UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended December 31, 1998
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
------------ ----------------
Commission file number 0-22432
DIPLOMAT DIRECT MARKETING CORPORATION
(Exact name of registrant as specified in its charter)
(Formerly Diplomat Corporation)
Delaware 13-3727399
- -------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
25 Kay Fries Drive
Stony Point, New York 10980
- --------------------- -----
(Address of principal executive offices) (Zip Code)
(914) 786-5552 (Registrant's telephone number, including area code)
Check 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, 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,
$.0001 Par Value, on March 4, 1999 was 12,162,372 shares.
DIPLOMAT DIRECT MARKETING CORPORATION
DECEMBER 1998 QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Page Number
Item 1. Financial Statements ................................................1-8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................9-13
Item 3. Quantitative and Qualitative Disclosures About Market Risk............13
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.....................................................14
Item 2. Changes in Securities and Use of Proceeds.............................14
Item 3. Defaults Upon Senior Securities.......................................14
Item 4. Submission of Matters to a Vote of Security Holders...................14
Item 5. Other Information.....................................................14
Item 6. Exhibits and Reports on Form 8-K......................................14
i
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements
as defined by the Private Securities Litigation Reform Act of 1995.
Forward-looking statements include statements concerning plans, objectives,
goals, strategies, future events or performance and underlying assumptions and
other statements, which are other than statements of historical facts. These
statements are subject to uncertainties and risks including, but not limited to,
product and service demand and acceptance, changes in technology, economic
conditions, the impact of competition and pricing, government regulation, and
other risks defined in this document and in statements filed from time to time
with the Securities and Exchange Commission. All such forward-looking statements
are expressly qualified by these cautionary statements and any other cautionary
statements that may accompany the forward-looking statements. In addition,
Diplomat Direct Marketing Corporation disclaims any obligations to update any
forward-looking statements to reflect events or circumstances after the date
hereof.
INTRODUCTORY NOTE
The term "Company" used herein refers to Diplomat Direct Marketing
Corporation and its wholly-owned subsidiaries, Lew Magram Ltd. ("Lew Magram"),
Brownstone Holdings, Inc. ("Brownstone"), Ecology Kids, Inc. ("Ecology Kids")
and Diplomat Holdings, Inc.
ii
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets as of December 31, 1998
and September 30, 1998..............................................2
Consolidated Statements of Operations
for the quarters ended December 31, 1998 and 1997..............3
Consolidated Statements of Cash Flows
for the quarters ended December 31, 1998 and 1997..............4
Notes to Consolidated Financial Statements.........................5-8
1
Diplomat Direct Marketing Corporation and Subsidiaries
Consolidated Balance Sheets
(Unaudited)
December 31, September 30,
1998 1998
---- ----
Assets
Current:
Cash and cash equivalents $ 662,467 $ 322,778
Accounts receivable, net 2,164,393 1,921,209
Inventories 12,465,451 11,066,380
Prepaid catalogs 6,211,502 8,051,651
Prepaid expenses 1,630,278 1,379,567
Other current assets 559,268 837,946
---------------- ---------------
Total current assets 23,693,359 23,579,531
---------------- ---------------
Property and equipment, net 3,982,169 4,176,903
---------------- ---------------
Other assets:
Goodwill, net of amortization 14,463,686 14,587,358
Customer list, net of amortization 6,900,000 7,100,000
Note receivable 870,000 870,000
Other 645,091 645,091
---------------- ---------------
Total assets $50,554,305 $50,958,883
=========== ===========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses $14,492,021 $ 18,469,136
Loans payable - officers 225,000 225,000
Loans payable - Congress Financial Corp. 8,759,731 5,504,371
Open prepaid orders 872,542 1,211,165
Outstanding merchandise credit 2,299,289 1,892,148
Current maturities of long-term debt 845,337 939,816
---------------- ---------------
Total current liabilities 27,493,920 28,241,636
---------------- ---------------
Long-term debt, less current maturities 6,367,764 6,383,585
---------------- ---------------
Stockholders' equity
Preferred stock, $.10 par value - shares authorized 1,000,000;
issued and outstanding 545,983 (Liquidation value of $16,380,000) 5,461 5,461
Common stock, $.0001 par value - shares authorized 50,000,000;
issued and outstanding 11,049,872 1,112 1,112
Additional paid-in capital 25,835,390 25,835,445
Accumulated deficit (9,149,342) (9,508,356)
---------------- ---------------
Total stockholders' equity 16,692,621 16,333,662
---------------- ---------------
Total liabilities and stockholders' equity $50,554,305 $50,958,883
================ ===============
See accompanying notes to consolidated financial statements.
