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 March 31, 1999
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.)
414 Alfred Avenue
Teaneck, New Jersey 07666
- ------------------- -----
(Address of principal executive offices) (Zip Code)
(201) 833-4450 (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 May 13, 1999 was 12,342,941 shares.
DIPLOMAT DIRECT MARKETING CORPORATION
MARCH 31, 1999 QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Page Number
Item 1. Financial Statements ............................................................................ 1
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations....................................................................... 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk....................................... 14
PART II - OTHER INFORMATION
Item 1. Legal Proceedings................................................................................ 15
Item 2. Changes in Securities and Use of Proceeds........................................................ 15
Item 3. Defaults Upon Senior Securities.................................................................. 15
Item 4. Submission of Matters to a Vote of Security Holders.............................................. 15
Item 5. Other Information................................................................................ 15
Item 6. Exhibits and Reports on Form 8-K................................................................. 17
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
[NEED TO UPDATE]
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets as of March 31, 1999 and September 30, 1998.........................2
Consolidated Statements of Operations
for the six months and three months ended March 31, 1999 and 1998........................ 3
Consolidated Statements of Cash Flows
for the six months ended March 31, 1999 and 1998...........................................4
Notes to Consolidated Financial Statements....................................................5-8
1
Diplomat Direct Marketing Corporation and Subsidiaries
Consolidated Balance Sheets
(Unaudited)
March 31, September 30,
1999 1998
----------- -----------
Assets
Current:
Cash and cash equivalents $ 310,613 $ 322,778
Accounts receivable, net 2,372,660 1,921,209
Inventories 11,768,919 11,066,380
Prepaid catalogs 6,359,778 8,051,651
Prepaid expenses 1,755,647 1,379,567
Other current assets 659,268 837,946
Total current assets 23,526,885 23,579,531
----------- -----------
Property and equipment, net 1,559,914 4,176,903
----------- -----------
Other Assets:
Goodwill, net of amortization 14,340,015 14,587,358
Customer list, net of amortization 6,700,000 7,100,000
Note receivable 870,000 870,000
Other 1,145,090 645,091
----------- -----------
Total assets $50,141,904 $50,958,883
=========== ===========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses $16,211,072 $18,469,136
Loans payable-officers 25,000 225,000
Loans payable-bank 7,814,035 5,504,371
Open prepaid orders 805,086 1,211,165
Outstanding merchandise credit 3,100,344 1,892,148
Current maturities of long-term debt 847,793 939,816
----------- -----------
Total current liabilities 28,803,330 28,241,636
----------- -----------
Long term debt, less current maturities 6,266,835 6,383,585
----------- -----------
Stockholders' equity
Preferred stock, $.10 par value-shares authorized 1,000,000;
issued and outstanding 545983 (Liquidation value of $16,380,000) 4,683 5,461
Common stock, $.0001 par value-shares authorized 50,000,000;
issued and outstanding 12,162,303 1,212 1,112
Additional paid-in capital 29,382,656 25,835,445
Accumulated (deficit) (14,316,812) (9,508,356)
----------- -----------
Total stockholders' equity 15,071,739 16,333,662
----------- -----------
Total liabilities and stockholders' equity $50,141,904 $50,958,883
=========== ===========
See accompanying notes to consolidated financial statements.
