<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q/A
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
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
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
25800 Commercentre Drive 92630
Lake Forest, California (Zip Code)
(Address of Principal Executive Offices)
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
November 6, 1998 was 19,994,126.
<PAGE> 2
This Amendment on Form 10-Q/A amends the Registrant's Quarterly Report on Form
10-Q for the period ended September 30, 1998, as filed by the Registrant on
November 16, 1998, and is being filed to reflect the restatement of the
Registrant's consolidated financial statements (the "Restatement"). The
Restatement reflects the reversal of a gain on sale of investment originally
recorded in the quarter ended March 31, 1998. See Note 7 of Notes to Condensed
Consolidated Financial Statements.
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TABLE OF CONTENTS
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ITEM PAGE
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PART I - FINANCIAL INFORMATION
1. FINANCIAL STATEMENTS
A. Condensed Consolidated Statements of Operations (unaudited) for
the three and nine month periods ended September 30, 1998 and
September 30, 1997 (restated) ........................................ 1
B. Condensed Consolidated Balance Sheets at September 30, 1998
(unaudited) and December 31, 1997 (restated) ......................... 2
C. Condensed Consolidated Statements of Cash Flows (unaudited) for
the nine month periods ended September 30, 1998 and September 30,
1997 (restated) ...................................................... 4
D. Notes to Condensed Consolidated Financial Statements .................... 6
2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
A. Results of Operations ................................................... 11
B. Liquidity and Capital Resources ......................................... 15
PART II - OTHER INFORMATION
2. CHANGES IN SECURITIES AND USE OF PROCEEDS ...................................... 17
3. DEFAULTS UPON SENIOR SECURITIES ................................................ 17
6. EXHIBITS AND REPORTS ON FORM 8-K ............................................... 18
SIGNATURES ..................................................................... 18
</TABLE>
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
THE L.L. KNICKERBOCKER CO., INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(unaudited)
<TABLE>
<CAPTION>
1998 1997
------------ ------------
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Sales, net of returns $ 15,769,000 $ 14,112,000
Cost of sales 7,705,000 6,477,000
------------ ------------
Gross profit 8,064,000 7,635,000
Advertising expense 2,124,000 1,869,000
Selling expense 2,026,000 1,579,000
General and administrative expense 5,159,000 4,731,000
------------ ------------
Operating loss (1,245,000) (544,000)
Loss on equity method investments 167,000 468,000
Other (income) expense, net (Note 7) (421,000) (762,000)
Interest expense (Note 3) 893,000 471,000
------------ ------------
Loss before minority interest and income tax benefit (1,884,000) (721,000)
Minority interest in loss of subsidiary -- --
Income tax benefit (194,000) (135,000)
------------ ------------
Net loss $ (1,690,000) $ (586,000)
============ ============
Net loss per share:
Basic and diluted $ (0.09) $ (0.03)
============ ============
Shares used in computing net loss per share:
Basic and diluted 19,634,624 18,408,572
============ ============
</TABLE>
1
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THE L.L. KNICKERBOCKER CO., INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(unaudited)
<TABLE>
<CAPTION>
1998 1997
--------------------------------------------------- ------------
As previously
reported Adjustment As restated
-------------- ------------ -----------
(Note 7)
<S> <C> <C> <C> <C>
Sales, net of returns $ 40,685,000 $ 40,685,000 $ 45,162,000
Cost of sales 19,049,000 19,049,000 21,644,000
------------ ------------ ------------
Gross profit 21,636,000 21,636,000 23,518,000
Advertising expense 7,148,000 7,148,000 5,388,000
Selling expense 4,487,000 4,487,000 4,288,000
General and administrative
expense 15,324,000 15,324,000 15,527,000
------------ ------------ ------------
Operating loss (5,323,000) (5,323,000) (1,685,000)
Loss on equity method
investments 982,000 982,000 1,344,000
Other (income) expense, net
(Note 7) (3,088,000) 2,847,000 (241,000) (526,000)
Interest expense (Note 3) 2,176,000 2,176,000 3,997,000
------------ ------------ ------------
Loss before minority
interest and income tax
benefit (5,393,000) (8,240,000) (6,500,000)
Minority interest in loss of
subsidiary (274,000) (274,000) (219,000)
Income tax benefit (988,000) (32,000) (1,020,000) (1,295,000)
------------ ------------ ------------
Net loss $ (4,131,000) $ (6,946,000) $ (4,986,000)
============ ============ ============
Net loss per share:
Basic and diluted $ (0.22) $ (0.36) $ (0.28)
============ ============ ============
Shares used in computing net
loss per share:
Basic and diluted 19,118,538 19,118,538 17,731,737
============ ============ ============
</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>
December 31,
September 30, 1998 1997
-------------------------------------------------- ------------
As previously
reported Adjustment As restated
-------------- ------------ -----------
ASSETS (Note 7)
<S> <C> <C> <C> <C>
Cash and cash equivalents $ 700,000 $ 700,000 $ 92,000
Restricted cash -- -- 250,000
Accounts receivable 11,901,000 11,901,000 8,021,000
Receivable from stockholder 1,048,000 1,048,000 1,383,000
Inventories 13,106,000 13,106,000 10,851,000
Prepaid expenses and other
current assets 8,436,000 8,436,000 7,486,000
------------ ------------ ------------
Total current assets 35,191,000 35,191,000 28,083,000
Property and equipment, net 5,776,000 5,776,000 5,537,000
Notes Receivable 1,800,000 1,800,000 1,800,000
Investments (Note 7) 6,760,000 (2,847,000) 3,913,000 2,585,000
Deferred income taxes 4,500,000 4,500,000 4,215,000
Other assets 2,677,000 2,677,000 2,348.000
Goodwill, net of accumulated
amortization of $1,539,000
and $971,000 as of September
30, 1998 and December 31,
1997, respectively 5,979,000 5,979,000 6,393,000