2
Diplomat Direct Marketing Corporation and Subsidiaries
Consolidated Statements of Operations
(Unaudited)
Three Months Ended December 31,
1998 1997
---- ----
Net sales $23,059,559 $17,983,991
Cost of goods sold 11,273,661 7,864,273
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Gross profit 11,785,898 10,119,718
Selling, general and administrative expenses 10,839,172 9,171,837
-------------- --------------
Operating income 946,726 947,881
Interest expense (482,779) (337,961)
-------------- --------------
Income before income tax (expense) benefit 463,947 609,920
Income tax (expense) benefit -- --
-------------- --------------
Income from continuing operations 463,947 609,920
Loss on discontinued operations (26,183) (386,266)
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Net income 437,764 223,654
Preferred stock dividends (78,750) (126,640)
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Net income to common stockholders $ 359,014 $ 97,014
============== ==============
Per common share - Basic
Net income from continuing operations $ .03 $ .05
Net income (loss) from discontinued operations -- (.04)
-------------- --------------
Net income - Basic $ .03 $ .01
Per common share - Diluted:
Net income from continuing operations $ .03 $ .06
Net income (loss) from discontinued operations -- (.04)
-------------- --------------
Net income - Diluted $ .03 $ .02
============== ==============
Average number of shares used in computation - Basic 11,049,872 8,880,733
========== =========
- Diluted 15,737,317 10,331,206
========== ==========
See accompanying notes to consolidated financial statements.
3
Diplomat Direct Marketing Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
Three Months Ended
12/31/98 12/31/97
Cash flows from operating activities:
Net income $437,764 $223,654
Adjustments to reconcile net income to net cash
Used in operating activities:
Amortization 323,672 203,256
Depreciation 124,926 167,609
(Increase) decrease in accounts receivable (243,184) (1,467,223)
(Increase) decrease in inventories (1,399,071) (4,895,696)
(Increase) decrease in prepaid expenses (250,711) 113,799
(Increase) decrease in prepaid catalogs 1,840,149 (1,858,527)
(Increase) decrease in other assets 278,678 391,731
(Increase) decrease in assets held for sale 420,148
Increase (decrease) in accounts payable (3,977,170) 694,365
and accrued liabilities
Increase (decrease) in outstanding merchandise credits 407,141 6,110,983
Increase (decrease) in prepaid orders (338,623) 314,279
--------- -------
Net cash provided (used) by operating activities (2,796,429) 418,378
Cash flows from investing activities:
Purchase and sale of property and equipment 69,808 (494,972)
Acquisition of subsidiary assets 0 (4,079,530)
--------- -----------
Net cash provided (used) by investing activities 69,808 (4,574,502)
Cash flows from financing activities:
Issuance of common and preferred stock 478,398
Revolving credit loans 3,255,360 4,439,337
Preferred stock dividends paid (78,750) (126,640)
Increase in long term debt and loans payable (110,300) 58,523
--------- ------
Net cash provided (used) by financing activities 3,066,310 4,849,618
Net increase (decrease) in cash 339,689 693,494
Cash at beginning of period 322,778 59,750
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Cash at end of period $662,467 $753,244
======== ========
See accompanying notes to consolidated financial statements.
4
Diplomat Direct Marketing Corporation and Subsidiaries
Notes to Consolidated Financial Statements
1. Summary of Significant (a) The consolidated financial statements
Accounting Policies include the accounts of Diplomat
Direct Marketing Corporation (the
"Company") and its wholly owned
subsidiaries. All significant
intercompany balances and transactions
have been eliminated.
(b) Inventories are stated at the lower of
cost or market. Cost is determined by the
first-in, first-out (FIFO) method.
(c) Property and equipment are stated at
cost. Depreciation is provided using
primarily the straight-line method and
accelerated methods (for machinery and
equipment) over the expected useful lives
of the assets, which range from 31.5
years for the building and real property
to between five and ten years for
machinery, furniture and equipment.
