<PAGE> 1
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 SEPTEMBER 30, 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
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
25800 COMMERCENTRE DRIVE
LAKE FOREST, CALIFORNIA 92630
- ---------------------------------------- -------------------
(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
November 3, 1999 was 43,162,733.
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TABLE OF CONTENTS
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PAGE
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PART I
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ITEM
1. FINANCIAL INFORMATION................................................................... 1
A. Condensed Consolidated Statements of Operations (unaudited) for the three
month periods ended September 30, 1999 and September 30, 1998 ............ 1
B. Condensed Consolidated Statements of Operations (unaudited) for the nine
month periods ended September 30, 1999 and September 30, 1998............ 2
C. Condensed Consolidated Statements of Comprehensive Income/Loss
(unaudited) for the three and nine month periods ended September 30, 1999
and September 30, 1998.................................................... 3
D. Condensed Consolidated Balance Sheets at September 30, 1999
(unaudited) and December 31, 1998......................................... 4
E. Condensed Consolidated Statements of Cash Flows (unaudited) for
the nine month periods ended September 30, 1999 and
September 30, 1998........................................................ 6
F. Notes to Condensed Consolidated Financial Statements........................... 8
2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS... 13
A. General Business Description................................................... 13
B. Results of Operations.......................................................... 13
C. Liquidity and Capital Resources................................................ 17
PART II
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1. LEGAL PROCEEDINGS ...................................................................... 21
2. CHANGES IN SECURITIES AND USE OF PROCEEDS............................................... 22
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.............................. 22
6. EXHIBITS AND REPORTS ON FORM 8-K........................................................ 22
SIGNATURES.............................................................................. 23
</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, 1999 AND 1998
(unaudited)
<TABLE>
<CAPTION>
1999 1998
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Sales, net of returns $ 9,344,000 $ 15,769,000
Cost of sales 5,354,000 7,705,000
------------ ------------
Gross profit 3,990,000 8,064,000
Advertising expense 375,000 2,124,000
Selling expense 1,308,000 2,026,000
General and administrative expense 3,280,000 5,159,000
------------ ------------
Operating loss (973,000) (1,245,000)
Loss on equity method investments -- 167,000
Other (income) expense, net (76,000) (421,000)
Interest expense (Note 4) 366,000 893,000
------------ ------------
Loss before income taxes (1,263,000) (1,884,000)
Income tax expense (benefit) (72,000) (194,000)
------------ ------------
Net loss $ (1,191,000) $ (1,690,000)
============ ============
Net loss per share:
Basic and diluted $ (0.03) $ (0.09)
============ ============
Shares used in computing net loss per share:
Basic and diluted 38,145,602 19,634,624
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
1
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THE L.L. KNICKERBOCKER CO., INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
(unaudited)
<TABLE>
<CAPTION>
1999 1998
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<S> <C> <C>
Sales, net of returns $ 32,196,000 $ 40,685,000
Cost of sales 17,501,000 19,049,000
------------ ------------
Gross profit 14,695,000 21,636,000
Advertising expense 2,423,000 7,148,000
Selling expense 5,060,000 4,487,000
General and administrative expense 10,507,000 15,324,000
------------ ------------
Operating loss (3,295,000) (5,323,000)
Loss on equity method investments -- 982,000
Other (income) expense, net (243,000) (241,000)
Interest expense (Note 4) 1,502,000 2,176,000
------------ ------------
Loss before minority interest and
income taxes (4,554,000) (8,240,000)
Minority interest in loss of subsidiary -- (274,000)
Income tax expense (benefit) 2,000 (1,020,000)
============ ============
Net loss $ (4,556,000) $ (6,946,000)
============ ============
Net loss per share:
Basic and diluted $ (0.15) $ (0.36)
============ ============
Shares used in computing net loss per share:
Basic and diluted 31,341,932 19,118,538
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
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THE L.L. KNICKERBOCKER CO., INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME / LOSS
(unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30 September 30
-------------------------- --------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
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Net loss $(1,191,000) $(1,690,000) $(4,556,000) $(6,946,000)
Other comprehensive income (loss):
Foreign currency translation adjustments (541,000) 305,000 (664,000) 1,116,000
----------- ----------- ----------- -----------
Comprehensive loss $(1,732,000) $(1,385,000) $(5,220,000) $(5,830,000)