------------ ------------ ------------
$ 62,683,000 $ 59,836,000 $ 50,961,000
============ ============ ============
</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>
December 31,
September 30, 1998 1997
-------------------------------------------------- ------------
As previously
reported Adjustment As restated
-------------- ------------ -----------
LIABILITIES AND (Note 7)
STOCKHOLDERS' EQUITY
<S> <C> <C> <C> <C>
Current Liabilities:
Accounts payable and accrued
expenses $ 10,984,000 $ 10,984,000 $ 7,838,000
Commissions and royalties
payable 1,179,000 1,179,000 751,000
Notes payable 6,542,000 6,542,000 3,650,000
Interest payable 428,000 428,000 270,000
Income taxes payable 45,000 (32,000) 13,000 123,000
Due to shareholders of
Krasner Group, Inc. 513,000 513,000 900,000
Loan from stockholder 248,000
Current portion of long-term
debt 262,000 262,000 242,000
Other current liabilities 186,000 186,000 125,000
Deferred income taxes 49,000 49,000 49,000
Convertible debentures, net 5,988,000
of discounts of $1,012,000 5,988,000
------------ ------------ ------------
Total current liabilities 26,176,000 26,144,000 14,204,000
------------ ------------ ------------
Long-term liabilities:
Long-term debt, less current
portion 555,000 555,000 661,000
Convertible debentures, net
of discounts of $157,000 at
September 30, 1998 and
$444,000 at December 31, 1997 7,742,000 7,742,000 9,455,000
Deferred gain 1,642,000 1,642,000 1,642,000
------------ ------------ ------------
Total long-term liabilities 9,939,000 9,939,000 11,758,000
------------ ------------ ------------
Minority interest -- -- 274,000
------------ ------------ ------------
Stockholders' equity (Note 8):
Common stock 29,900,000 29,900,000 27,282,000
Additional paid-in capital 6,144,000 6,144,000 3,904,000
Accumulated deficit (5,361,000) (2,815,000) (8,176,000) (1,230,000)
Foreign currency translation
adjustment (4,115,000) (4,115,000) (5,231,000)
------------ ------------ ------------ ------------
Total stockholders' equity 26,568,000 23,753,000 24,725,000
============ ============ ============ ============
$ 62,683,000 $ 59,836,000 $ 50,961,000
============ ============ ============ ============
</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)
<TABLE>
<CAPTION>
September 30,
September 30, 1998 1997
------------------------------------------------ -----------
As previously
reported Adjustment As restated
------------- ----------- -----------
(Note 7)
<S> <C> <C> <C> <C>
Cash flows provided by operating activities:
Net loss $(4,131,000) (2,815,000) $(6,946,000) $(4,986,000)
Adjustments to reconcile net income
(loss) to net cash used in operating activities:
Depreciation and amortization 1,975,000 1,975,000 1,746,000
Debenture inducement 1,899,000
Gain on sale of investment -
PEC (3,616,000) 2,847,000 (769,000)
Equity in loss of investees 982,000 982,000 1,344,000
Loss on disposal of fixed
assets 18,000 18,000
Minority interest (274,000) (274,000) (219,000)
Amortization of debt discount 445,000 445,000 605,000
Expense related to issuance
of stock options, warrants
and common stock 491,000 491,000
Deferred income taxes (1,000,000) (1,000,000) (1,000)
Changes in operating accounts:
Accounts receivable, net (3,880,000) (3,880,000) 1,544,000
Receivable from
stockholder/officer 185,000 185,000 (793,000)
Income tax receivable (400,000)
Inventories (2,255,000) (2,255,000) (4,045,000)
Prepaid expenses and other
current assets (950,000) (950,000) (4,880,000)
Other assets (473,000) (473,000) 5,000
Accounts payable and accrued
expenses 3,480,000 3,480,000 (437,000)
Commissions and royalties
payable 428,000 428,000 (302,000)
Income tax payable (78,000) (32,000) (110,000) 461,000
Other long term liabilities (51,000)
----------- ----------- -----------
Net cash used in operations (8,653,000) (8,653,000) (8,510,000)
Cash flows from investing activities:
Acquisitions of property and
equipment (846,000) (1,991,000)
Proceeds from sales of
property and equipment 21,000
</TABLE>
5
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THE L.L. KNICKERBOCKER CO., INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(unaudited)
<TABLE>
<CAPTION>
September 30,
September 30, 1998 1997
----------------------------------------------- -------------
As previously
reported Adjustment As restated
------------- ----------- -----------
(Note 7)
<S> <C> <C> <C> <C>
Proceeds from sales of investment 818,000 818,000
Investments/advances to
investees (571,000) (571,000) (107,000)
----------- ----------- -----------
Net cash used in investing
activities (578,000) (578,000) (2,098,000)
----------- ----------- -----------
Cash flows from financing activities:
Net borrowings on line of
credit 2,892,000 2,892,000 467,000
Payments on long-term debt (264,000) (264,000) (808,000)
Borrowings on long-term debt 45,000 45,000 466,000
Proceeds from exercise of
common stock purchase
warrants/options 45,000 45,000 732,000
Net proceeds (repayments) (248,000)
from shareholder loan (248,000) 400,000
Deferred debt issue costs (427,000) (427,000) (325,000)
Proceeds from issuance of 7,000,000
convertible debentures 7,000,000 5,000,000
----------- ----------- -----------
Net cash provided by
financing activities 8,998,000 8,998,000 5,932,000
----------- ----------- -----------
Effect of Foreign currency
translation 591,000 591,000 (518,000)
----------- ----------- -----------
Net increase (decrease) in
cash and cash equivalents 358,000 358,000 (51,94,000)
Cash and cash equivalents,
beginning of period 342,000 342,000 6,247,000
----------- ----------- -----------
Cash and cash equivalents,
end of period $ 700,000 $ 700,000 $ 1,553,000
=========== =========== ===========
Supplemental Schedule of Noncash Investing
and Financing Activity:
Cash paid for interest $ 894,000 $ 894,000 $ 782,000
=========== =========== ===========
Cash paid (refunded) for
income taxes $ 78,000 $ 78,000 $ (946,000)
=========== =========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements
6
<PAGE> 10
THE L.L. KNICKERBOCKER CO., INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(unaudited)
Supplemental Schedule of Noncash Investing and Financing Activity:
During the nine months ended September 30, 1998 and 1997, $2,000,000 and
$10,770,000 of convertible debentures and $123,000 and $121,000 of accrued
interest, respectively, was converted to common stock.