(d) The Company follows Statement of
Financial Accounting Standards ("SFAS")
No. 109. Pursuant to SFAS No. 109, for
income taxes, deferred tax assets and
liabilities are determined based on
differences between the financial
reporting and tax bases of assets and
liabilities and are measured by applying
enacted tax rates and laws to taxable
years in which such differences are
expected to reverse.
(e) For purposes of the statement of cash
flows, the Company considers all highly
liquid debt instruments purchased with an
original maturity of three months or less
to be cash equivalents.
(f) The preparation of financial statements
in conformity with generally accepted
accounting principles requires management
to make estimates and assumptions that
affect the reported amounts of assets and
liabilities and disclosure of contingent
assets and liabilities at the date of the
consolidated financial statements and the
reported amounts of revenues and expenses
during the reporting period. Actual
results could differ from those
estimates.
(g) Statement of Financial Accounting
Standards No. 128, "Earnings per Share."
("SFAS No. 128") is effective for
financial statements for fiscal periods
ending after December 15, 1997. The new
standard establishes standards for
computing and presenting earnings per
share. The effect of adopting SFAS No.
128 is not expected to be material.
Statement of Financial Accounting
Standards No. 130, "Reporting
Comprehensive Income," established
standards for reporting and display of
comprehensive income, its components and
accumulated balances. Comprehensive
income is defined to include all changes
in equity except those resulting from
investments by owners and distributions
to owners. Among other disclosures, SFAS
No. 130 requires that all items that are
required to be recognized under current
accounting standards are components of
comprehensive income be reported in a
financial statement that is displayed
with the same prominence as other
financial statements.
Statement of Financial Accounting
Standards No. 131, "Disclosures about
Segments of an Enterprise and Related
Information," which supersedes SFAS No.
14, "Financial Reporting for Segments of
a Business Enterprise," establishes
standards for the way that public
enterprises report information about
operating segments in interim
5
financial statements issued to the
public. It also establishes standards for
disclosures regarding products and
services, geographic areas and major
customers. SFAS No. 131 defines operating
segments as components of and enterprises
about which separate financial
information is available that is
evaluated regularly by Management in
deciding how to allocate resources and in
assessing performance.
Both SFAS Nos. 130 and 131 are effective
for financial statements for periods
beginning after December 15, 1997 and
require comparative information for
earlier years to be restated. The
adoption of these standards is not
expected to have a material effect on the
Company?s financial position or results
of operations. The Company is currently
reviewing SFAS No. 131 and has of yet
been unable to fully evaluate the impact,
if any, it may have on future financial
statement disclosures.
Statement of Financial Accounting
Standards No. 133 "Accounting for
Derivative Instruments and Hedging
Activities" establishes accounting and
reporting standards for Derivative
Instruments. The Company has not in the
past or does it anticipate that it will
engage in transactions involving
Derivative Instruments which will impact
the Financial Statements.
(h) Long-lived assets, primarily property and
equipment, goodwill and customer lists
are periodically reviewed by management
to determine if there has been a
permanent impairment in their value by
evaluating various factors, including
current and projected operating results.
Based on this assessment, management
concluded that at December 31, 1998 and
September 30, 1998, the Company's long-
lived assets were fully realizable.
(i) The carrying amounts reported in the
balance sheet for cash, trade
receivables, accounts payable and accrued
expenses approximate fair value based on
the short-term maturity of these
instruments.
(j) The Company accounts for stock
transactions with employees in accordance
with APB No. 25, "Accounting for Stock
Issued to Employees." In accordance with
SFAS No. 123, "Accounting for Stock Based
Compensation," the Company has adopted
the pro forma disclosure requirements
contained therein.
(k) Direct response advertising costs,
consisting primarily of catalog
preparation, printing and postage
expenditures, are amortized over the
period in which related revenues are
expected to be realized, generally three
to six month. Advertising costs,
principally the amortization of such
prepaid catalog costs attributable to
continuing operations, included in the
accompanying statement of operations were
$6,298,336 for the three months ended
December 31, 1998 and $5,174,353 for the
three months ended December 31, 1997.
Included in other current assets at
December 31, 1998, is $6,211,502 and at
September 30, 1998, $8,051,651 of prepaid
catalog costs.
(l) Revenue is recognized at the time
merchandise is shipped to customers.
Proceeds received for merchandise not yet
shipped are reflected as "prepaid
orders," a current liability.
