SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
FORM 10-QSB
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 For The Quarter Ended March 31, 1997
or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For The Transition Period from _______to_______
Commission File Number 0-22432
DIPLOMAT CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 13-3727399)
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
25 Kay Fries Drive, Stony Point, New York 10980
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 914 786-5552
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ___
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: May 10, 1997 5,843,525
Common Shares outstanding
Transitional Small Business Disclosure (check One):
Yes _____ No __X__
DIPLOMAT CORPORATION
INDEX
PAGE
PART I - FINANCIAL INFORMATION
Item 1- Financial Statements
Consolidated Balance Sheet - March 31, 1997 3
Consolidated Statements of Operations - For the three months
and six months ended March 31, 1997 and March 31, 1996 4
Consolidated Statements of Cash Flows - For the six months ended
March 31, 1997 and March 31, 1996 5
Notes to Financial Statements 6-8
Item 2 - Management's Discussion and Analysis of Financial
Conditions and Results of Operations 9-15
PART II - OTHER INFORMATION
Item 3 - Defaults Upon Senior Securities 16
Item 6 - Exhibits and Reports on Form 8-K 16
SIGNATURE 16
2
DIPLOMAT CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
(Unaudited)
MARCH 31, 1997
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 43,592
Accounts receivable, trade, net 1,795,055
Inventories 5,396,381
Prepaid expenses 1,187,154
Other current assets 70,121
-----------
TOTAL CURRENT ASSETS 8,492,303
PROPERTY AND EQUIPMENT
less accumulated depreciation 2,159,831
INTANGIBLE ASSETS 3,532,444
OTHER ASSETS 625,062
-----------
$14,809,640
LIABITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable-trade $ 4,719,231
Loans payable-stockholders 241,000
Loans payable-bank 3,248,682
Accrued expenses 1,026,710
Current maturities of long term debt 665,057
Subordinated convertible term notes 1,470,000
-----------
TOTAL CURRENT LIABILITIES 11,370,680
-----------
LONG TERM DEBT, less current maturities 1,003,017
-----------
STOCKHOLDERS' EQUITY:
Preferred stock 4,191,380
Common stock 535
Paid-in-capital 6,321,364
Accumulated deficit (8,077,336)
-----------
TOTAL SHAREHOLDERS' EQUITY 2,435,943
-----------
$14,809,640
See notes to financial statements.
3
DIPLOMAT CORPORATION AND SUBSIDIARY
STATEMENTS OF OPERATIONS
(Unaudited)
Six Months Ended Three Months Ended
March 31 March 31 March 31 March 31
1997 1996 1997 1996
---- ---- ---- ----
NET SALES $13,829,270 $ 6,506,762 $ 6,781,748 $ 5,152,866
COST OF SALES 6,241,654 3,884,889 3,034,704 2,640,134
----------- ----------- ----------- -----------
GROSS PROFIT 7,587,616 2,621,873 3,747,044 2,512,732
----------- ----------- ----------- -----------
OPERATING EXPENSES:
Selling expenses 2,468,107 1,801,948 1,376,070 1,313,568
General and administrative expenses 3,153,424 1,862,304 1,383,852 1,314,420
Warehouse and distribution expenses 350,109 394,110 212,257 214,984
----------- ----------- ----------- -----------
TOTAL OPERATING EXPENSES 5,971,640 4,058,362 2,972,179 2,842,972
----------- ----------- ----------- -----------
OPERATING INCOME (LOSS) 1,615,976 (1,436,489) 774,865 (330,240)
OTHER INCOME (EXPENSE) 2,105 (1,270) 195 2,685
INTEREST EXPENSE (330,873) (336,374) (181,116) (220,222)
----------- ----------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES 1,287,208 (1,774,133) 593,944 (547,777)
INCOME TAXES (BENEFIT) 321,000 (209,392) 182,000 (209,392)
----------- ----------- ----------- -----------
NET INCOME (LOSS) 966,208 (1,564,741) 411,944 (338,385)
PREFERRED STOCK DIVIDEND 131,250 0 78,750 0
----------- ----------- ----------- -----------
NET INCOME (LOSS) $ 834,958 $(1,564,741) $ 333,194 $ (38,385)
NET INCOME (LOSS) PER COMMON SHARE $0.16 $(0.35) $0.06 $(0.08)
NUMBER OF SHARES USED IN COMPUTATION 5,293,525 4,493,525 5,343,525 4,493,525
See notes to financial statements.