During the nine months ended September 30, 1998 and 1997, the Company issued
138,031 and 243,606 shares of common stock in payment of $387,000 and
$1,253,000, respectively, of liability to former Krasner shareholders.
During the nine months ended September 30, 1998, the Company acquired property
and equipment under capital lease obligations totaling $91,000.
During the nine months ended September 30, 1998, the Company recorded a
$1,788,000 increase to investments in connection with the initial public
offering of Ontro, Inc. (Note 7).
During the nine months ended September 30, 1997, the Company issued 150,000
warrants with an ascribed value of $434,000 as commission in connection with the
issuance of the 1997 Debentures (Note 3).
During the nine months ended September 30, 1998, the Company cancelled 200,000
shares of previously issued common stock in settlement of $150,000 receivable
from stockholder.
7
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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, 1997 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 The
Krasner Group, Inc., Harlyn International, Ltd., L.L. Knickerbocker (Thai)
Company, 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 and nine month periods ended September 30,
1998 are not necessarily indicative of the results that may be expected for the
year ended December 31, 1998. For further information, refer to the financial
statements and notes thereto included in the Company's annual report on Form
10-KSB for the year ended December 31, 1997.
Certain prior period balances have been reclassified to conform with current
presentation.
NOTE 2: EARNINGS PER SHARE
The Company adopted Statement of Financial Accounting Standards No. 128,
"Earnings per Share" (SFAS 128), in the fourth quarter of 1997. 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 and
nine month periods ended September 30, 1998 and 1997 per share calculation
because their effect is antidilutive.
NOTE 3: CONVERTIBLE 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 the related debt. The 1998 Debentures are convertible at the
option of the holder into shares of the Company's common stock at a conversion
price of $4.02. As of September 30, 1998, none of the 1998 Debentures had been
converted.
The 1998 Debentures are 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 will
be exchanged for shares of newly created Preferred Stock of the Company, the
terms of which shall be substantially similar to that of the 1998 Debentures.
The Preferred Stock will 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% applies if the investor
does not convert prior to the two-year anniversary of the closing date. To the
extent the Company is not able to exchange the 1998 Debentures for Preferred
Stock, under the terms of the agreements related to the 1998 Debentures (the
Agreements), the 1998 Debentures will mature on December 28, 1998. Events of
default under the
8
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1998 Debentures have occurred with respect to meeting filing deadlines as
outlined in the Agreements. However, management believes that the Company has,
through its discussions with the 1998 Debenture Holders, what constitutes an
implied waiver of defaults which have occurred. Remedies of default, if enforced
include demanding that all or any portion of the 1998 Debentures be prepaid by
the Company for cash. As a result, the Company has reflected the 1998 Debentures
as a current liability in the accompanying financial statements.
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. 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,
which was recorded as debt discount (the warrant discount) and additional
paid-in capital. The Company is recognizing the warrant discount as non-cash
interest expense over the term of the securities (three years). Upon conversion
of the 1998 Debentures any portion of the conversion discount not previously
recognized is recorded as interest expense on the conversion date. During the
nine months ended September 30, 1998, a total of $200,000 of non-cash interest
expense was recorded relating to the 1998 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. Interest is payable in either cash or common stock of the
Company at the option of the Company. 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. Through September 30, 1998, the Company issued
a total of 828,663 shares of its common stock in connection with the conversion
of $2,000,000 of the principal amount of the 1997 Debentures, plus interest
accrued through the conversion date.
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 Company is recognizing the conversion
discount as non-cash 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 nine months ended September
30, 1998 and 1997, a total of $432,000 and $19,000, respectively, of non-cash
interest expense was recorded relating to the 1997 Debentures, including
$135,000 in the nine months ended September 30, 1998 relating to the additional
conversion discount recorded upon conversion.
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 1996 Debentures accrue interest at the rate of 7% per
annum, payable quarterly. The 1996 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.
Through September 30, 1998, the Company issued
9
<PAGE> 13
a total of 1,903,174 shares of its common stock in connection with the
conversion of $12,499,000 of the original principal amount of the 1996
Debentures, plus interest accrued through the conversion dates.