=========== =========== =========== ===========
</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)
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<CAPTION>
September 30, December 31,
1999 1998
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ASSETS
Cash and cash equivalents $ 115,000 $ 199,000
Restricted cash 285,000 310,000
Accounts receivable 9,789,000 8,365,000
Inventories 7,953,000 10,989,000
Prepaid expenses and other current assets 1,726,000 2,745,000
Notes receivable 1,800,000 1,800,000
----------- -----------
Total current assets 21,668,000 24,408,000
Property and equipment, net 4,490,000 4,970,000
Receivable from stockholder 1,090,000 1,072,000
Investments 3,541,000 3,541,000
Other assets 983,000 1,342,000
Goodwill, net of accumulated amortization of $1,735,000
at September 30, 1999 and $1,395,000 at December 31, 1998 3,005,000 3,409,000
----------- -----------
$34,777,000 $38,742,000
=========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
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THE L.L. KNICKERBOCKER CO., INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
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<CAPTION>
September 30, December 31,
1999 1998
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LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 9,112,000 $ 9,461,000
Accrued expenses 2,008,000 1,974,000
Notes payable 6,120,000 5,430,000
Commissions and royalties payable 1,880,000 1,368,000
Interest payable 468,000 595,000
Income taxes payable 137,000 279,000
Current portion of long-term debt 120,000 215,000
Due to former shareholders of Krasner Group, Inc. -- 280,000
Deferred gain 1,642,000 1,642,000
Convertible debentures, net of discount of $96,000 at
September 30, 1999 and $491,000 at December 31, 1998 4,344,000 10,949,000
------------ ------------
Total current liabilities 25,831,000 32,193,000
Long-term debt, less current portion 433,000 541,000
Convertible debentures, net of discount of $110,000
at December 31, 1998 -- 2,740,000
------------ ------------
Total long-term liabilities 433,000 3,281,000
Stockholders' equity:
Common stock 41,322,000 30,757,000
Additional paid-in capital 6,012,000 6,112,000
Accumulated deficit (34,501,000) (29,945,000)
Accumulated other comprehensive loss (4,320,000) (3,656,000)
------------ ------------
Total stockholders' equity 8,513,000 3,268,000
------------ ------------
$ 34,777,000 $ 38,742,000
============ ============
</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
(unaudited)
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<CAPTION>
September 30, September 30,
1999 1998
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Cash flows from operating activities:
Net loss $(4,556,000) $(6,946,000)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 978,000 1,975,000
Equity in loss of investees -- 982,000
Gain on sale of investment -- (769,000)
(Gain) loss on disposition of fixed assets (2,000) 18,000
Minority interest -- (274,000)
Amortization of debt discount 505,000 445,000
Expense related to issuance of stock options, warrants
and common stock -- 491,000
Deferred income taxes -- (1,000,000)
Changes in operating accounts:
Accounts receivable, net (1,424,000) (3,880,000)
Inventories 3,032,000 (2,255,000)
Prepaid expenses and other current assets 1,019,000 (950,000)
Other assets 153,000 (473,000)
Accounts payable and accrued expenses 53,000 3,480,000
Commissions and royalties payable 512,000 428,000
Income taxes payable (142,000) (110,000)
Due to former shareholders of Krasner Group, Inc. (60,000) --
----------- -----------
Net cash provided by (used in) operating activities 68,000 (8,838,000)
Cash flows from investing activities:
Acquisitions of property and equipment (514,000) (846,000)
Proceeds from sales of property and equipment 89,000 21,000
Receivable from stockholder (18,000) 185,000
Proceeds from sales of investment -- 818,000
Investments/advances to investees -- (571,000)
----------- -----------
Net cash used in investing activities (443,000) (393,000)
Cash flows from financing activities:
Net borrowings on line of credit 690,000 2,892,000
Payments on long-term debt (154,000) (264,000)
Borrowings on long-term debt -- 45,000
Net repayments on stockholder loan -- (248,000)
Deferred debt issue costs -- (427,000)
Proceeds from issuance of convertible debentures -- 7,000,000
----------- -----------
Net cash provided by financing activities 536,000 8,998,000
Effect of exchange rate changes on cash (270,000) 591,000
----------- -----------
Net (decrease) increase in cash and cash equivalents (109,000) 358,000
Cash and cash equivalents, beginning of period 509,000 342,000
----------- -----------
Cash and cash equivalents, end of period $ 400,000 $ 700,000
=========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
6
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THE L.L. KNICKERBOCKER CO., INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(unaudited)
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
September 30, September 30,
1999 1998
------------- -------------
Cash paid for interest $529,000 $894,000
======== ========
Cash paid for income taxes $ 56,000 $ 78,000
======== ========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITY:
During the nine months ended September 30, 1999 and 1998, $9,850,000 and
$2,000,000 of convertible debentures and $406,000 and $123,000 of accrued
interest, respectively, was converted to common stock.