4
DIPLOMAT CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six months ended
March 31, March 31,
1997 1996
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (Loss) 966,208 (1,564,741)
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization 142,621 80,854
---------- ----------
1,108,829 (1,483,887)
CHANGES IN ASSETS AND LIABILITIES
(Increase) decrease in accounts receivable (316,898) (371,852)
(Increase) decrease in inventories (1,648,641) (2,450,904)
(Increase) decrease in prepaid expenses (540,210) (749,956)
(Increase) decrease in other current assets 1,022,893 (612,257)
(Increase) decrease in other assets 60,598 (414,617)
Increase (decrease) in accounts payable 49,905 2,844,550
Increase (decrease) in accrued expenses (706,034) 1,343,535
---------- ----------
(969,558) (1,895,388)
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment, net (80,104) (315,897)
Acquisition of Biobottoms 0 (3,645,613)
---------- ----------
(80,104) (3,961,510)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of warrants 628,000
Preferred stock dividend (131,250) 0
Proceeds from loans payable 200,000 4,389,642
Repayments of loans payable (122,784) (94,638)
Revolving credit agreement 1,078,030 926,178
---------- ----------
1,023,996 5,849,182
---------- ----------
NET INCREASE (DECREASE) IN CASH (25,666) (7,716)
CASH AND CASH EQUIVALENTS-beginning of period 69,258 49,695
---------- ----------
CASH AND CASH EQUIVALENTS-end of period 43,592 41,979
Supplemental disclosure of cash flow activity:
Financing
Issue of common and preferred stock
in settlement of obligations 336,380 600,000
Supplemental cash flow information:
Cash paid for the year for:
Interest 257,159 336,374
Taxes 4,837 0
5
DIPLOMAT CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED MARCH 31, 1997 AND 1996
1. SIGNIFICANT ACCOUNTING POLICIES
A. The financial statements include the accounts of the Company and its
wholly-owned subsidiary. All significant intercompany balances and transactions
have been eliminated.
B. Inventories are stated at the lower of cost or market. Cost is
determined by the first-in, first-out (FIFO) method.
C. Property and equipment are stated at cost. Depreciation is provided
using primarily the straight-line method and accelerated methods (for machinery
and equipment) over the expected useful lives of the assets, which range from
31.5 years for the building and real property, to between five and 10 years for
machinery, furniture and equipment.
D. The Company follows SFAS 109 for income taxes.
E. For purposes of the statement of cash flows, the Company considers
all highly liquid debt instruments purchased with an original maturity of three
months or less to be cash equivalents.
F. The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reported
period. Actual results could differ from those estimates.
G. In March 1995, the Financial Accounting Standards Board ("FASB"
issued Statement of Financial Accounting Standards ("SFAS") No. 121. "Accounting
For the Impairment of Long Lived Assets and For Long Lived Assets to be Disposed
Of" SFAS No. 121 requires the Company to review long-lived assets and certain
identifiable assets and any goodwill related to those assets for impairment
whenever circumstances and situations change such that there is an indication
that the carrying amounts may not be recoverable. The adoption of SFAS No. 121
did not result in any material adjustments in the financial statements for the
period ended March 31, 1997.
H. Effective December 30, 1995, the Company adopted SFAS No. 107,
"Disclosures About Fair Value of Financial Instruments", which requires
disclosure of fair value information about financial instruments whether or not
recognized in the balance sheet. The carrying amounts reported in the balance
sheet for cash, trade receivables, accounts payable and accrued expenses
approximate fair value based on the short term maturity of these instruments.
I. The Company accounts for stock transactions in accordance with APB
No. 25 "Accounting for Stock to Employees". In accordance with SFAS No. 123,
"Accounting for Stock based Compensation", the Company has adopted the pro-forma
disclosure requirements contained therein.
6
J. Direct response advertising costs, consisting primarily of catalog
preparation, printing and postage expenditures, are amortized over the period
during which the benefits are expected. Advertising costs, principally the
amortization of such prepaid catalog costs, are included in the statements of
operations.