The conversion of the notes at 85% of the closing price of the Company's common
stock resulted in the 1996 Debentures being issued at a discount (the conversion
discount). The conversion discount was being recognized by the Company as
non-cash interest expense over the term of the 1996 Debentures with a
corresponding increase to the original principal amount of the Debentures. Upon
conversion of the 1996 Debentures any portion of the conversion discount not
previously recognized was recorded as interest expense on the conversion date.
During the nine months ended September 30, 1998 and 1997, a total of $81,000 and
$2,648,000, respectively, of non-cash interest expense was recorded relating to
the 1996 Debentures, including $537,000 in the nine months ended September 30,
1997 relating to the additional conversion discount recorded upon conversion. In
January 1997, the Company reached agreement with the 1996 Debenture holders to
tender all outstanding 1996 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 are convertible at the option of the holder into
shares of the Company's common stock at $8.00 per share. The New Debentures must
be converted by January 1999. As a result of the 17.5% premium given as an
inducement to the Debenture holders to tender the original debentures into New
Debentures, the Company recorded a non-cash charge of $1,899,000 in the first
quarter of 1997.
NOTE 4: BANK FINANCING
The Company has available to use for working capital purposes and to post
letters of credit, a line of credit totaling $20,000,000, 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 $4,000,000 for LLK, $13,000,000 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 $13,000,000, $4,000,000 and
$3,000,000 for GCI, LLK and TKG, respectively. Borrowings bear interest at the
bank's base rate (8.5% at September 30, 1998) 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 September 30, 1998, the Company had $6,542,000 of cash borrowings
outstanding. Available borrowings under the line of credit aggregated $2,891,000
at September 30, 1998. Borrowings are collateralized by substantially all assets
of the Company. The line of credit agreement contains, among other things,
restrictive financial covenants that 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 September 30, 1998, the Company was in compliance
with these covenants or had received a waiver from the bank for certain covenant
violations.
S.L.S. Trading Co., Ltd. and Harlyn International, Inc. have available lines of
credit aggregating 72,000,000 Thai baht (approximately $1,823,000 at September
30, 1998). Outstanding borrowings bear interest at rates ranging from 15% to
18.75%.
NOTE 5: CHANGES IN ACCOUNTING PRINCIPLES
Effective January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income". This statement requires
that all items recognized under accounting standards as components of
comprehensive earnings be reported in an annual financial statement that is
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displayed with the same prominence as other annual financial statements. This
statement also requires that an entity classify items of other comprehensive
earnings by their nature in an annual financial statement. For example, other
comprehensive earnings may include foreign currency translation adjustments and
unrealized gains and losses on marketable securities classified as
available-for-sale. Annual financial statements for prior periods will be
reclassified, as required. The Company's total comprehensive loss is as follows:
<TABLE>
<CAPTION>
September 30, September 30,
Nine months ended: 1998 1997
------------- ------------
<S> <C> <C>
Net loss $(6,946,000) $(4,986,000)
Foreign currency translation gain (loss) 1,116,000 (1,478,000)
----------- -----------
Total Comprehensive loss $(5,830,000) $(6,464,000)
=========== ===========
</TABLE>
<TABLE>
<CAPTION>
September 30, September 30,
Three months ended: 1998 1997
------------- ------------
<S> <C> <C>
Net loss $(1,690,000) $ (586,000)
Foreign currency translation gain (loss) 305,000 (1,343,000)
----------- -----------
Total Comprehensive loss $(1,385,000) $(1,929,000)
=========== ===========
</TABLE>
NOTE 6: INVENTORIES
As of September 30, 1998 and December 31, 1997 inventories consisted of the
following:
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- -----------
<S> <C> <C>
Finished goods $10,536,000 $ 8,968,000
Work-in-progress 864,000 342,000
Raw materials 1,706,000 1,541,000
----------- -----------
$13,106,000 $10,851,000
=========== ===========
</TABLE>
NOTE 8: INVESTMENTS/RESTATEMENT
Subsequent to the issuance of the Company's Quarterly Report on Form 10-Q for
the nine months ended September 30, 1998, the Company determined that the gain
recorded in connection with the Securities Purchase Agreement (the Agreement)
to exchange shares of Pure Energy Corporation (PEC) for shares of Phoenix
Environmental, Ltd. (PEL) should be reversed.
On March 17, 1998, the Company entered into the Agreement and agreed to
exchange 2% of PEC for a 6% interest in PEL, a development-stage corporation.
The Company sold 1,364 shares of PEC, and accepted as consideration 34,700
shares of PEL. No cash was exchanged in the transaction. The Company recorded a
gain of $2,847,000 during the quarter ended March 31, 1998 in connection with
the Agreement.
On November 27, 1998, the Company and PEL entered into an Option Agreement,
granting each of the companies the right to rescind the Agreement. During the
quarter ended December 31, 1998, the Company and PEL mutually agreed to rescind
the March 17, 1998 Agreement. As a result of the rescission, and in light of
the fact that the underlying PEC shares had not yet been delivered to PEL, the
Company has reversed the $2,847,000 gain as of the original transaction date
and restated its September 30, 1998 financial statements.
A summary of the significant effects of the restatement is as follows:
<TABLE>
<CAPTION>
1998
------------------------------
As
previously As
reported restated
------------ -----------
<S> <C> <C>
At September 30:
Investments $ 6,760,000 $ 3,913,000
Income taxes payable 45,000 13,000
Accumulated deficit (5,361,000) (8,176,000)
For the nine months ended September 30:
Other (income) expense, net (3,088,000) (241,000)
Income tax benefit (988,000) (1,020,000)
Net loss (4,131,000) (6,946,000)
Net loss per share - Basic and diluted ($0.22) ($0.36)
</TABLE>
In September 1998, the Company sold a portion of its investment in Pure Energy
Corporation with a carrying value of $49,000 for net cash proceeds of $818,000.