During the nine months ended September 30, 1999 and 1998, the Company issued
441,007 and 138,031 shares of common stock in payment of $220,000 and $387,000,
respectively, of liability to former shareholders of Krasner Group, Inc.
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.
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.
See accompanying notes to condensed consolidated financial statements.
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, 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 nine month period ended September 30, 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.
On August 23, 1999, an involuntary petition under Chapter 7 of the United States
Bankruptcy Code was filed against the Company by three of its Asian vendors (the
Filing). The Company plans to convert the Filing to a voluntary Chapter 11
filing on or about December 1, 1999, and to propose a plan of reorganization.
Accordingly, the accompanying consolidated financial statements have been
prepared in conformity with principles of accounting applicable to a going
concern, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. As a result of the Filing and
circumstances relating to this event, realization of assets and satisfaction of
liabilities are subject to uncertainty. Under Chapter 7, actions to enforce
claims against the Company are stayed if the claims arose, or are based on
events that occurred, on or before the petition date of August 23, 1999, and
such claims cannot be paid or restructured prior to the conclusion of the
proceedings or approval of the Bankruptcy Court. A plan of reorganization could
materially change the amounts reported in the accompanying consolidated
financial statements, which do not give effect to adjustments to the carrying
values of assets and liabilities which may be necessary as a consequence of a
plan of reorganization. The Company's ability to continue as a going concern is
contingent upon, among other things, its ability to formulate a plan of
reorganization that will be confirmed by the Bankruptcy Court, to achieve
satisfactory levels of profitability and cash flow from operations, maintain
compliance with its financing agreement (Note 5) and obtain financing sources to
meet future obligations.
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 and
nine month periods ended September 30, 1999 and 1998 per share calculations
because their effect is antidilutive.
8
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NOTE 3: INVENTORIES
Inventories consisted of the following:
September 30, 1999 December 31, 1998
------------------ -----------------
Finished goods $ 8,958,000 $11,710,000
Work-in-progress 544,000 663,000
Raw materials 1,206,000 1,532,000
Inventory reserves (2,505,000) (2,670,000)
----------- -----------
$ 8,203,000 $11,235,000
=========== ===========
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 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
September 30, 1999, the Company issued a total of 15,484,680 shares of its
common stock in connection with the conversion of $4,210,000 of the principal
amount of the 1998 Debentures, plus interest accrued through the conversion date
of $210,000.
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 $2,790,000, 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 nine
months
9
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ended September 30, 1999 and 1998, a total of $592,000 and $200,000,
respectively, of noncash interest expense was recorded relating to the 1998
Debentures, including $238,000 in the nine months ended September 30, 1999
relating to the additional conversion discount recorded upon conversion (none in
1998).
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 September 30, 1999, the Company issued a total of 6,044,393 shares of its
common stock in connection with the conversion of $3,350,000 of the principal
amount of the 1997 Debentures, plus interest accrued through the conversion date
of $218,000.