6
(m) The Company issues merchandise credits
for certain returns of merchandise sold
with substantial discounts. Because of
Lew Magram's policy of writing off unused
credits issued with the return of sale
merchandise, it may be liable for future
claims on such amounts previously written
off.
2. Business The Company is engaged in two continuing
lines of business and, accordingly, its
operations are classified into two
business segments: mail order catalog
retail operations, and the manufacturing,
marketing and distribution of infants'
accessories principally to mass
merchandisers. In 1998, the Company sold
the Biobottoms subsidiary. The operations
of that company have been accounted for
as discontinued operations.
(a) Acquisition of Lew Magram
On February 19, 1998, the Company
(through its wholly owned subsidiary,
Magram Acquisition Corp.) closed on the
acquisition of Lew Magram, Ltd. ("Lew
Magram"), a New York corporation with a
place of business in Teaneck, New Jersey,
which is in the business of mail order
catalog sales of women's clothing. For
accounting purposes, the acquisition was
effected as of July 1, 1997, the date
that the Company assumed effective
control of Lew Magram. The acquisition
was accounted for as a purchase and the
consideration consisted of the issuance
of 95,000 shares of the Company's $.01
par value, Series D, convertible into
3,166,667 shares of the Company's common
stock (which assumes a market value of
$4.00 per share). The preferred stock
does not pay any dividends, but
participates with common in any Company
distributions. The preferred stock has a
liquidation preference of $100 per share.
An additional 250,000 shares of common
stock were also given as consideration to
the sellers. The fair market value of the
consideration was approximately $8.7
million and acquisition costs were
approximately $646,000. The Company
recorded the carryover basis for certain
selling stockholders of Lew Magram who
are also principal stockholders of the
Company.
The net fair market value of identifiable
assets acquired was approximately $6.9
million, and included customer lists
valued at $5 million. The customer lists
are being amortized over a period of 10
years. Cost in excess of net assets
acquired amounted to approximately $10
million and is being amortized over 25
years.
(b) Acquisition of Brownstone
On October 30, 1997, the Company acquired
out of bankruptcy all the assets of Jean
Grayson's Brownstone Studios, Inc., a
mail order catalog company for the
assumption of approximately $10,000,000
in liabilities and an option to the
owners of Jean Grayson's Brownstone
Studios, Inc. to purchase 200,000 shares
of Diplomat common stock at $3.9375
(market value) for a period of three
years. The acquisition was accounted for
as a purchase, accordingly, the operating
results include the operations of
Brownstone for the period November 1,
1997, through October 3, 1998. The
purchase price was allocated to assets
acquired based on their estimated fair
value, including customer lists valued at
$3,000,000 which will be amortized on a
straight line basis over ten years. This
treatment results in approximately
$4,000,000 in cost in excess of net
assets acquired which will be amortized
on a straight line basis over twenty-five
years. As a result of this acquisition,
the scope of the Company's business has
expanded into the mature women's apparel
and accessories markets primarily through
direct mail catalogs. Since Brownstone
was in bankruptcy prior to its
acquisition in October 1997, presentation
of financial information as if it had
been acquired on October 1, 1996 was not
available and would not be meaningful.
7
(c) Sale of Biobottoms
On April 17, 1998, the Company entered
into an Asset Purchase Agreement (the
"Agreement") with Genesis Direct Thirty
Four, LLC ("Buyer") in which the Buyer
purchased substantially all of the assets
and assumed certain of the liabilities of
Biobottoms. The Buyer paid $2,270,000 in
cash and a note and assumed $5,749,000 in
liabilities. The note is subject to
reduction depending on the net assets
acquired as determined in a closing date
balance sheet. The amount of the
reduction of the note is in dispute. The
Company, however, believes that the
reduction will not be material. If the
amount of the net value of acquired
assets is less than negative $778,000 or
the accrued expenses and customer
liabilities included in the assumed
liabilities exceed $828,877, the greater
of such deficiencies will reduce the
amount of the note.
The Company shall retain all claims for
tax refunds, tax loss carryforwards or
carrybacks of tax credits of any kind
applicable to the business of Biobottoms
prior to the closing of the asset sale.
The Agreement further specifies that
certain intercompany and affiliated
person liabilities will not be assumed by
the Buyer.