The sale resulted in a gain to the Company of $769,000, which is included in
other income.
In September 1996, the Company purchased an equity interest in Ontro, Inc.
(Ontro). The purchase price consisted of $600,000 in cash for 858,673 common
shares. The investment provided the Company with a 27.8% common equity interest
in Ontro. In May 1998 Ontro successfully completed an initial public offering
whereby Ontro received approximately $15 million and issued 3,400,000 shares of
its common
11
<PAGE> 15
stock. As a result of the sale of previously unissued shares to the public, the
Company's ownership interest in Ontro was reduced to 13.2% and the Company
increased the balance of its investment in Ontro to reflect the enhanced value
of the Company's equity interest in Ontro. The net increase of $1,073,000 was
recorded as a capital transaction, resulting in an increase to the Company's
additional paid-in capital account after giving effect to deferred taxes of
$715,000.
NOTE 8: STOCKHOLDERS' EQUITY
In August 1998, the Company entered into an agreement with the 1997 Debenture
holders whereby the Company had the right, until September 1, 1998, to purchase
up to $3,000,000 of the principal amount of the 1997 Debentures, adjusted for
conversions through September 1, 1998, for a purchase price in cash of 110% of
face value. In connection with the agreement the Company issued warrants to the
Debenture holders to purchase an aggregate of 213,132 shares of common stock.
The warrants have an aggregate ascribed value of $228,000, which was recorded as
other expense in the third quarter of 1998. The Company did not purchase any of
the debentures under the agreement.
NOTE 9: SUBSEQUENT EVENTS
In November 1998, the Company issued 231,487 shares of its common stock in
connection with the conversion of $150,000 of the principal amount of the 1997
Debentures, plus interest accrued through the conversion date.
12
<PAGE> 16
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 SEPTEMBER 30, 1998 AND 1997
NET SALES
Net sales increased to $15,769,000 for the three months ended September 30, 1998
from $14,112,000 for the three months ended September 30, 1997, an increase of
$1,657,000, or 11.7%. The $1,657,000 increase in quarterly net sales was
comprised of a $2,294,000 increase in net sales in the Company's
celebrity-driven collectible doll program, a $1,081,000 increase in the
Company's fine jewelry program, a $442,000 increase in the Company's
celebrity-driven fashion jewelry program, offset by a decrease in net sales of
$2,160,000 attributed to the Company's non-celebrity collectible doll programs.
The increase in net sales from celebrity-driven collectible doll programs
related primarily to new product introductions to the Company's major customer
in the home shopping industry and an increase in volume through the Company's
retail distribution channel. The increase in fine jewelry sales related to an
expanded customer base established by the Company in 1998. The increase in net
sales from the Company's fashion jewelry sales was primarily attributed to a
higher number of new product introductions at the Company's major customer in
the home shopping industry, the primary distribution channel for the Company's
fashion jewelry. The decrease in non-celebrity collectible doll revenues was
primarily attributed to lower than expected response from the Company's direct
response advertisement campaigns. 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 increased to $8,064,000 for the three months ended September 30,
1998 from $7,635,000 for the three months ended September 30, 1997, an increase
of $429,000 or 5.6%. As a percentage of net sales, gross profit for the quarter
decreased to 51.1% in 1998 from 5.9% in 1997. The decrease in the gross profit
percentage in 1998 from 1997 is due primarily to decreased volume in the
Company's non-celebrity collectible doll programs where products are sold
directly to the customer, through catalog mailings and print advertisements,
that generate higher gross margins than the Company's wholesale sales. In the
quarter ended September 30, 1998, 23.7% of the Company's revenues were generated
from direct response distribution, versus 41.7% in the corresponding quarter of
1997. Partially mitigating the gross profit impact of the decline in direct
response sales in 1998 was an increase in the gross margin of the Company's
fashion jewelry program, which generated an increase in gross profit percentage
in 1998 to 44% from 33% in 1997. The increase in gross margin in the Company's
fashion jewelry program is due to obtaining lower manufacturing costs on the
Company's products, accomplished partially by outsourcing the manufacturing of
certain products and by aggressive cost cutting measures.
ADVERTISING EXPENSE
Advertising expense increased to $2,124,000 for the three months ended September
30, 1998 from $1,869,000 for the three months ended September 30, 1997, due
primarily to the Company's expansion of its direct response advertising
campaigns among a greater number of collectible brands in 1998 and its attempt,
in early 1998, to aggressively prospect for new customers for its Georgetown
Collection non-celebrity collectible doll brand. Additionally, the Company is
incurring higher advertising costs in 1998 due to the expansion into retail
distribution for the Company's products. Included in advertising expense
13
<PAGE> 17
are advertisement printing costs, catalog printing costs, media space in
magazines, and advertisement creative and development costs.
SELLING EXPENSE
Selling expense increased to $2,026,000 for the three months ended September 30,
1998 from $1,579,000 for the three months ended September 30, 1997, an increase
of $447,000, or 28.3%. As a percentage of net revenues, selling expense
increased from 11.2% in 1997 to 12.8% in 1998. The increase in selling expense
is due primarily to higher variable royalty expense attributable to higher
revenues in 1998, and to increases in trade show and commission expenses related
to the Company's expansion of its retail distribution channel. Selling expenses
include royalty expense, commission expense, trade show expenses, and other
sales promotion expenses.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense increased to $5,159,000 for the three months
ended September 30, 1998 from $4,731,000 for the three months ended September
30, 1997, an increase of $428,000, or 9.0%. The percentage of revenues
represented by these expenses decreased from 33.5% in 1997 to 32.7% in 1998, due
primarily to the increased sales volume in 1998. The increase in overall levels
of general and administrative expenses was due primarily to legal fees and other
litigation costs of approximately $550,000 in the third quarter of 1998.