2
Diplomat Direct Marketing Corporation and Subsidiaries
Consolidated Statements of Income
(Unaudited)
Six months ended Three months ended
Mar. 31, 1999 Mar. 31, 1998 Mar. 31, 1999 Mar. 31, 1998
------------- ------------- ------------- -------------
Net sales $41,580,537 $36,515,628 $18,520,978 $18,531,637
Cost of goods sold 20,938,435 17,029,324 9,664,774 9,165,051
----------- ----------- ----------- -----------
Gross profit 20,642,102 19,486,304 8,856,204 9,366,586
Selling, general and administrative expenses 23,933,263 17,070,661 13,094,091 7,898,825
----------- ----------- ----------- -----------
Operating income (3,291,161) 2,415,643 (4,237,887) 1,467,761
Interest expense (1,050,159) (642,249) (567,380) (304,288)
----------- ----------- ----------- -----------
Income(loss) before income tax (expense) benefit (4,341,320) 1,773,394 (4,805,267) 1,163,473
Income tax (expense) benefit 0 0 0 0
----------- ----------- ----------- -----------
Income(loss) from continuing operations (4,341,320) 1,773,394 (4,805,267) 1,163,473
Loss on discontinued operations (37,386) (2,072,098) (11,203) (1,685,832)
----------- ----------- ----------- -----------
Net income(loss) (4,378,706) (298,704) (4,816,470) (522,359)
Preferred stock dividends (429,750) (157,500) (351,000) (78,750)
----------- ----------- ----------- -----------
Net income(loss) to common stockholders ($4,808,456) ($456,204) ($5,167,470) ($601,109)
Per common share-Basic:
Net income(loss) from continuing operations ($0.40) $0.16 ($0.42) $0.10
Net income(loss) from discontinued operations $0.00 ($0.21) $0.00 ($0.15)
------ ------ ------ ------
Net income(loss)-Basic ($0.40) ($0.05) ($0.42) ($0.05)
Per common share-Diluted:
Net income(loss) from continuing operations ($0.31) $0.10 ($0.33) $0.06
Net income(loss) from discontinued operations $0.00 ($0.12) $0.00 ($0.09)
------ ------ ------ ------
Net income(loss)-Diluted ($0.31) ($0.02) ($0.33) ($0.03)
Average number of shares used in computation-Basic 11,884,247 9,941,023 12,162,372 10,975,873
Diluted 15,525,748 16,269,007 15,803,873 17,303,857
See accompanying notes to consolidated financial statements.
3
Diplomat Direct Marketing Corp and Subsidiaries
Consolidated Statements of Cash Flow
Six Months Ended
3/31/99 3/31/98
------- -------
Cash flows from operating activities:
Net income (loss) ($4,378,706) ($298,704)
Adjustments to reconcile net income to net
cash used in operating activities:
Amortization 647,343 477,826
Depreciation 389,167 401,802
Changes in assets and liabilities:
(Increase) decrease in accounts receivable (451,451) (2,192,733)
(Increase) decrease in inventories (702,539) (3,972,465)
(Increase) decrease in prepaid expenses (376,080) (57,125)
(Increase) decrease in prepaid catalogs 1,691,873 (1,911,148)
(Increase) decrease in other assets (321,321) (2,656,946)
(Increase) decrease in assets held for sale 3,254,010
Increase (decrease) in accounts payable
and accrued liabilities (2,258,064) (3,612,371)
Increase (decrease) in outstanding
merchandise credits 1,208,196 8,296,234
Increase (decrease) in prepaid orders (406,079) 1,108,677
---------- ----------
(4,957,661) (1,162,943)
---------- ----------
Cash flows from investing activities:
Purchase and sale of property and equipment (72,178) (664,311)
---------- ----------
Acquisition of subsidiary assets 0 (4,764,240)
---------- ----------
(72,178) (5,428,551)
---------- ----------
Cash flows from financing activities:
Issuance of common and preferred stock 3,546,533 3,941,294
Revolving credit loans 2,309,664 4,399,085
Preferred stock dividends paid (429,750) (205,390)
Increase(decrease) in long term debt and loans payable (408,773) (159,748)
---------- ----------
Net cash provided by financing activities 5,017,674 7,975,241
---------- ----------
Net increase (decrease) in cash (12,165) 1,383,747
Cash at beginning of period 322,778 59,750
---------- ----------
Cash at end of period $310,613 $1,443,497
========== ==========
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 include the
Accounting Policies 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 financial
5
statements issued to the public. It also
establishes standards fordisclosures 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
March 31, 1999 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
$14,500,000 for the six months ended March 31,
1999 and $8,200,000 for the three months ended
March 31, 1999. Included in other current assets
at March 31, 1999, is $6,360,000 and at September
30, 1998, $8,052,000 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.
(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.
6
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.