Following is a summary of net assets and
the results of operations of Biobottoms:
December 31, 1997
Assets
Current $5,206,854
Property and Equipment 349,025
Other 3,493,295
Liabilities
Current 6,148,011
Long-Term 67,301
Net assets disposed of 2,833,862
Periods Ended December 31 1998 1997
Sales $ -- $4,357,043
------------ ----------
Cost of Sales -- 2,206,720
Operating Expenses 26,183 2,474,061
Interest -- 62,528
----------- ------
26,183 4,743,309
----------- ---------
Net Loss $(26,183) $(386,266)
========= ==========
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the Financial Statements and Notes thereto appearing elsewhere herein.
Except for historical information contained herein, certain statements herein
are forward-looking statements that are made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements involve known and unknown risks and uncertainties
that may cause the Company's actual results in future periods to differ
materially from forecasted results. Those risks include, among others, the
receipt and timing of future customer orders, price pressures and other
competitive factors leading to a decrease in anticipated revenues and gross
profit margins.
Introduction
The Company's core business has historically focused on the wholesale
marketing and distribution of infant apparel and accessories. Through recent
acquisitions, the Company has repositioned its business to direct mail catalog
retailing with a significant emphasis on the women's apparel market.
Ecology Kids, a wholly owned subsidiary of the Company, manufactures
and distributes cloth diapers, diaper covers, layette, infant and child travel
products and other infants accessories marketed primarily under the Ecology Kids
name, primarily to major mass merchandisers.
On October 30, 1997, Brownstone, a newly formed, wholly owned
subsidiary of the Company, acquired out of bankruptcy all of the assets of Jean
Grayson's Brownstone Studios, Inc., a mail order catalog company. As a result of
this acquisition, the scope of the Company's business has expanded into the
mature women's apparel and accessories markets primarily through direct mail
catalog.
On February 19, 1998, the Company completed the acquisition of Lew
Magram Ltd., a New York corporation, resulting in Lew Magram becoming a wholly
owned subsidiary of the Company. Lew Magram is a direct-mail cataloger of
women's fashion clothing founded approximately 50 years ago. The Company, which
effectively took control over Lew Magram in July 1997, has integrated the
operations of Brownstone and Lew Magram.
On April 17, 1998, the Company sold substantially all of the assets of
its then wholly owned subsidiary Biobottoms, Inc. ("Biobottoms") for $2,270,000
in cash and notes and $5,749,000 in assumption of liabilities.
The Company is currently experiencing significant delays in fulfilling
merchandise orders. This is a result of the Company's difficulty in obtaining
timely shipment of inventory from its vendors to meet the strong customer
demand. Some of the Company's vendors and their lending institutions have been
reluctant to extend credit to the Company in such amounts and upon such terms as
to support timely delivery of inventory as needed to meet orders. This
reluctance is principally a result of the Company's insufficient working capital
to satisfy vendors extending additional credit. The Company's inability to
timely deliver merchandise has resulted in increased order cancellations, which
for the quarter ended December 31, 1998, have been approximately 25% of demand.
The Company's order cancellations have historically been 10% of demand, which is
consistent with industry standards. The Company has received a non-binding
proposal for new financing to improve its working capital position, thereby
strengthening
9
its ability to obtain improved credit availability on more favorable terms,
timely deliver merchandise to its customers, reduce order cancellations, and
improve initial customer response.
Results of Operations
Three Months Ended December 31, 1998 Compared to Three Months Ended
December 31, 1997
Net Sales
Consolidated net sales from continuing operations for the three months
ended December 31, 1998, increased by 20% to $23.1 million from $18.0 million
for the three months ended December 31, 1997. This significant sales growth was
primarily due to the acquisition by Brownstone of the assets of Jean Grayson's
Brownstone Studio out of bankruptcy as of October 26, 1997. This new subsidiary
accounted for sales of $10.8 million for the three months ended December 31,
1998 compared to $2.4 million for the three months ended December 31, 1997.
The Company believes that its strategy to maintain circulation plans
but convert more orders to shipped sales, plus its entry into e-commerce in
1999, can substantially increase sales without proportionate expense.
Gross Margin
Consolidated gross profit from continuing operations increased by 17%
from $10.1 million for the three months ended December 31, 1997 to $11.8 million
for the three months ended December 31, 1998, primarily as a result of the
Company's increase sales from its Brownstone subsidiary. However, gross profit
from continuing operations as a percentage of net sales decreased from 56% for
the three months ended December 31, 1997 to 51% for the three months ended
December 31, 1998 due to a decrease in margins on clearance merchandise.