2. ACQUISITION OF BIOBOTTOMS, INC. AND RELATED FINANCING
A. Acquisition of Biobottoms, Inc. On February 9, 1996, the Company
completed the acquisition of Biobottoms, Inc. ("Biobottoms"), a California-based
mail-order catalog company, specializing in apparel and accessories for newborn
through preteen children, pursuant to an Agreement and Plan of Merger made as of
December 22, 1995 by and among Diplomat Corporation, Diplomat Acquisition
Corporation, a wholly-owned subsidiary of the Company, organized under the laws
of the State of Delaware ("DAC"), Biobottoms and Joan Cooper and Anita
Dimondstein, individuals and principal stockholders of Biobottoms (the "Merger
Agreement"). Biobottoms has become a wholly-owned subsidiary of the Company and
will continue its principal place of business in Petaluma, California.
The Company paid $2,500,000 for Biobottoms, $1,000,000 in cash and
$1,500,000 in the form of two promissory notes to Biobottoms' shareholders, each
in the amount of $750,000 ("Acquisition Notes"). The notes bear interest at 1%
over the prime rate as defined in the agreements as long as no default occurs.
One such note was due six months from the acquisition date and the second note
was due in two equal installments of $375,000, nine months and eighteen months
after the date of acquisition, respectively. The Company did not make the
payments which were required in August and November 1996. On December 9, 1996
the Company received notification of the default from the former Biobottoms
shareholders, which required that the Company cure the default under the notes
within 270 days, or be subject to enforcement action. On February 25, 1997, the
Biobottoms former shareholders agreed not to initiate enforcement action as a
result of this or subsequent defaults until not earlier than December 31, 1997.
In connection with obtaining this agreement, Diplomat agreed to pay the
Biobottoms shareholders ten installments of $5,000 to be applied against the
acquisition notes, commencing on February 21, 1997 and to undertake to conduct a
private placement of its securities to raise funds for the remaining balance due
on the acquisition notes. Should the Company fail to raise enough funds for
repayment, it has agreed to repay the Biobottoms shareholders additional
payments of $50,000 on July 1, 1997 and $100,000 on December 15, 1997, such
amounts to be applied against the acquisition notes and pay interest beginning
September 30, 1997. Additionally, the Company incurred costs related to the
acquisition in the amount of approximately $720,000. Of this amount, $600,000
represents the estimated fair value of 100,000 shares of the Company's
convertible Series A Preferred Stock issued to a significant stockholder (who is
also a member of the Board of Directors), as a fee for his assistance in
consummating the acquisition. The Series A Preferred shares are convertible to
1,000,000 common shares of the Company. The Series A Preferred Stock is not
entitled to any specific dividends or liquidation rights.
The acquisition of Biobottoms has been accounted for as a purchase and
accordingly its results of operations are included with the Company's beginning
February 9, 1996.
The following unaudited pro-forma summary combines the consolidated
results of operations of the Company and Biobottoms as if the acquisition had
occurred at the beginning of 1995, after giving effect to certain adjustments,
including amortization of goodwill, increased interest expense on the
acquisition debt, and the adjustments required as a result of changes to certain
employment agreements as a direct result of the acquisition.
7
Six Months Ended
March 31, 1996
-----------------
(unaudited)
Net Sales $12,127,539
Net Loss (1,860,350)
Net Loss Per Common Share (0.41)
The pro-forma results do not necessarily represent results which would
have occurred if the acquisition had taken place on the basis assumed above, nor
are they indicative of the results of future combined operations.
B. Financing: Simultaneously with the closing of the Biobottoms
acquisition, the Company and Biobottoms entered into a loan and subordinated
security agreement with a director and principal stockholder of the Company and
an affiliate of such individual pursuant to which the Company borrowed from such
director and principal stockholder and affiliate $2,353,100 and $450,000.,
respectively. The loan from the director and principal stockholder was utilized
to fund the acquisition of Biobottoms in part. The loan from the affiliate has
been utilized for working capital purposes. Subject to an intercreditor
agreement between the Company's asset based lender and other lenders, the
$450,000 loan was payable in full on May 4, 1996 and was paid in full together
with a financing fee of $50,000 paid in May 1996.