(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
7
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 at December
31, 1997 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 March 31 1999 1998
-------- -----------
Sales $ -- $ 7,539,651
-------- -----------
Cost of Sales -- 5,105,464
Operating Expenses 37,386 5,016,906
Interest -- 182,171
-------- -----------
37,386 10,304,491
-------- -----------
Loss before sale $(37,386) $(2,764,840)
======== ===========
Gain on sale of assets 0 4,101,693
-------- -----------
Net income (Loss) $(37,386) $ 1,336,853
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 is 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 March 31, 1999, continue to be approximately 25% of
demand. As a result we have recognized increased charges in the quarter for the
write off of catalog expenditure disproportionate to the net sales realized for
the quarter and projected for the next quarter approximately 25% of demand. The
Company's order cancellations have historically been 10% of demand, which is
consistent with industry standards. The Company has recently restructured its
asset based credit facility to improve its working capital position, which the
Company anticipates will strengthen 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. It
is too early, however, to determine whether such additional capital will yield
such results.
9
Results of Operations
Six Months Ended March 31, 1999 Compared to Six Months Ended March 31,
1998
Net Sales
Consolidated net sales from continuing operations for the six months
ended March 31, 1999 increased by 14% to $41.6 million from $36.5 million for
the six months ended March 31, 1998. 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 $23.8 million for the six months ended March 31, 1999 compared to
$7.7 million for the six months ended March 31, 1998.
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 6%
from $19.5 million for the six months ended March 31, 1998 to $20.6 million for
the six months ended March 31, 1999 primarily as a result of the Company's
increased sales from its Brownstone subsidiary. However, gross profit from
continuing operations as a percentage of net sales decreased from 53% for the
six months ended March 31, 1998 to 50% for the six months ended March 31, 1999
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 increased from 47% for the six months
ended March 31, 1998 to 58% for the six months ended March 31, 1999. The
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 six
months ended March 31, 1999 these costs were $14.5 million as compared to $9.6
million for the six months ended March 31, 1998. 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
six months ended March 31, 1999 as compared to the six months ended March 31,
1998, due primarily to an increase in depreciation and amortization as well as
an increase in interest expense.
Income from Continuing Operations
Loss from continuing operations before income taxes for the six months
ended March 31, 1999 was approximately $4,341,000 as compared to income of
$1,773,000 for the six months ended March 31, 1998 primarily due to an increase
in interest, depreciation and amortization expenses in addition to lower margins
attributable to unshipped backorders.
Net Income
Net loss for the six months ended March 31, 1999 was $4,378,706, as
compared to a net loss for the six months ended March 31, 1998 of $299,000. This
difference included the loss in 1998 from the discontinued Biobottoms operations
of $2,072,000.
10
Three Months Ended March 31, 1999 Compared to Three Months Ended
March 31, 1998
Net Sales
Consolidated net sales from continuing operations for the three months
ended March 31, 1999 remained constant at $18.5 million compared to the three
months ended March 31, 1998.
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 decreased by 6%
from $9.4 million for the three months ended March 31, 1998 to $8.9 million for
the three months ended March 31, 1999. Gross profit from continuing operations
as a percentage of net sales was 48% for the three months ended March 31, 1999
and 51% for the three months ended March 31, 1998.
Selling, General, and Administrative Expenses
Selling, general, and administrative expenses from continuing
operations as a percentage of net sales increased from 43% for the three months
ended March 31, 1998 to 11% for the three months ended March 31, 1999. The
increase in expenses is attributable to the increase in catalog production costs
which are typically written off over the sales life of the catalog. High
cancellation rates for the quarter and anticipated cancellation rates for the
quarter ended June 30, 1999 caused us to recognize these additional expenses.
For the three months ended March 31, 1999 these costs were $8.2 million as
compared to $4.4 million for the three months ended March 31, 1998. 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 March 31, 1999 as compared to the three months ended March
31, 1998 due primarily to an increase in depreciation and amortization of
tangible assets as well as an increase in interest expense.