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 nine months ended September
30, 1999 and 1998, a total of $270,000 and $432,000, respectively, of noncash
interest expense was recorded relating to the 1997 Debentures, including $38,000
and $135,000 in the nine months ended September 30, 1999 and 1998, respectively,
relating to the additional conversion discount recorded upon conversion.
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
Through July 16, 1999, the Company had 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 encompassed The
10
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L.L. Knickerbocker Co., Inc. (LLK), Georgetown Collection, Inc. (GCI) and
Krasner Group, Inc. (TKG) and expired on July 16, 1999. At the expiration of the
line of credit on July 16, 1999, the Company did not have sufficient funds to
pay off the line of credit. The Company entered into a forbearance agreement
with the financial institution initially extending the general terms of the line
of credit until August 30, 1999 and in the event certain conditions were met,
until September 20, 1999. The forbearance agreement limited the Company's use of
the credit facility to total borrowings of $6,250,000. As a result of the Filing
(Note 1), the financial institution has placed the Company's credit facility on
an offering basis, effectively reserving the right to discontinue funding the
Company at any time. The Company is in the process of working to replace the
current line of credit with a new facility, however there can be no assurance of
the Company's success in doing so. Under the current credit facility, borrowing
availability is determined by an advance rate on eligible accounts receivable
and inventory. Borrowings bear interest at the bank's base rate (8.25% at
September 30, 1999) plus 2% through July 31, 1999, increasing to 3% thereafter.
In addition, the Company is charged an Unused Line fee of .25% of the unused
portion of the revolving loans.
At September 30, 1999, the Company had $4,311,000 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 prohibits the payment of dividends. At September 30, 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 $681,000 at September 30, 1999.
S.L.S. and Harlyn have available lines of credit aggregating 66,000,000 Thai
baht (approximately $1,784,000 at September 30, 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 $285,000 and $310,000, at September
30, 1999 and December 31, 1998, respectively.
NOTE 6: LITIGATION
Following is a summary of litigation against the Company existing at September
30, 1999. As a result of the Filing (Note 1), all litigation against the Company
has been stayed pursuant to Section 362 of Title 11 of the U.S. Bankruptcy Code.
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 (PEC) held by the Company with a carrying value of
$168,000. This amount is included in accrued liabilities at September 30, 1999
and December 31, 1998. Due to restrictions placed by the Company's lender (Note
5) on the transfer of PEC shares, the Company has been unable to fulfill the
terms of the settlement agreement and risks future litigation should the terms
of the agreement not be fulfilled in the future.
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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 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.
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.
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 September 30, 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.
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
Subsequent to September 30, 1999, the Company issued 939,061 shares of its
common stock in connection with the conversion of $31,000 of the principal
amount of the 1998 Debentures plus interest accrued through the conversion date.
Effective October 29, 1999, the Company sold the inventory, trademarks and
certain other assets related to its Georgetown Collection brand of collectible
dolls for an aggregate purchase price of $1.2 million, subject to adjustment
based on the results of the buyer's inspection of the inventory. Net proceeds to
the Company after deducting costs associated with the transaction are estimated
to be approximately $1.1 million.