In connection with such aforementioned loan by a director and
principal stockholder of the Company in the amount of $2,353,100, the Company
issued 100,000 shares of its Series A Preferred Stock, which are convertible
into 1,000,000 shares of common stock at the option of the directo and principal
stockholder. The holder of such shares of preferred stock will have the right,
subject to subordination and intercreditor agreement by and among Congress
Financial Corporation and others, during any period during which there shall be
an Event of Default under such loans, as such term is defined therein, to
designate a majority of the members of the Board of Directors of the Company.
Such right of designation will continue during the duration of any such Event of
Default. The Company has agreed at its sole cost and expense to include the
common shares issuable upon conversion of the shares in any registration
statement filed with the Securities and Exchange Commission by the Company
within six months of the date hereof.
3. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
During the three months and six months period ended March 31, 1997,
certain lawsuits were settled resulting in a reduction of accounts payable and
certain accrued liabilities were adjusted aggregating $270,000 less than
originally estimated. This reduction has been included as a reduction of general
and administrative expenses during the periods. During the periods, there was
also a reduction of accounts payable and accrued liabilities of approximately
$336,000 by the issuance of preferred stock and common stock in payment of the
obligations.
8
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Six Months Ended March 31, 1997 Compared to Six Months Ended March 31, 1996
NET SALES
Consolidated net sales for the Six Month Period ended March 31, 1997
("1997 Period") increased approximately $7,322,000 or 42% from the Six Month
Period ended March 31, 1996 ("1996 Period"), primarily as a result of the
Biobottoms sales of $5,566,000 not included in the 1996 period. Biobottoms was
acquired February 9, 1996. The sales of Diplomat for the 1997 Period were
$3,619,000 as compared to $3,173,000 for the 1996 Period and the sales of
Biobottoms were $10,210,000 in the 1997 Period as compared to $8,955,000 in the
1996 Period.
Consolidated cost of sales were 45%% of net sales in the 1997 Period
and 60% in the 1996 Period. The increase in cost of sales of $2,357,000,000 in
the 1997 Period included $2,705,000 from Biobottoms. Cost of sales of Diplomat
for the 1997 Period were $1,637,000,000 as compared to $2,400,000 in the 1996
Period. The reduction of 32%% was a result of the restructuring of the Company
during the 1997 Period. Cost of sales of Biobottoms increased 6% even though
sales increased 14% from the 1996 Period to the 1997 Period.
OPERATING EXPENSES
Consolidated operating expenses, which include selling, general,
administrative, warehouse and distribution expenses increased approximately
$1,913,000 from the 1996 Period to the 1997 Period primarily as a result of
$5,045,000 of Biobottoms operating expenses in the 1997 Period. Operating
expenses of Diplomat for the 1997 Period were $855,000 as compared to $2,400,000
in the 1996 Period. The reduction of 63%% resulted from decreased expenses from
restructuring, in addition to elimination of licensing fees and lower
professional, advertising and consulting fees in the 1997 Period together with
the settlement of lawsuits and adjustment of accrued expenses which reduced
operating expenses by $270,000 Operating expenses of Biobottoms remained
constant from the 1996 Period. Consolidated operating expenses were 43% of net
sales in the 1997 Period and 62% in the 1996 Period.
The net income for the 1997 Period was $966,000,000 as compared to a
net loss of $1,565,000 for the 1996 Period.
Three Months Ended March 31, 1997 Compared to Three Months Ended March 31, 1996
NET SALES
Consolidated net sales for the Three Month Period ended March 31, 1997
("1997 Period") increased approximately $1,629,000 or 32% from the Three Month
Period ended March 31, 1996 ("1996 Period"), primarily as a result of the
Biobottoms sales of $1,649,000 not included in the 1996 Period. Biobottoms was
acquired February 9, 1996. The sales of Diplomat for the 1997 Period
9
were $2,230,000 as compared to $1,819,000 for the 1996 Period and the sales of
Biobottoms were $4,552,000 in the 1997 Period as compared to $4,453,000 in the
1996 Period.
Consolidated cost of sales were 45% of net sales in the 1997 Period
and 51% in the 1996 Period. The increase in cost of sales of $395,000 in the
1997 Period included $38,000 from Biobottoms. Cost of sales of Diplomat for the
1997 Period were $822,000 as compared to $1,156,000 in the 1996 Period. The
reduction of 29% was a result of the restructuring of the Company during the
1997 Period. Cost of sales of Biobottoms increased 2% on increased sales of 2%
from the 1996 Period to the 1997 Period.