Income from Continuing Operations
Loss from continuing operations before income taxes for the three
months ended March 31, 1999 was approximately $4,805,000 as compared to income
of $1,163,000 for the three months ended March 31, 1998 primarily due to an
increase in interest, depreciation and amortization expenses and lower margins
attributable to unshipped backorders.
Net Income
Net loss for the three months ended March 31, 1999 was $4,816,000, as
compared to a net loss for the three months ended March 31, 1998 of $522,000.
This difference included the loss in 1998 from the discontinued Biobottoms
operations of $1,686,000
Liquidity and Capital Resources
The Company's principal source of working capital has historically been
asset based loan facilities provided by Congress Financial Corporation. On May
12, 1999, the Company entered into a Secured Credit Agreement with First Source
Financial LLP providing the Company with a $17 million asset based loan facility
replacing its existing asset based loan facilities provided by Congress.
The loan facility provides the Company with a $13 million revolving
loan with an interest rate at
11
prime plus 1 1/2%, a $3 million three year term loan with an interest rate at
prime plus 2% and a $1 million three year term loan with an interest rate at
prime plus 2% increasing to prime plus 3% on November 15, 1999. The Company may
convert any or all of the loans with a LIBOR-based rate. The revolving loan may
be converted to LIBOR plus 31/4%, the $3 million term loan may be converted to
LIBOR plus 4% and the $1 million term loan may be converted to LIBOR plus 4%
increasing to LIBOR plus 5% on November 15, 1999.
The credit facility is secured by substantially all of the assets of
the Company, a personal guarantee by Robert M. Rubin, the Company's Chairman of
the Board up to $1 million and an additional $1 million cash collateral deposit
by Mr. Rubin.
The amount of funds available for the Company to borrow under the
revolving loan is based on a percentage of the Company's inventory and
receivables. As of May 12, 1999, the aggregate availability under the revolving
loan was approximately $8.5 million.
Under the Secured Credit Agreement, the Company is obligated to comply
with numerous covenants including (i) providing current information to First
Source; (ii) maintaining corporate status, books and records and minimum
insurance; (iii) complying with tax and other laws and regulations; (iv)
maintaining its real estate; (v) maintaining a minimum net worth of $14 million
increasing periodically to $16.5 million; (vi) maintaining an interest coverage
ratio of 2 to 1; and (vii) maintaining a fixed charge coverage ratio of 1.1 to
1.
The Company is also prohibited, except under certain circumstances to
(i) redeem any of its outstanding common or preferred stock; (ii) prepay any
subsidiary's debt; (iii) pay dividends on its common stock; (iv) make
investments in other companies; (v) acquire other companies; (vi) amend its
charter; (vii) engage in other types of businesses; (viii) engage in
transactions with its officers, directors, control persons and other affiliates;
(ix) incur debt other than debt in the ordinary course of business and purchase
money debt of less than $1 million; (x) create any liens against its property
with certain exceptions; (xi) move its assets; (xii) sell its assets other than
in the ordinary course of business; (xiii) hire management consultants; (xiv)
make capital expenditures in excess of $500,000 per year; or (xv) incur lease
obligations in excess of $1.5 million per year.
The loan facility will terminate and the loans become due and payable
in the event of a default. Events of default include, with limited exceptions
(i) failure to pay any of the loans when due, (ii) failure to pay any other
debts when due; (iii) breach of certain material agreements: (iv) insolvency;
(v) breach of any guaranty under the loan facility; (vi) breach of a covenant in
loan facility; (vii) breach of a representation in the loan facility; (viii)
change to the Company's pension plan; (ix) breach of any of the other agreements
delivered in connection with the credit facility; (x) suffering judgments or
levies of more than $50,000; (xi) destruction of the Company's assets
representing more than 15% of the Company's revenues; (xii) any event resulting
in any lien securing the credit facility to cease to have a first priority
position; or (xiii) a change in control of the Company. A change in control
includes (i) more than one-half of the Company's voting stock is transferred;
(ii) two-thirds of the Company's board is removed or not re-elected; or (iii)
any two of Jonathan Rosenberg, Warren N. Golden or Stephanie Sobel resigns or is
terminated without cause.