Selling, General and Administrative Expenses
Selling, general and administrative expenses from continuing operations
as a percentage of net sales decreased from 51% for the three months ended
December 31, 1997 to 47% for the three months ended December 31, 1998. Although
expenses as a percentage of net sales were lower for the three months ended
December 31, 1998 as compared to the same period ended December 31, 1997, the
dollar increase in expenses is attributable to the increase in catalog
production costs which are typically written off over the sales life of the
catalog. For the three months ended December 31, 1998, these costs were $6.3
million as compared to $5.2 million for the three months ended December 31,
1997. Order cancellations resulted in lost net sales and an inflated catalog
cost relationship in both periods.
Other operating expenses as a percent of net sales increased for the
three months ended December 31, 1998 as compared to the three months ended
December 31, 1997 due primarily to an increase in depreciation and amortization
of tangible and intangible assets as well as an increase in interest expense.
Income from Continuing Operations
10
Income from continuing operations before income taxes for the three
months ended December 31, 1998 was approximately $464,000 as compared to
$610,000 for the three months ended December 31, 1997 primarily due to an
increase in interest, depreciation and amortization expenses.
Net Income
Net income for the three months ended December 31, 1998 was $359,000,
as compared to net income for the three months ended December 31, 1997 of
$97,000, a 309% increase. This difference was primarily due to the loss in 1997
from the discontinued Biobottoms operations.
Liquidity and Capital Resources
The Company's principal source of working capital is asset based loan
facilities provided by Congress Financial Corporation ("Congress"). Each of the
Company's operating subsidiaries, Ecology Kids, Lew Magram and Brownstone, has a
separate loan facility from Congress. Each loan facility is guaranteed by the
Company and cross-guaranteed by each operating subsidiary. In addition, Robert
M. Rubin, the Company's Chairman of the Board, has personally guaranteed the
Brownstone and Lew Magram loan facilities up to an aggregate of $1.0 million.
The Company's aggregate indebtedness to Congress increased from $5.5 million on
September 30, 1998 to $8.8 million on December 31, 1998. The Company's accounts
payable and accrued expenses decreased from $18.5 million on September 30, 1998
to $14.5 million on December 31, 1998. This increase in borrowing from Congress
was used to pay down certain accounts payable and accrued expenses.
The loan facility with Ecology Kids provides Ecology Kids with a
maximum $3 million secured line of credit to be used for loans and trade letters
of credit. The loan facility is secured by substantially all of the assets of
Ecology Kids. The interest rate is 1 1/2% above the prime rate announced by
CoreStates Bank. The loan facility contains certain restrictive covenants
including restrictions relating to the payment of dividends. Ecology Kids is
required to maintain a minimum of $(250,000) in stockholders' equity and a
minimum of $1,500,000 of working capital (excluding the Congress loan and
certain subordinated debt). Under the terms of the agreement, the Company could
borrow up to 80% of the amount of eligible accounts receivable (as defined in
the agreement), not to exceed the maximum credit.
The loan facility with Brownstone provides Brownstone with a maximum
$5.5 million secured line of credit to be used for loans and trade letters of
credit. The loan facility is secured by all of the assets of Brownstone. The
interest rate is 2% above the prime rate announced by CoreStates Bank. The loan
facility provides for certain restrictive covenants, including restrictions on
additional debt financing, dividends and distributions, and transactions with
the Company and its subsidiaries, and requires Brownstone maintain minimum
working capital and net worth.
The Loan Facility with Magram provides Magram with a maximum $5.0
million secured line of credit to be used for loans and trade letters of credit.
The line of credit is secured by all of the assets of Magram. The interest rate
is 1 1/2% above the prime rate announced by CoreStates Bank. The loan agreement
provides for certain restrictive covenants, including restrictions on Magram's
debt financing, dividends and distributions and transactions with the Company
and its subsidiaries, and requires Magram maintain minimum working capital and
net worth.
On June 29, 1998, the Company issued $5,000,000 principal amount of its
8% subordinated secured debentures to Sirrom Capital Corporation, d/b/a Tandem
Capital ("Tandem Debentures"). The
11
debentures are due June 29, 2003, and bear interest at 8%, payable quarterly.