OPERATING EXPENSES
Consolidated operating expenses, which include selling, general,
administrative, warehouse and distribution expenses increased approximately
$299,000 or 5% from the 1996 Period to the 1997 Period, primarily as a result of
an increase of $254,000 of Biobottoms operating expenses in the 1997 Period.
Operating expenses of Diplomat for the 1997 Period were $346,000 as compared to
$1,084,000 in the 1996 Period. The reduction of 68% resulted from decreased
expenses from restructuring, in addition to elimination of licensing fees, lower
professional, advertising and consulting fees in the 1997 Period together with
the settlement of lawsuits and the adjustment of accrued expenses which reduced
operating expenses by $270,000. Operating expenses of Biobottoms remained
relatively constant from the 1996 Period to the 1997 Period. Consolidated
operating expenses were 44% of net sales in the 1997 Period and 55% in the 1996
Period.
Interest expense decreased from $220,000 in the 1996 Period to
$181,000 in the 1997 Period because of the borrowing of Biobottoms.
The net income for the 1997 Period was $412,000 as compared to a net
loss of $338,000 for the 1996 Period.
The following summary combines the consolidated results of operations
of the Company and Biobottoms as if the acquisition had occurred at the
beginning of fiscal 1995, after giving effect to the amortization of goodwill
and increased interest expense on the acquisition debt.
10
Six Months Pro-Forma
Ended Six Months Ended
March 31, 1997 March 31, 1996
-------------- --------------
Net Sales $13,829,270 $12,127,539
Cost of Goods Sold 6,241,000 6,730,421
----------- -----------
Gross Profit 7,587,616 5,397,118
Selling, General & Administrative Expenses 5,969,535 7,273,144
----------- -----------
Operating Income (Loss) 1,618,081 (1,876,026)
Interest Expense 330,873 405,901
----------- -----------
Income (Loss) Before Income Taxes 1,287,208 (2,281,927)
Income Taxes (Benefit) 321,000 (421,577)
----------- -----------
Net Income (Loss) 966,208 (1,860,350)
Six Months Ended March 31, 1997 Compared to Pro-Forma Six Months Ended March 31,
1996
NET SALES
Consolidated net sales for the Six Month Period ended March 31, 1997
("1997 Period") increased approximately $1,702,000 or 14% from the Six Month
Period ended March 31, 1996 ("1996 Period"), as a result of the increase of
Biobottoms sales of $1,255,000 and an increase in the sales of Diplomat for the
1997 Period of $447,000.
Consolidated cost of sales were 45% of net sales in the 1997 Period
and 55% in the 1996 Period. Cost of sales decreased $489,000 in the 1997 Period.
Cost of sales of Diplomat for the 1997 Period decreased $764,000 as compared to
the 1996 Period. The reduction of 32% was a result of the restructuring of the
Company during the 1997 Period. Cost of sales of Biobottoms increased 6% even
though sales increased 14% from the 1996 Period to the 1997 Period.
OPERATING EXPENSES
Consolidated operating expenses, which include selling, general,
administrative, warehouse and distribution expenses decreased approximately
$1,304,000 from the 1996 Period to the 1997 Period. Operating expenses of
Diplomat for the 1997 Period were $855,000 as compared to $2,300,000 in the 1996
Period. The reduction of 63% resulted from decreased expenses from
restructuring, in addition to elimination of licensing fees and lower
professional, advertising and consulting fees in the 1997 Period together with
the settlement of lawsuits and adjustment of accrued expenses which reduced
operating expenses by $270,000. Operating expenses of Biobottoms remained
constant from the 1996 Period. Consolidated operating expenses were 43% of net
sales in the 1997 Period and 60% in the 1996 Period.
The net income for the 1997 Period was $966,000 as compared to a net
loss of $2,125,000 for the 1996 Period.
Liquidity and Capital Resources
The Company completed an initial public offering on November 13, 1993
and received net proceeds of approximately $4,454,000. Proceeds of the offering
were used for purchases of inventory,
11
marketing and promotion, product development, reduction of accounts payable and
repayment of loans from a principal stockholder and executive officer. The
Company has relied upon the proceeds of its initial public offering, borrowings
from an institutional lender, a principal stockholder and director of the
Company, and proceeds from the exercise of warrants in 1995,1996 and 1997 in
order to fund its operations.