On June 29, 1998, the Company issued $5,000,000 principal amount of its
12% subordinated secured debentures to Sirrom Capital Corporation, d/b/a Tandem
Capital ("Tandem Debentures"). The debentures are due June 29, 2003, and bear
interest at 12%, 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
12
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, however, continues to experience working capital
shortages and requires additional capital resources to fund its existing
operations. The Company has borrowed the maximum amounts available under its
loan facility 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 could 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 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.
13
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable
14
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The Company granted a warrant which grants the holder the right to
purchase in the aggregate up to 80,000 shares of the Company's common stock at
an exercise price of $1.50 per share. The warrant expire on March 18, 2002. The
grant of the warrant is exempt under the Securities Act of 1933, as amended,
("1933 Act") by virtue of the exemption under Section 4(2).
The Company issued 32,440 shares of its Series F Preferred Stock and
346,027 shares of its common stock for $3,244,000. The issuance is exempt under
the 1933 Act by virtue of the exemption under section 4(2).
The Company issued 75 shares of its Series E Preferred Stock and 38,470
shares of its common stock. The issuance is exempt under the 1933 Act by virtue
of the exemption under section 4(2).
The Company issued 100,000 shares of its common stock for $100,000.
The issuance is exempt under the 1933 Act by virtue of the exemption under
section 4(2).
The holders of all of the outstanding Series D Preferred Stock
converted their shares. The Company issued 3,083,447 shares of common stock
upon the conversion of the Series D Preferred Stock. The issuance is exempt
under the 1933 Act 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
(a) First Source Financial LLP Loan Facility
On May 12, 1999, the Company entered into a Secured Credit Agreement
with First Source Financial LLP providing the Company with a $17 million asset
based loan facility replacing its existing asset based loan facilities provided
by Congress Financial Corporation.
The loan facility provides the Company with a $13 million revolving
loan with an interest rate at prime plus 1 1/2%, a $3 million three year term
loan with an interest rate at prime plus 2% and a $1 million three year term
loan with an interest rate at prime plus 2% increasing to prime plus 3% on
November 15, 1999. The Company may convert any or all of the loans with a
LIBOR-based rate. The revolving loan may be converted to LIBOR plus 3 1/4%, the
$3 million term loan may be converted to LIBOR plus 4% and the $1 million term
loan may be converted to LIBOR plus 4% increasing to LIBOR plus 5% on November
15, 1999.
15
The credit facility is secured by substantially all of the assets of
the Company, a personal guarantee by Robert M. Rubin, the Company's Chairman of
the Board up to $1 million and an additional $1 million cash collateral deposit
by Mr. Rubin.
The amount of funds available for the Company to borrow under the
revolving loan is based on a percentage of the Company's inventory and
receivables. As of May 12, 1999, the aggregate availability under the revolving
loan was approximately $8.5 million.
Under the Secured Credit Agreement, the Company is obligated to comply
with numerous covenants including (i) providing current information to First
Source; (ii) maintaining corporate status, books and records and minimum
insurance; (iii) complying with tax and other laws and regulations; (iv)
maintaining its real estate; (v) maintaining a minimum net worth of $14 million
increasing periodically to $16.5 million; (vi) maintaining an interest coverage
ratio of 2 to 1; and (vii) maintaining a fixed charge coverage ratio of 1.1 to
1.
The Company is also prohibited, except under certain circumstances to
(i) redeem any of its outstanding common or preferred stock; (ii) prepay any
subsidiary's debt; (iii) pay dividends on its common stock; (iv) make
investments in other companies; (v) acquire other companies; (vi) amend its
charter; (vii) engage in other types of businesses; (viii) engage in
transactions with its officers, directors, control persons and other affiliates;
(ix) incur debt other than debt in the ordinary course of business and purchase
money debt of less than $1 million; (x) create any liens against its property
with certain exceptions; (xi) move its assets; (xii) sell its assets other than
in the ordinary course of business; (xiii) hire management consultants; (xiv)
make capital expenditures in excess of $500,000 per year; or (xv) incur lease
obligations in excess of $1.5 million per year.