Additionally, the Company is consolidating a major direct response division and
is incurring costs related to moving the operations, computer and fulfillment
planning and set up, and personnel costs. The Company is focusing on
aggressively reducing its general and administrative expense levels.
LOSS FROM EQUITY METHOD INVESTMENTS
Loss from equity method investments decreased to $167,000 for the three months
ended September 30, 1998 from $468,000 for the three months ended September 30,
1997. The major component of the 1998 loss from equity method investments stems
from the Company's 50% interest in Arkenol Asia, LLC. Included in the September
30, 1997 loss from equity method investments are losses incurred from
independent, development-stage corporations of which the Company owns a
substantial interest, in most cases greater than 19.9%. Under the equity method
of accounting, the Company must report its percentage ownership of losses
incurred by the development-stage corporations. During the three months ended
September 30, 1998, the Company did not account for investments in Pure Energy
Corporation and Ontro, Inc. under the equity method due to reductions in
ownership interest.
OTHER (INCOME) EXPENSE
Other income decreased to $421,000 for the three months ended September 30, 1998
from $762,000 for the three months ended September 30, 1997, a decrease of
$341,000, or 44.8%. The decrease relates primarily to foreign currency losses
realized by Thailand-based subsidiaries as a result of foreign currency
fluctuations and expense related to the issuance of common stock and common
stock purchase warrants in 1998, offset by a $769,000 gain on sale of investment
in the third quarter of 1998.
INTEREST EXPENSE
Interest expense increased to $893,000 for the three months ended September 30,
1998 from $471,000 for the three months ended September 30, 1997, an increase of
$422,000, or 89.6%. The increase occurred primarily as a result of increased
interest charges from the issuance of convertible debentures totaling $5,000,000
and $7,000,000 in September 1997 and June 1998, respectively. Included in
interest expense for the three months ended September 30, 1998 and 1997, are
noncash charges of $354,000 and $19,000, respectively, that are classified as
interest expense.
14
<PAGE> 18
NET LOSS
As a result of the foregoing factors, net loss increased to $1,690,000 for the
three months ended September 30, 1998 from net loss of $586,000 for the three
months ended September 30, 1997, an increase in net loss of $1,104,000.
NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
Subsequent to the issuance of the Company's Quarterly Report on Form 10-Q for
the nine months ended September 30, 1998, the Company determined that the gain
recorded in connection with the Securities Purchase Agreement (the Agreement) to
exchange shares of Pure Energy Corporation (PEC) for shares of Phoenix
Environmental, Ltd. (PEL) should be reversed.
On March 17, 1998, the Company entered into the Agreement and agreed to exchange
2% of PEC for a 6% interest in PEL, a development-stage corporation. The Company
sold 1,364 shares of PEC, and accepted as consideration, 34,700 shares of PEL.
No cash was exchanged in the transaction. The Company recorded a gain of
$2,847,000 during the quarter ended March 31, 1998 in connection with the
Agrement.
On November 27, 1998, the Company and PEL entered into an Option Agreement,
granting each of the companies the right to rescind the Agreement. During the
quarter ended December 31, 1998, the Company and PEL mutually agreed to rescind
the March 17, 1998 Agreement. As a result of the rescission, and in light of
the fact that the underlying PEC shares had not yet been delivered to PEL, the
Company has reversed the $2,847,000 gain as of the original transaction date and
restated its June 30, 1998 financial statements. The effects of the Restatement
are presented in Note 7 of Notes to Condensed Consolidated Financial Statements.
NET SALES
Net sales decreased to $40,685,000 for the nine months ended September 30, 1998
from $45,162,000 for the nine months ended September 30, 1997, a decrease of
$4,477,000, or 9.9%. The $4,477,000 decrease in year to date net sales was
comprised of a $3,279,000 decrease in the Company's non-celebrity collectible
doll program, a $1,319,000 decrease in the Company's fashion jewelry program, a
$350,000 decrease in the Company's celebrity-driven collectible doll program,
offset by an increase in net sales of $471,000 in the Company's fine jewelry
program. The decrease in non-celebrity collectible doll revenues was primarily
attributed to lower than expected response from the Company's direct response
advertisement campaigns. The decrease in net sales from the Company's fashion
jewelry program was primarily attributed to lower dollar amount orders from the
Company's major customer in the home shopping industry, the primary distribution
channel for the Company's fashion jewelry. The decrease in net sales from
celebrity-driven collectible doll programs on a year-to-date basis related
primarily to decreased programming time in the first and second quarters of 1998
for new products by the Company's major customer in the home shopping industry.