The Company's principal working capital credit facility is provided by
Congress Financial Corporation.
In April 1994, the Company entered into an agreement with Congress
providing the Company with a maximum $3 million secured line of credit to be
used for loans and trade letters of credit. The loans are secured by
substantially all of the Company's personal property, including with limitation,
accounts receivable, inventory and trademarks. The interest rate on loans is two
(2%) percent above the prime rate announced by Core States Bank. The credit
agreement contains restrictions relating to the payment of dividends.
Additionally, prior to amendment, the Company was required to maintain a minimum
of $3,500,000 in stockholders' equity and a minimum of $4,500,000 of working
capital (excluding the Congress loan and certain subordinated debt). At
September 30, 1996, the Company was not in compliance with these financial
covenants, however Congress continued to extend the Company credit under the
terms of the original agreement. On February 25, 1997, the violations were
waived by Congress, and the Company and Congress agreed on revised financial
covenants. Under the revised agreement, the stockholders' equity and working
capital minimums (excluding the Congress loan and certain subordinated debt)
were reduced to (750,000) and 500,000, respectively, and shall be increased
during the fiscal year ending September 30, 1997 to (250,000) and 1,500,000,
respectively. The Company expects to be in compliance with the revised financial
covenants at each measurement date.
Under the terms of the credit agreement, the Company could borrow up
to 85% of the amount of eligible accounts receivable (as defined in the
agreement), not to exceed the maximum credit. In February 1995 the Agreement was
amended to adjust the formula used to determine the amount available for
revolving loans by including therein an amount based upon eligible inventory not
to exceed $750,000.
In connection with that amendment, Robert Rubin, a director and
principal stockholder of the Company, furnished the lender with a personal
limited guarantee up to a maximum liability of $375,000, pertaining to loans
made based upon eligible inventory. In connection with the initial Congress
transaction, the Company borrowed from Robert Rubin $590,000 on a secured term
loan basis, subordinated to Congress Financial, in order to repay in full its
then existing outstanding principal indebtedness to Citibank, N.A. Such Citibank
facility in the initial principal amount of $650,000, was established in June,
1993, secured by certain assets of the Company and a shareholder guaranty from
Mr. Rubin. The loan from Mr. Rubin was repayable with interest at the prime rate
plus 1 1/2%, with required principal payment amortization identical to the terms
applicable to the Citibank loan terms.
Accordingly, the Company made principal payments of $120,000 in 1994,
$120,000 in 1995, $175,000 in 1996 and would have been required to make payments
of $174,800 in 1997. The balance of the debt was converted into Preferred Stock
in September, 1996.
In connection with the Biobottoms acquisition, the Company incurred
debt of $4,303,100 consisting of Deferred Payment Notes, payable to (i) the
former Biobottoms stockholders in the amount of $1,500,000, (ii) Mr. Rubin in
the amount of $2,353,100, and (iii) American United Global in the amount of
$450,000. The American United Global loan was paid in May, 1996. Under the
Deferred Payment Note, $750,000 was due August 9, 1996, $375,000 was due
November 9, 1996 and $375,000 had been due August 9, 1997 together with
interest. The August and November payments have not been made which accelerated
the entire amount to be due. On December 9, 1996, the holders of these
12
notes gave notice of default in accordance with the acquisition agreement. Under
the Intercreditor Agreement ( as such term is defined below) the holders of the
notes must wait 270 days after giving notice before taking any further action in
the collection of these notes. On February 25, 1997, the holders of these notes
agreed not to initiate an enforcement action prior to December 31, 1997. In
connection with the obtaining of this agreement, Diplomat agreed to pay the
holders of the Deferred Payment Notes ten installments of $5,000 to be applied
against the Deferred Payment Notes commencing on February 21, 1997 and to
undertake to conduct a private placement of its securities to raise funds for
repayment of the remaining balance due on the Deferred Payment Notes. Should the
Company fail to raise enough funds for repayment, it has agreed to repay the
Biobottoms shareholders additional payments of $50,000 on July 1, 1997 and
$100,000 on December 15, 1997 to be applied against the Deferred Payment Notes
and pay interest beginning September 30, 1997. Mr. Rubin furnished the former
Biobottoms shareholders with a limited guarantee up to a maximum liability of
$100,000 pertaining to the payments due July 1, 1997 and December 15, 1997.