The loan facility will terminate and the loans become due and payable
in the event of a default. Events of default include, with limited exceptions
(i) failure to pay any of the loans when due, (ii) failure to pay any other
debts when due; (iii) breach of certain material agreements: (iv) insolvency;
(v) breach of any guaranty under the loan facility; (vi) breach of a covenant in
loan facility; (vii) breach of a representation in the loan facility; (viii)
change to the Company's pension plan; (ix) breach of any of the other agreements
delivered in connection with the credit facility; (x) suffering judgments or
levies of more than $50,000; (xi) destruction of the Company's assets
representing more than 15% of the Company's revenues; (xii) any event resulting
in any lien securing the credit facility to cease to have a first priority
position; or (xiii) a change in control of the Company. A change in control
includes (i) more than one-half of the Company's voting stock is transferred;
(ii) two-thirds of the Company's board is removed or not re-elected; or (iii)
any two of Jonathan Rosenberg, Warren N. Golden or Stephanie Sobel resigns or is
terminated without cause.
(b) Series F Preferred Stock
The Company has designated 33,000 shares of Series F Preferred Stock.
The Series F Preferred Stock is not convertible and has no voting rights except
as provided under Delaware law, and is redeemable by the Company at its option
equal to the liquidation value plus any accrued but unpaid dividends. The Series
F Preferred Stock provides for cumulative dividends at the rate of 10% per year
based on the liquidation value of $100 per share.
(c) Series E Preferred Stock
The Company increased the number of the authorized shares of its Series
E Preferred Stock to 3,705. The Company has issued 3,705 shares of its Series E
Preferred Stock.
16
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(b) Exhibits.
3.1 Amended Certificate of Designation of Series E of Preferred Stock
3.2 Certificate of Designation of Series F Preferred Stock
10.1 Secured Credit Agreement dated May 12, 1999 among First Source Financial LLP, as
Lender, Brownstone Holding, Inc., Ecology Kids, Inc., Diplomat Holdings, Inc. and
Lew Magram Ltd. as Borrowers and Diplomat Direct Marketing Corporation, as Funds
Administrator (exhibits and schedules omitted)
10.2 Security Agreement dated May 12, 1999 among First Source Financial LLP.,
Brownstone Holdings, Inc., Ecology Kids, Inc. Diplomat Holding, Inc. and Lew
Magram Ltd. (exhibits and schedules omitted)
10.3 Guaranty of Diplomat Direct Marketing Corporation (First Source Financial LLP) dated
May 12, 1999.
27 Financial Data Schedule
(b) Reports on Form 8-K.
On April 23, 1999, the Company filed Form 8-K/A2, amending the
Company's 8-K filed on March 6, 1998, as amended October 16, 1998, solely to
amend the financial statements in connection with the Company's acquisition of
Lew Magram Ltd.
17
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: May 18, 1999 By: /s/ Warren H. Golden
-------------------------------------
Warren H. Golden
President
By: /s/ Irwin Oringer
-------------------------------------
Irwin Oringer
Chief Accounting Officer
18
EXHIBIT INDEX
3.1 Amended Certificate of Designation of Series E of Preferred Stock
3.2 Certificate of Designation of Series F Preferred Stock
10.1 Secured Credit Agreement dated May 12, 1999 among First Source Financial LLP, as
Lender, Brownstone Holding, Inc., Ecology Kids, Inc., Diplomat Holdings, Inc. and
Lew Magram Ltd. as Borrowers and Diplomat Direct Marketing Corporation, as Funds
Administrator (exhibits and schedules omitted)
10.2 Security Agreement dated May 12, 1999 among First Source Financial LLP.,
Brownstone Holdings, Inc., Ecology Kids, Inc. Diplomat Holding, Inc. and Lew
Magram Ltd. (exhibits and schedules omitted)
10.3 Guaranty of Diplomat Direct Marketing Corporation (First Source Financial LLP) dated
May 12, 1999.
27 Financial Data Schedule