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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 SEPTEMBER 30, 1999 AND 1998
NET SALES
Net sales decreased to $9,344,000 for the three months ended September 30, 1999
from $15,769,000 for the three months ended September 30, 1998, a decrease of
$6,425,000, or 40.7%. The $6,425,000 decrease in net sales was comprised of
decreases of $2,739,000 in the celebrity-driven collectible doll and bear
programs, $1,954,000 in the non-celebrity, direct response and catalog-driven
collectible doll programs, $1,406,000 in the fine jewelry program and $326,000
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 twenty-four 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, and to a decline in sales to a home
shopping industry customer. The decrease in net sales from celebrity-driven
collectible doll and bear programs was due primarily to production delays
experienced as a result of the involuntary Chapter 7 bankruptcy petition filed
against the Company which temporarily halted production for many of the
Company's product lines. 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 $3,990,000 for the three months ended September 30,
1999 from $8,064,000 for the three months ended September 30, 1998, a decrease
of $4,074,000, or 50.5%. As a percentage of net sales, gross profit for the
quarter decreased to 42.7% in 1999 from 51.1% in 1998. The decrease in the gross
profit percentage in 1999 from 1998 is due primarily to a change in the mix of
products sold directly to the consumer via print advertisements and catalogs,
versus products sold at wholesale prices. In 1999, 18.9% of the Company's sales
were directly to the consumer via catalogs and print advertisements, referred to
as direct response sales, versus 23.6% in 1998. Direct response sales, as
opposed to wholesale, business to business sales, generate higher gross margins
to the Company as the products are sold at retail prices to individual
consumers, but require substantial advertising expenditures. 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. In the
future, the Company expects its direct response sales to decline in relation to
total sales. Also impacting gross profit is the Company's focus on reducing
inventory levels on hand which, on occasion, require the Company to accept lower
gross margins in order to move inventory.
ADVERTISING EXPENSE
Advertising expense decreased to $375,000 for the three months ended September
30, 1999 from $2,124,000 for the three months ended September 30, 1998, a
decrease of $1,749,000, or 82.3%. The reduction in advertising expense was
primarily attributed to the Company's continuation of its planned reduction in
unprofitable direct response advertising spending, which began in the second
half of 1998. The Company made a strategic decision in 1998 to grow retail
distribution for its products, which is not heavily dependent on advertising
spending. Included in advertising expense are advertisement printing costs,
catalog-printing costs, media space in magazines, and creative and development
costs.
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SELLING EXPENSE
Selling expense decreased to $1,308,000 for the three months ended September 30,
1999 from $2,026,000 for the three months ended September 30, 1998, a decrease
of $718,000, or 35.4%. As a percentage of net sales, selling expense increased
from 12.8% in 1998 to 14.0% in 1999. The increase in selling expense was
primarily attributed to increases in commission expenses related to the
Company's expansion of its products into retail distribution and decreases in
sales in the Company's direct response and fine jewelry programs, which, due to
the nature of their distribution channels, have lower selling expenses. 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 $3,280,000 for the three months
ended September 30, 1999 from $5,159,000 for the three months ended September
30, 1998, a decrease of $1,879,000, or 36.4%. The percentage of revenues
represented by these expenses increased from 32.7% in 1998 to 35.1% in 1999. The
dollar decrease in general and administrative expense 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.
Included in general and administrative expense in 1999 were legal fees of
$136,000 and professional fees of $265,000 related to the involuntary Chapter 7
petition filed against the Company.
LOSS ON EQUITY METHOD INVESTMENTS
Loss on equity method investments decreased to $0 for the three months ended
September 30, 1999 from $167,000 for the three months ended September 30, 1998.
The major components of the 1998 loss from equity method investments stem from
the Company's 50% interest in Arkenol Asia, LLC, a development-stage
corporation. Under the equity method of accounting, the Company recorded loss on
equity method investments equal to the investee's net loss multiplied by the
Company's ownership percentage. 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 decreased to $76,000 for the three months ended September 30, 1999
from $421,000 for the three months ended September 30, 1998, a change of
$345,000. The decrease relates primarily to a $769,000 gain on sale of
investment in the three months ended September 30, 1998, offset by expense of
$486,000 related to the issuance of common stock and common stock purchase
warrants.
INTEREST EXPENSE
Interest expense decreased to $366,000 for the three months ended September 30,
1999 from $893,000 for the three months ended September 30, 1998, a decrease of
$527,000, or 59.0%. The decrease in interest expense relates primarily to a
lower outstanding principal balance of convertible debentures in 1999 than in
the comparable period in 1998. Included in interest expense for the three months
ended September 30, 1999 and 1998, is non-cash interest related to convertible
debentures of $180,000 and $510,000, 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.
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NET LOSS
As a result of the foregoing factors, net loss decreased to $1,191,000 for the
three months ended September 30, 1999 from net loss of $1,690,000 for the three
months ended September 30, 1998, a decrease in net loss of $499,000.
NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
NET SALES
Net sales decreased to $32,196,000 for the nine months ended September 30, 1999
from $40,685,000 for the nine months ended September 30, 1998, a decrease of
$8,489,000, or 20.9%. The decrease in net sales was comprised of decreases of
$9,077,000 in the Company's non-celebrity, direct response and catalog-driven
collectible doll programs and $2,737,000 in the Company's fine jewelry program,
offset by increases in net sales of $2,169,000 in the Company's celebrity-driven
collectible doll and bear programs and $1,156,000 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
twenty-four 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, and to a
decline in sales to a home shopping industry customer. The increase in net sales
from celebrity-driven collectible doll and bear programs and fashion jewelry
program is due primarily to increased sales to the Company's largest home
shopping industry customer and, in the case of the celebrity-driven collectible
doll and bear programs, 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 $14,695,000 for the nine months ended September 30,
1999 from $21,636,000 for the nine months ended September 30, 1998, a decrease
of $6,941,000, or 32.1%. As a percentage of net sales, gross profit for the
nine-month period decreased to 45.6% in 1999 from 53.2% in 1998. The decrease in
the gross profit percentage in 1999 from 1998 is due primarily to a change in
the mix of products sold directly to the consumer via print advertisements and
catalogs, versus products sold by the Company at wholesale prices. In 1999,
18.1% of the Company's sales were directly to the consumer through catalogs and
print advertisements, referred to as direct response sales, versus 36.6% in
1998. Direct response sales, as opposed to wholesale, business to business
sales, generate higher gross margins to the Company as the products are sold at
retail prices to individual consumers, but require substantial advertising
expenditures. 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.
ADVERTISING EXPENSE
Advertising expense decreased to $2,423,000 for the nine months ended September
30, 1999 from $7,148,000 for the nine months ended September 30, 1998, a
decrease of $4,725,000, or 66.1%. The decrease in advertising expense was
primarily attributed 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 creative and development
costs.
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SELLING EXPENSE
Selling expense increased to $5,060,000 for the nine months ended September 30,
1999 from $4,487,000 for the nine months ended September 30, 1998, an increase
of $573,000, or 12.8%. As a percentage of net sales, selling expense increased
from 11.0% in 1998 to 15.7% in 1999. The increase in selling expense was
primarily attributed to increases in commission expenses related to the
Company's expansion of its products into the retail distribution channel and
higher variable celebrity royalty expense attributable to higher revenues in
1999 for the Company's celebrity-driven collectible doll, bear 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 $10,507,000 for the nine months
ended September 30, 1999 from $15,324,000 for the nine months ended September
30, 1998, a decrease of $4,817,000, or 31.4%. The percentage of revenues
represented by these expenses decreased from 37.7% in 1998 to 32.6% 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 nine months ended
September 30, 1999 from $982,000 for the nine months ended September 30, 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 $243,000 for the nine months ended September 30, 1999
from $180,000 for the nine months ended September 30, 1998, a change of $2,000.
The change was primarily attributable to $153,000 of foreign currency gains from
transactions of the Company's Thailand operations in the nine months ended
September 30, 1999 compared to foreign currency transaction losses of $173,000
in the comparable 1998 period, due to fluctuations in the Thai Baht. Also
included in other income for the nine months ended September 30, 1998, is a
$769,000 gain on sale of investment and $486,000 of expense related to the
issuance of common stock and common stock purchase warrants.
INTEREST EXPENSE
Interest expense decreased to $1,502,000 for the nine months ended September 30,
1999 from $2,176,000 for the nine months ended September 30, 1998, a decrease of
$674,000,or 31.0%. The decrease in interest expense relates primarily to a lower
outstanding principal balance of convertible debentures in 1999 than in the
comparable period in 1998. Included in interest expense for the nine months
ended September 30, 1999 and 1998, is non-cash interest related to convertible
debentures of $868,000 and $1,041,000, 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.