Effective September 30, 1996, Mr. Rubin, a director and principal
stockholder of the Company, agreed to convert an aggregate of $2,900,000 in
outstanding debt into an aggregate of 290,000 Shares of Series B Preferred
Stock, which pay an annual dividend of 9% based on per share liquidation value.
The Company issued Mr. Rubin an aggregate of 550,000 shares of Common
Stock in consideration of Mr. Rubin's waiver of certain compensation owed to him
and for restructuring certain debt owed to him, waiving certain defaults and
making additional loans to the Company in the aggregate amount of $600,000. As
of September 30, 1996, the $600,000 loan was converted into 60,000 shares of
Series C Preferred Stock which pay an annual dividend of 9% based on per share
liquidation value.
In connection with the February 9, 1996 closing on the Biobottoms
acquisition ( the "Closing), Biobottoms established an inventory based credit
facility with Congress Financial Corporation, the Company's principal lender,
secured by a first priority security interest in substantially all of the assets
of Biobottoms and a guaranty of such obligations by the Company (the
"Biobottoms/Congress Loan Facility"). The maximum credit available under the
facility is $2 million and on the date of Closing, $848,531 was available and
borrowed.
The Biobottoms/Congress Loan Facility is guaranteed by the Company and
a default thereunder constitutes a default under the Company's Loan and Security
Agreement with Congress. The interest rate charged on the loan is the prime rate
as announced by Core States Bank, N.A. (the "Prime Rate") plus 2%. At September
30, 1996, Biobottoms was not in compliance with certain covenants of the loan
agreement, however Congress continued to extend Biobottoms credit under the
terms of the agreement. On February 25, 1997 the violations were waived by
Congress, and Congress and the Company agreed on revised financial covenants for
the remainder of the Company's fiscal year ending September 30, 1997. The
Company expects to be in compliance with the revised financial covenants at each
measurement date.
In February 1997, Mr. Rubin made an additional loan to the Company in
the amount of $200,000. This loan, and the Series B and C Preferred Stock are
referred to hereafter as the "Rubin Obligations".
The Deferred Payment notes and the Rubin Obligations are, and the
American United loans were subject to an Intercreditor Agreement with Congress
Financial Corporation (the "Intercreditor Agreement") which has the effect of
restricting or limiting enforcement remedies under the promissory notes
evidencing the Deferred Payment and the Rubin Obligations prior to repayment of
the senior debt payable to Congress Financial Corporation and restricting the
repayment of principal payable thereon based upon certain minimum excess loan
availability requirements.
13
The Intercreditor Agreement also provides that irrespective of the
relative priority status between the holders of the Deferred Payment obligations
and the Rubin Obligations, repayment of the Deferred Payment is permitted to be
paid provided that there has been no default of senior debt payable by the
Company or Biobottoms to Congress, minimum excess availability requirements
under the Company's loan facility with Congress are satisfied and such payments
are made with proceeds from a subsequent sale of its capital stock. Subject to
the Intercreditor Agreement, the Deferred Payment and the Rubin Obligations were
payable from the proceeds from any sale of capital stock by the Company in the
proportions of 40% on account of the Deferred Payment and 60% on account of the
Rubin Obligations, except that before any such distributions are made, the
Company will be required to reduce the outstanding principal amount of the
Deferred Payment by $150,000. These provisions were amended on February 25,
1997, such that the proceeds of a private placement of the Company's Common
Stock shall be applied first to repay in full the principal of, and all accrued
interest thereon, the Deferred Payment Notes. The Company does not presently
have any commitment for any such financing.
The Intercreditor Agreement contains provisions to the effect that
prior to March 1, 1998, no principal amount of the Rubin Obligations may be
repaid, except from proceeds from the sale of capital stock by the Company,
subject in all respect to the Intercreditor Agreement. Commencing March 1, 1998
and subject to the provisions of the Intercreditor Agreement, including without
limitation the requirement that the Company have certain minimum levels of
excess loan availability at the time of the making of any such principal
payment, the Rubin Obligations are subject to principal payments monthly of the
amount equal to 25% of the Company's net profit for the second preceding month,
plus depreciation and amortization expenses for said month, with the unpaid
principal amount of the Rubin Obligations and unpaid interest accrued thereon
payable in full on February 9, 1999.
