to manufacture and ship various clothing goods. A cross-complaint was filed by
Beverly Johnson against Knickerbocker Creations, Ltd. and Louis Knickerbocker
for $25,000 for commissions allegedly owed to her. The Company became involved
in the case in the fall of 1998 when a motion to substitute The L.L.
Knickerbocker Company, Inc. as plaintiff and cross-defendant for Knickerbocker
Creations, Ltd., an inactive corporation, was granted by the court. The matter
is currently set for trial on April 5, 1999.
The Company brought claims against State Street Bank and Trust Company ("State
Street") in federal district court in Boston, Massachusetts (Civil Action No.
97-12573-NO, U.S. District Court, D. MA) for conversion, breach of contract,
unjust enrichment, a declaratory judgment and violation of Massachusetts General
Laws, c. 93A arising from State Street's wrongful retention of 72,188 shares of
the Company's common stock after the Company's obligations to State Street under
a Settlement Agreement of the prior indebtedness of Georgetown Collection, Inc.,
a subsidiary acquired in 1996, had been paid in full. The stock retained by
State Street had an original value of $617,000. State Street denies liability
and brought a counterclaim against the Company for breach of contract and
specific performance seeking $102,000 in damages, plus attorneys fees and costs.
Discovery is substantially complete, and the final pre-trial conference is
scheduled on June 1, 1999. The company is currently negotiating with State
Street to settle the above matter.
Finance Authority of Maine, Costal Enterprises, Inc, and the Southern Maine
Economic Development District brought claims in federal district court in
Portland, Maine (Civil Action No.98-2235-8, U.S. District Court, D. Maine) for
breach of contract, indemnification and specific performance arising from the
Company's performance under certain settlement documents following the
acquisition of the subsidiary, Georgetown Collection, Inc., in 1996. The
plaintiffs are seeking an order requiring the Company to purchase 63,030 shares
of the Company's stock previously transferred to plaintiffs for $11.50 per
share, plus interest and attorneys fees. The Company answered and denied
liability on plaintiffs' claims. The plaintiffs moved for summary judgment, and
the motion is currently under advisement. No discovery has been conducted and
the current scheduling order provides for a trial date in September 1999.
A former shareholder of GCI alleges that the Company is liable for a $750,000
note payable to the former shareholder. No accrual for potential loss related to
this note has been recorded as of March 31, 1999, as the Company believes that
the note payable was settled in connection with the acquisition of GCI and that
the Company is not liable for this amount.
17
<PAGE> 20
The Company is involved in certain other legal and administrative proceedings
and threatened legal and administrative proceedings arising in the normal course
of its business. While the outcome of such proceedings and threatened
proceedings cannot be predicted with certainty, in the opinion of management,
the ultimate resolution of these matters individually or in the aggregate will
not have a material adverse effect on the Company.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
During the three months ended March 31, 1999, the Company issued 6,136,130
shares of its common stock in connection with the conversion of $950,000 and
$1,800,000 of the principal amount of the 1997 Debentures and 1998 Debentures,
respectively, plus interest accrued through the conversion date. Additionally,
during the three months ended March 31, 1999, the Company issued 586,650 shares
of its common stock in connection with the conversion at maturity of the
remaining $4,600,000 principal amount of the 1996 New Debentures, plus interest
accrued through January 31, 1999, the maturity date. The issuance of such shares
of common stock was deemed to be exempt from registration under the Act by
virtue of Section 4(2) of the Act and Regulation D promulgated thereunder
because the issuance did not involve a public offering.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On January 5, 1999, the Company held a Special Meeting of Shareholders. The
meeting involved (1) the approval of a proposed amendment to the Company's
articles of incorporation to authorize the issuance of 10,000,000 shares of
preferred stock, and (2) the approval of transactions contemplated by a June 8,
1998 Securities Purchase Agreement, including the issuance by the Company of
convertible term debentures. The number of shares cast is as follows:
<TABLE>
<CAPTION>
For Against Abstain
---------- ------- -------
<S> <C> <C> <C>
(1) Approval of the issuance of preferred stock: 10,485,327 322,913 41,109
(2) Approval of Securities Purchase Agreement: 10,462,353 324,388 62,608
</TABLE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
27.0 -- Financial Data Schedule
(b) Reports on Form 8-K:
There were no reports on Form 8-K filed during the quarter for which this
report is filed.
18
<PAGE> 21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE L.L. KNICKERBOCKER CO., INC.
Date: May 14, 1999 By: /s/ Anthony P. Shutts
-----------------------------
Anthony P. Shutts
Chief Financial Officer
(Principal financial and
accounting officer)
19
<PAGE> 22
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------ -----------
<C> <S>
27.0 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 485,000
<SECURITIES> 0
<RECEIVABLES> 8,261,000
<ALLOWANCES> 0
<INVENTORY> 11,666,000
<CURRENT-ASSETS> 25,349,000
<PP&E> 4,847,000
<DEPRECIATION> 0
<TOTAL-ASSETS> 39,350,000
<CURRENT-LIABILITIES> 27,845,000
<BONDS> 0
0
0
<COMMON> 38,513,000
<OTHER-SE> (29,354,000)
<TOTAL-LIABILITY-AND-EQUITY> 39,350,000
<SALES> 9,485,000
<TOTAL-REVENUES> 9,485,000
<CGS> 4,768,000
<TOTAL-COSTS> 4,768,000
<OTHER-EXPENSES> (118,000)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 633,000
<INCOME-PRETAX> (2,256,000)
<INCOME-TAX> 21,000
<INCOME-CONTINUING> (2,277,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,277,000)
<EPS-PRIMARY> (.09)
<EPS-DILUTED> (.09)
</TABLE>