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NET LOSS
As a result of the foregoing factors, net loss decreased to $4,556,000 for the
nine months ended September 30, 1999 from net loss of $6,946,000 for the nine
months ended September 30, 1998, a decrease in net loss of $2,390,000.
LIQUIDITY AND CAPITAL RESOURCES
On August 23, 1999, an involuntary Chapter 7 petition was filed against the
Company by Jeffrey H. McKinnon, the ex-CEO of Georgetown Collection, Inc., a
subsidiary of the Company, on behalf of three Asian creditors (the Filing). The
Company, as a result of the Filing, has experienced many difficulties. The
Company's secured senior lender, BankBoston, has placed the Company's credit
facility on an offering basis, effectively reserving the right to discontinue
funding the Company at any time. Additionally, many of the Company's contracts
are in technical default. Several of the Company's important vendors temporarily
ceased production after the Filing, thereby impacting the Company's ability to
deliver on back ordered product.
To date, the Company has been able to negotiate with its senior secured lender,
holders of important contracts with the Company, and essential vendors to
continue working with the Company. Other than the temporary delays experienced
shortly after the Filing, the Company is making progress in its turn-around
efforts.
As a result of the Filing, the Company plans to convert the Filing to a
voluntary Chapter 11 filing on or about December 1, 1999. The Company believes
it has a pre-negotiated plan of reorganization with its creditors, although no
assurance can be made the reorganization will be successful.
The Company has financed its operations from internally generated cash flow,
short-term borrowings and equity financings. As of September 30, 1999 the
Company had negative working capital of $4,163,000. Working capital increased
from negative $7,785,000 at December 31, 1998 to negative $4,163,000. Through
July 16, 1999, the Company had 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 encompassed The L.L. Knickerbocker Co., Inc.
(LLK), Georgetown Collection, Inc. (GCI) and Krasner Group, Inc. (TKG) and
expired on July 16, 1999. At the expiration of the line of credit on July 16,
1999, the Company did not have sufficient funds to pay off the line of credit.
The Company entered into a forbearance agreement with the financial institution
initially extending the general terms of the line of credit until August 30,
1999 and in the event certain conditions were met, until September 20, 1999. The
forbearance agreement limited the Company's use of the credit facility to total
borrowings of $6,250,000. As a result of the Filing, the financial institution
has placed the line of credit on an offering basis, effectively reserving the
right to discontinue funding the Company at any time. The Company is in the
process of working to replace the current line of credit with a new facility,
however there can be no assurance of the Company's success in doing so. Under
the current credit facility, borrowing availability is determined by an advance
rate on eligible accounts receivable and inventory. Borrowings bear interest at
the bank's base rate (8.25% at September 30, 1999) plus 2% through July 31,
1999, increasing to 3% thereafter. In addition, the Company is charged an Unused
Line fee of .25% of the unused portion of the revolving loans.
At September 30, 1999, the Company had $4,311,000 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 prohibits the payment of dividends. At September 30, 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
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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 $681,000 at September 30, 1999.
The Company is in the process of expanding distribution and product categories
and is limited in its ability to borrow on the credit facility based upon
current levels of inventory and receivables. As a result of the limitations on
the usage of the 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 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 generated from operations was $68,000 in the nine months ended
September 30, 1999 compared to cash used in operations $8,838,000 in the
comparable 1998 period. The $8,906,000 improvement in cash generated from
operations was due primarily to a $2,390,000 decrease in net loss offset by a
decrease in depreciation and amortization of $997,000 combined with favorable
changes in accounts receivable of $2,456,000, inventories of $5,287,000, prepaid
expenses of $1,969,000 and other assets of $626,000, offset by a decrease in
accounts payable and accrued expenses of $3,427,000.
Cash flow used in investing activities was $443,000 for the nine months ended
September 30, 1999, primarily related to acquisitions of property and equipment.
Cash flow provided by financing activities was $536,000 in the nine months ended
September 30, 1999 due primarily to borrowings on the bank credit facility. The
current ratio for the Company increased from .76 at December 31, 1998 to .84 at
September 30, 1999.