The Tandem Debentures are secured by all of the personal property of the Company
and its subsidiaries and includes certain restrictive covenants, including
restrictions on dividends and distributions, additional debt financing and
transaction with the Company and its subsidiaries. The Company also issued
warrants in connection with the issuance of the Tandem Debentures. At the time
of the loan, the Company issued warrants to purchase up to 208,300 shares of its
Common Stock exercisable at $2.35 per share for five years. Effective February
28, 1999, because the debentures remained outstanding, the Company issued
416,600 warrants to Tandem at an exercise price of $1.60 per share. The exercise
price is to be adjusted downward if the Company's common stock price is below
this exercise price to an exercise price equal to the greater of 80% of the
market price on June 29, 1999 or $2.00 per share. Tandem will also receive
200,000 warrants each June 29 commencing in 1999 while the debentures remain
outstanding.
The Company is currently experiencing working capital shortages and
requires additional capital resources to fund its existing operations. The
Company has borrowed the maximum amounts available under each of the Congress
loan facilities as of the date hereof and there is no unused loan availability.
Several letters of intent have been received by the Company from lending
institutions, one of which is anticipated, although there can be no assurance,
to be closed before the end of March 1999 creating additional working capital
availability of over $4.0 million. The majority stockholder has agreed to bridge
up to $1.5 million of the Company's new financing. The Company is pursuing a
number of financing alternatives, although there can be no assurance that such
efforts will result in necessary financing or that the terms of such financing
will be on terms favorable to existing stockholders. The failure to secure
additional working capital will materially adversely affect the business and
financial condition of the Company. Insufficient working capital may require the
Company to alter operations significantly.
There can be no assurance that the Company will operate profitably in
the future or that cash from operations will become the principal source of
funds for operations.
Seasonality
The Company's business does not follow the seasonal pattern typical of
the retail apparel industry, but is, instead, more closely related to the timing
and distribution of catalog mailings. Through 1997 there were significant
variations in the Company's seasonal sales volume with the largest volume period
being first quarter, ending December 31. In 1998, the Lew Magram and Brownstone
acquisitions helped to spread out the volume evenly throughout the year since
mail order volume varies only in proportion to the orders generated and
merchandise shipped. Accordingly, the Company is now less susceptible to
seasonable variations.
Impact of the Year 2000 Issue
The Year 2000 ("Y2K") issue is the result of computer programs being
written using two digits rather than four to define the applicable year. Any of
the Company's computer programs that have date sensitive software may recognize
a date using "00" as the year 1900 rather than the year 2000. This could result
in a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities.
The Company is totally Y2K compliant in its catalog operations software
and Ecology Kids
12
operating software. Certain minor changes may be required in ancillary network
related software which are not critical to daily operations. The Company plans
to complete these changes by July 31, 1999.
The Company has a plan in place to contact all of its significant
suppliers to determine the extent to which the Company is vulnerable to those
third parties' failure to remedy their own Year 2000 issues. There can be no
guarantees that the systems of third parties on which the Company's systems rely
or which influence the business of the Company's suppliers will be timely
remedied, that any attempted remediation will be successful, or that such
conversions would be compatible with the Company's systems.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable
13
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On December 28, 1998, the Company granted to certain of its employees
options under its November 1996 Stock Option Plan. The options permit the
holders the right to purchase in the aggregate up to 860,000 shares of the
Company's common stock at an exercise price of $1.00 per share. The options
expire on December 28, 2003. One-fourth of the options granted are immediately
exercisable and the remaining options are exercisable in equal numbers in an
equal amount each year for the next three years. The grant of the options is
exempt under the Securities Act of 1933, as amended, by virtue of the exemption
under Section 4(2).
ITEM 3. DEFAULTS IN SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(b) Exhibits.
27 Financial Data Schedule
(b) Reports on Form 8-K.
On October 16, 1998, the Company filed Form 8-K/A1, amending the
Company's 8-K filed on March 6, 1998, solely to include the financial statements
in connection with the Company's acquisition of Lew Magram Ltd.
14
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
Registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
DIPLOMAT DIRECT MARKETING CORPORATION
Dated: March 5, 1999 By: /s/ JONATHAN ROSENBERG
----------------------------
Jonathan Rosenberg
President and Chief Executive Officer
By: /s/ IRWIN ORINGER
-----------------
Irwin Oringer
Chief Accounting Officer
15
EXHIBIT INDEX
27 Financial Data Schedule