In connection with the Biobottoms Congress Loan Facility, Mr. Rubin
also issued to Congress his written commitment to provide additional term loans
to the Company, not to exceed in the aggregate the principal amount of $300,000,
such loans to be made solely at the discretion of Congress. Proceeds from any
such loans may only be used by the Company to provide working capital for
Biobottoms.
Proceeds from the Congress loan and the Rubin/American United Loans
were used on February 9, 1996 or remained otherwise available as follows:
Payment at Closing of Biobottoms'
Institutional Secured Lender $1,448,025
Cash portion of Biobottoms Purchase
Price 1,000,000
Loan Costs and Legal Fees 96,690
Available Working Capital 1,103,816
At the time that the Biobottoms acquisition was completed, additional
equity financing was contemplated to fund the scheduled payments of the
acquisition debt and working capital requirements for the Diplomat and
Biobottoms businesses. Such financing was not secured within the time
constraints contemplated by the management of the Company. As a result, the
acquisition debt was not paid when due. In addition, the Company is experiencing
severe working capital shortages and requires additional capital resources to
fund its existing operations. Under Diplomat's and Biobottoms' lending
facilities with Congress Financial, the Company has borrowed the maximum amounts
available as of the date hereof and there is no unused loan availability. The
Company is pursuing a number of financing alternatives, although there can be no
assurance that such efforts will result in necessary financing or that the terms
of such financing will be on terms favorable to existing stockholders. The
failure to secure additional working capital and funds to pay the Biobottoms
acquisition debt will materially adversely affect the business and financial
condition of the Company. Insufficient working capital may require the Company
to reduce operations significantly.
14
In July 1995, the Company, in connection with a financial consulting
agreement, issued to Boulder Enterprises, Inc., Class B, Class C and Class D
Warrants, each exercisable for 500,000 shares of common stock, at $1.37, $2.50
and $3.00 per share, respectively.
All of the Class B Warrants were exercised during 1995 providing the
Company with net proceeds of $628, 000. The Class D Warrants expired in July,
1996. The Class C Warrants were exercised in April 1997 providing the Company
with proceeds of $500,000.
In August 1996, the Company, in connection with a Non-Qualified Stock
Option Plan, issued 500,000 options which were exercised at a price of $.95 per
share.
In November 1996, the Company, in connection with an Incentive Stock
Option Plan, issued 1,060,000 options at an exercise price of $1.00 per share.
There can be no assurance that the Company will operate profitably in
the future or that cash from operations will become the principal source of
funds for operations.
During the six months ended March 31, 1997, there was a decrease in
cash flow from operating activities of approximately $970,000 primarily from an
increase in inventory required for the sale of seasonal products. This increase
was funded by the revolving line of credit from Congress and a $200,000 loan
from Robert Rubin.
15
PART II OTHER INFORMATION
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
As of December 31,1996, the Company was not in compliance with its
credit agreement with Congress Financial Corporation ("Congress"). Under the
agreement, the Company must maintain $4,500,000 in working capital (excluding
the Congress loan and certain subordinated debt), and stockholder's equity of
$3,500,000. At December 31,1996, the balance due to Congress was approximately
$2,101,900. On February 25, 1997, the violations were waived by Congress.
In August and November the Company failed to pay Deferred Payment
Notes, totaling $1,125,000 which it owed in connection with the acquisition of
Biobottoms, Inc. ("Biobottoms"). On December 9, 1996, the holders of the notes
gave notice of default in accordance with the acquisition agreement. Under this
agreement, the holders of the notes must wait 270 days after giving notice
before taking further action in the collection of these notes. On February 25,
1997, the holders of these notes agreed not to initiate an enforcement action
prior to December 31, 1997.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
None
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
DIPLOMAT CORPORATION
May 15, 1997 By: /s/ Jonathan Rosenberg
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Jonathan Rosenberg
Chief Executive Officer
May 15, 1997 By: /s/ Irwin Oringer
----------------------
Irwin Oringer
Principal Accounting Officer and
Controller