In order to be successful in its reorganization, the Company must obtain
necessary operational financing and believes it will be successful in its
efforts to obtain the financing. However, 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 must sell certain assets for which it has
entered into agreements to execute such sales, although no assurance can be made
that the assets will be sold. If the Company is unable to obtain additional
working capital financing and is unable to sell the assets it has placed for
sale, it is unlikely that the pre-negotiated settlement with its creditors would
be executed and there could 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.
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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 November 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
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 have been upgraded and tested as of September 30, 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 end of November 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,
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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.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Following is a summary of litigation against the Company existing at September
30, 1999. As a result of the Filing, all litigation against the Company
has been stayed pursuant to Section 362 of Title 11 of the U.S. Bankruptcy Code.
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 (PEC) held by the Company with a carrying value of
$168,000. This amount is included in accrued liabilities at September 30, 1999
and December 31, 1998. Due to restrictions placed by the Company's lender (Note
5) on the transfer of PEC shares, the Company has been unable to fulfill the
terms of the settlement agreement and risks future litigation should the terms
of the agreement not be fulfilled in the future.
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 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.
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,
21
<PAGE> 24
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.
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 September 30, 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.
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 September 30, 1999, the Company issued 8,225,465
shares of its common stock in connection with the conversion of $150,000 and
$700,000 of the principal amount of the 1997 Debentures and 1998 Debentures,
respectively, plus interest accrued through the conversion 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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to a variety of risks, including foreign currency
fluctuations and changes in interest rates affecting the cost of its bank debt.
Foreign Currency - The Company has subsidiary operations in Thailand, and
accordingly, the Company is exposed to transaction gains and losses that could
result from changes in foreign currency exchange rates. The Company uses the
local currency (Thai baht) as the functional currency for its Thai subsidiaries.
Translation adjustments resulting from the process of translating foreign
currency financial statements into U.S. dollars were not significant in fiscal
1998 and in the nine month period ended September 30, 1999 due to the fact that
the exchange rate remained relatively constant throughout the period. Under the
current circumstances, the Company believes that the foreign currency market
risk is not material. The Company actively monitors its foreign exchange
exposure and evaluates possible strategies to reduce its risk. Should
circumstances change, the Company intends to implement appropriate strategies at
such time that it determines that the benefits outweigh the associated costs.
There can be no assurance that management's efforts to reduce foreign exchange
exposure will be successful.
Interest Rates - The Company's bank line of credit bears interest based on the
lending bank's prime rate. The interest rate on the balance of $4.3 million
outstanding at September 30, 1999 ranged from 9.75% to 11.25%. The Company
believes that if interest rates were to increase by as much as 10%, the impact
on the Company's financial statements would not be material.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
27 -- 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.
22
<PAGE> 25
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: November 12, 1999 By: /s/ Anthony P. Shutts
----------------------------
Anthony P. Shutts
Chief Financial Officer
(Principal financial and
accounting officer)
23
<PAGE> 26
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------ -----------
<C> <S>
27 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 400,000
<SECURITIES> 0
<RECEIVABLES> 9,789,000
<ALLOWANCES> 0
<INVENTORY> 7,953,000
<CURRENT-ASSETS> 21,668,000
<PP&E> 4,490,000
<DEPRECIATION> 0
<TOTAL-ASSETS> 34,777,000
<CURRENT-LIABILITIES> 25,831,000
<BONDS> 0
0
0
<COMMON> 41,322,000
<OTHER-SE> (32,809,000)
<TOTAL-LIABILITY-AND-EQUITY> 34,777,000
<SALES> 32,196,000
<TOTAL-REVENUES> 32,196,000
<CGS> 17,501,000
<TOTAL-COSTS> 17,501,000
<OTHER-EXPENSES> (243,000)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,502,000
<INCOME-PRETAX> (4,554,000)
<INCOME-TAX> 2,000
<INCOME-CONTINUING> (4,556,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,556,000)
<EPS-BASIC> (.15)
<EPS-DILUTED> (.15)
</TABLE>