The increase in fine jewelry sales related to an expanded customer base
established by the Company in 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 $21,636,000 for the nine months ended September 30,
1998 from $23,518,000 for the nine months ended September 30, 1997, a decrease
of $1,882,000 or 8.0%. As a percentage of net sales, gross profit for the
quarter increased to 53.2% in 1998 from 52.1% in 1997. The increase in the gross
profit percentage in 1998 over 1997 is due primarily to increases in gross
profit margins in the Company's celebrity-driven collectible doll program and
fine and fashion jewelry programs, offset by the impact of lower direct response
sales in 1998. Impacting gross profit margins of the Company is the percentage
of the Company's sales mix that is generated from collectible products sold via
direct response. In the nine months ended September 30, 1998, 36.7% of the
Company's revenues were generated from direct response distribution, versus
40.2% in 1997. Direct response sales are generated by catalog mailings and print
advertisements placed by the Company. 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. The remaining
net sales of the Company, other than the portion contributed by direct response
sales, are generated from wholesale sales. Therefore, the Company's gross profit
percentage will vary depending on the volume of direct response sales during the
year. Correspondingly, should the majority of the Company's sales come from fine
and costume jewelry sales in any quarter, 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 increased to $7,148,000 for the nine months ended September
30, 1998 from $5,388,000 for the nine months ended September 30, 1997, due
primarily to the Company's expansion of its direct response advertising
campaigns among more collectible brands in 1998 and its attempt, in early 1998,
to aggressively prospect for new customers for its Georgetown Collection
non-celebrity collectible doll brand. Additionally, the Company is incurring
higher advertising costs in 1998 due to the expansion
15
<PAGE> 19
of retail distribution for the Company's products. Included in advertising
expense are advertisement printing costs, catalog printing costs, media space in
magazines, and advertisement creative and development costs.
SELLING EXPENSE
Selling expense increased to $4,487,000 for the nine months ended September 30,
1998 from $4,288,000 for the nine months ended September 30, 1997, an increase
of $199,000, or 4.6%. As a percentage of net sales, selling expense increased
from 19.8% in 1997 to 23.6% in 1998. 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 retail distribution, offset by lower
royalty expense attributable to lower revenues in 1998. Selling expenses include
royalty expense, commission expense, trade show expenses, and other sales
promotion expenses.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense decreased to $15,324,000 for the nine months
ended September 30, 1998 from $15,527,000 for the nine months ended September
30, 1997, a decrease of $203,000, or 1.3%. The percentage of revenues
represented by these expenses increased from 34.4% in 1997 to 37.7% in 1998. The
increase in general and administrative expenses as a percentage of revenues
resulted primarily from the 9.9% decrease in the revenue base in 1998 from 1997.
The $203,000 decrease in general and administrative expense related primarily to
the Company's aggressive efforts to cut general and administrative expenses
across the Company's diverse product divisions, offset by increased legal costs
related to preparation for two trials, higher personnel costs due to the
addition of members of management, and higher operating costs associated with
the Company's new headquarters in California and its jewelry facility in
Thailand.
LOSS FROM EQUITY METHOD INVESTMENTS
Loss from equity method investments decreased to $982,000 for the nine months
ended September 30, 1998 from $1,344,000 for the nine months ended September 30,
1997. 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, both development-stage corporations. Under the equity method
of accounting, the Company must report its percentage ownership of losses
incurred by the development-stage corporations. Effective April 1, 1998, the
Company discontinued the application of the equity method to its investment in
Pure Energy Corporation due to a reduction in ownership interest during 1998.
OTHER (INCOME) EXPENSE
Other income decreased to $241,000 for the nine months ended September 30, 1998
from $526,000 for the nine months ended September 30, 1997, a decrease of
$285,000. The decrease relates primarily to foreign currency losses realized by
Thailand-based subsidiaries as a result of foreign currency fluctuations and
expense related to the issuance of common stock and common stock purchase
warrants in 1998, offset by a $769,000 gain on sale of investment in the third
quarter of 1998.
INTEREST EXPENSE
Interest expense decreased to $2,176,000 for the nine months ended September 30,
1998 from $3,997,000 for the nine months ended September 30, 1997, a decrease of
$1,821,000, or 45.6%. The decrease occurred primarily as a result of a
$1,899,000 noncash restructuring charge and noncash conversion discounts
incurred in 1997 associated with the Company's 1996 convertible debenture
offering, offset by increased interest charges from the issuance of convertible
debentures totaling $5,000,000 and $7,000,000 in September 1997 and June 1998,
respectively. Included in interest expense for the nine months ended
16
<PAGE> 20
September 30, 1998 and 1997, are noncash charges of $713,000 and $2,667,000,
respectively, that are classified as interest expense.
NET LOSS
As a result of the foregoing factors, net loss increased to $6,946,000 for the
nine months ended September 30, 1998 from net loss of $4,986,000 for the nine
months ended September 30, 1997, an increase in net loss of $1,960,000.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations from its existing cash, short-term
borrowings and equity and debt financings. As of September 30, 1998, the Company
had working capital of $9,047,000, versus working capital of $20,798,000 at
September 30, 1997.
Through the third quarter of 1998, 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 $20,000,000, 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 $4,000,000 for LLK, $13,000,000 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 $13,000,000, $4,000,000 and
$3,000,000 for GCI, LLK and TKG, respectively. Borrowings bear interest at the
bank's base rate (8.5% at September 30, 1998) 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 September 30, 1998, the Company had $6,542,000 of cash borrowings
outstanding. Available borrowings under the line of credit aggregated $2,891,000
at September 30, 1998. Borrowings are collateralized by substantially all assets
of the Company. The line of credit agreement contains, among other things,
restrictive financial covenants that 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 September 30, 1998, the Company was in compliance
with these covenants or had received a waiver from the bank for certain covenant
violations.
The Company is in the process of expanding distribution and product categories
and is limited in its ability to borrow on the $20,000,000 credit facility based
upon current levels of inventory and receivables. As a result of the limitations
on the usage of the $20,000,000 credit facility, the Company has looked to
outside financing to supplement the credit facility, completing a $7,000,000
convertible debenture offering in June 1998.
Cash flow used in operations was $8,653,000 in 1998 compared to $8,510,000 in
1997. The increase in cash used in operations was due primarily to the increase
in accounts receivable during the nine months ended September 30, 1998, offset
by an increase in accounts payable and accrued expenses. Cash flow used in
investing activities was $578,000 for the nine months ended September 30, 1998,
primarily related to acquisitions of property and equipment and advances to
Arkenol Asia, LLC, a joint venture in which the Company has a 50% interest,
offset by proceeds from the sale of investments. Cash flow provided by financing
activities was $8,998,000 in 1998 due primarily to borrowings on the $20,000,000
credit facility
17
<PAGE> 21
and net proceeds from the convertible debenture offering completed in June 1998.
The current ratio for the Company decreased from 1.98 at December 31, 1997 to
1.35 at September 30, 1998.
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. The 1998 Debentures are 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 will be exchanged for shares of newly created Preferred Stock of
the Company, the terms of which shall be substantially similar to that of the
1998 Debentures. The Preferred Stock will 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%
applies if the investor does not convert prior to the two-year anniversary of
the closing date. To the extent the Company is not able to exchange the 1998
Debentures for Preferred Stock, under the terms of the agreements related to the
1998 Debentures (the Agreements), the 1998 Debentures will mature on December
28, 1998. Events of default under the 1998 Debentures have occurred with respect
to meeting filing deadlines as outlined in the Agreements. No assurances can be
made that additional events of default will not occur in the future. However,
management believes that the Company has, through its discussions with the 1998
Debenture Holders, what constitutes an implied waiver of defaults which have
occurred. Remedies of default, if enforced, include demanding that all or any
portion of the 1998 Debentures be prepaid by the Company for cash. As a result,
the Company has reflected the 1998 Debentures as a current liability in the
accompanying financial statements. The Company currently does not have
sufficient funds to pay the holders of the 1998 Debentures if such debt were
accelerated, and no assurances can be made that the Company will have sufficient
funds to pay such amounts if payment is demanded in the future.
SEASONALITY AND QUARTERLY RESULTS
The Company's business is subject to seasonal fluctuations. The Company's
celebrity collectible doll and non-celebrity doll programs and to a lesser
extent, its fine jewelry programs, 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
The Year 2000 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 time-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 has initiated a conversion from existing accounting software to
programs that are year-2000 compliant. Management has determined that the year
2000 issue will not pose significant operational problems for its computer
systems.
The Company will utilize both internal and external resources to reprogram, or
replace, and test the software for Year 2000 modifications. The Company
anticipates completing the Year 2000 project within one year but not later than
October 31, 1999, which is prior to any anticipated impact on its operating
systems. In the third quarter of 1998 the Company decided to outsource a key
data processing function which reduced the Company's estimate of the total cost
of the Year 2000 project to $200,000 and is being funded through operating cash
flows and lease financing.
The costs of the project and the date on which the Company believes it will
complete the Year 2000 modifications are based on management's best estimates,
which were derived utilizing numerous assumptions of future events, including
the continued availability of certain resources, third-party
18
<PAGE> 22
modification plans and other factors. However, there can be no guarantee that
these estimates will be achieved and actual results could differ materially from
those anticipated. Specific factors that might cause such material differences
include, but are not limited to, the availability and cost of personnel trained
in this area, the ability to locate and correct all relevant computer codes, and
similar uncertainties.
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.
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In August 1998, the Company entered into an agreement with the 1997 Debenture
holders whereby the Company had the right, until September 1, 1998, to purchase
up to $3,000,000 of the principal amount of the 1997 Debentures, adjusted for
conversions through September 1, 1998, for a purchase price in cash of 110% of
face value. In connection with the agreement the Company issued warrants to the
1997 Debenture holders to purchase an aggregate of 213,132 shares of common
stock at an exercise price of $3.00 per share. The issuance of the warrants was
deemed to be exempt from registration under the Securities Act of 1933, as
amended (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.
During the three months ended September 30, 1998, the Company issued 761,560
shares of its common stock in connection with the conversion of $1,750,000 of
the principal amount of the 1997 Debentures, plus interest accrued through the
conversion date. The conversion price of the convertible debentures was $2.42
per share of common stock. 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 3. DEFAULTS UPON SENIOR SECURITIES
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. The 1998 Debentures are 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 will be exchanged for shares of newly created Preferred Stock of
the Company, the terms of which shall be substantially similar to that of the
1998 Debentures. The Preferred Stock will 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%
applies if the investor does not convert prior to the two-year anniversary of
the closing date. To the extent the Company is not able to exchange the 1998
Debentures for Preferred Stock, under the terms of the agreements related to the
1998 Debentures (the Agreements), the 1998 Debentures will mature on December
28, 1998. Events of default under the 1998 Debentures have occurred with respect
to meeting filing deadlines as outlined in the Agreements. No assurances can be
made that additional events of default will not occur in the future. However,
management believes that the Company has, through its discussions with the 1998
Debenture Holders, what constitutes an implied waiver of
19
<PAGE> 23
defaults which have occurred. Remedies of default, if enforced, include
demanding that all or any portion of the 1998 Debentures be prepaid by the
Company for cash. The Company currently does not have sufficient funds to pay
the holders of the 1998 Debentures if such debt were accelerated, and no
assurances can be made that the Company will have sufficient funds to pay such
amounts if payment is demanded in the future.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
27.0 Financial Data Schedule
(b) Reports on Form 8-K:
None.
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: April 14, 1999 By: /s/ Anthony P. Shutts
Anthony P. Shutts
Chief Financial Officer
(Principal financial and accounting
officer)
20
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