-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, UQEXPPDYiOWyTymt6tClbgafAHoGUnWL2YCVBI8JUG9tVHcECHmzpq8ZW9L8KJnI NzhyNjWU5g6S4mBy3gJ2Og== 0000889812-98-000688.txt : 19980324 0000889812-98-000688.hdr.sgml : 19980324 ACCESSION NUMBER: 0000889812-98-000688 CONFORMED SUBMISSION TYPE: 10KSB40/A PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19980323 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: DIPLOMAT CORP CENTRAL INDEX KEY: 0000910319 STANDARD INDUSTRIAL CLASSIFICATION: MISCELLANEOUS FABRICATED TEXTILE PRODUCTS [2390] IRS NUMBER: 133113085 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB40/A SEC ACT: SEC FILE NUMBER: 033-66910 FILM NUMBER: 98570476 BUSINESS ADDRESS: STREET 1: 25 KAY FRIES DR CITY: STONY POINT STATE: NY ZIP: 10980 BUSINESS PHONE: 9147865552 MAIL ADDRESS: STREET 1: 25 KAY FRIES DR STREET 2: 25 KAY FRIES DR CITY: STONY POINT STATE: NY ZIP: 10980 FORMER COMPANY: FORMER CONFORMED NAME: DIPLOMAT JUVENILE CORP DATE OF NAME CHANGE: 19930806 10KSB40/A 1 AMENDED ANNUAL REPORT SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-KSB/A2 (Mark One) [ X ] Annual Report to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended September 30, 1997 [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission File No. 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 Identification No.) incorporation or organization) 25 Kay Fries Drive, Stony Point,New York - ---------------------------------------- 10980 (Address of principal executive offices) (Zipcode) Registrant's telephone number, including area code (914) 786-5552 Securities registered pursuant to Section 12(b) of the Act: Title of each Class Name of exchange on which - ------------------- ------------------------- Applicable registered Nasdaq Stock Market ---------- Securities registered pursuant to Section 12(g) of the Act: Common Stock,$.0001 par value and Common Stock Purchase Warrants ----------------------------------------------------------------- (Title of Class) 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 prior 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 Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B in this form, and no disclosure will be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB (X) The issuer's net sales for the most recent fiscal year were $35,147,333. The aggregate market value of the voting stock held by non-affiliates based upon the closing bid price on February 20, 1998 was approximately $26,620,930. As of February 20, 1998 there were 10,904,433 shares of Common Stock, par value $.0001 per share, outstanding. Certain exhibits listed in Part IV have been incorporated by reference. The index to exhibits appears on Page 39. 2 PART I Item 1. Business The term "the Company" shall include Diplomat Corporation and its wholly-owned subsidiaries, Biobcttoms, Inc. ("Biobottoms"), Lew Magram Ltd. ("Lew Magram") and Brownstone Holdings, Inc. ("Brownstone") unless otherwise indicated. The term "Diplomat" shall refer to the operations of Diplomat Corporation exclusive of its subsidiaries. Except for historical information contained herein, the statements in this Item 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 which may cause the Company's actual results in future periods to differ materially from forecasted results. Those risks include, among others, risks associated with the integration of the operations of Lew Magram and Brownstone, 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. General The Company's core business has historically focused on the wholesale marketing and distribution of infant and toddler apparel and accessories. Through recent acquisitions, the Company has expanded its business to direct mail catalog retailing with a significant emphasis on the women's apparel market. The Company manufactures and distributes, through its Diplomat division, primarily cloth diapers, diaper covers, furniture covers, layette, infant and child travel products and other infants accessories marketed principally under the Ecology Kids(TM) trademark, principally to major mass merchandisers. On February 9, 1996, the Company completed the acquisition of Biobottoms, a California corporation located in Petaluma, California. Biobottoms is a children's, mail order catalog company selling apparel and accessories in the United States for newborns through preteens. 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 wolly-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. 3 Description of Business The Company currently operates three lines of business (i) direct mail catalog retail sales of women's apparel through its Lew Magram and Brownstone subsidiaries, (ii) direct mail catalog retail sales of infant and toddler apparel and accessories through its Biobottoms subsidiary and (iii) sales of apparel and accessories for toddlers through preteens to mass merchandisers through its Diplomat/Ecology Kids(TM) division. Lew Magram Lew Magram, which has been engaged in the sale of women's apparel since 1984 as the successor to a men's apparel business founded in 1948, is a leading calalog marketer of fashionable women's apparel. Lew Magram has customers in all fifty states and in many foreign countries. For each of the past two years, Lew Magram mailed over 30 million catalogs in ten different issues. The Lew Magram trademarked tagline "the Latest Fashions...the Greatest Values," means unique, modern, affordable women's apparel to hundreds of thousands of women across the nation. Lew Magram focuses on selecting and developing clothing and accessories which enable it to meet or surpass its customers' expectations while allowing pricing that maintains its high gross margins. Lew Magram has built strong relationships with over 350 vendors and has presented such well-known design houses as Kenneth Cole, Guess, Mary McFadden, Oleg Cassini and ABS, all of which recognize that the Lew Magram catalog affords them an opportunity to showcase their designs before millions of prospective shoppers every year. Lew Magram's products are marketed to a diverse audience, from the value-oriented middle-income customer to the fashion-conscious executive who spends hundreds of dollars per purchase. Lew Magram has developed an extensive database containing more than two million names, of which 1.5 million are customers, 209,000 are gift recipients and 325,000 are catalog inquiries. More than 22% of Lew Magram's 12-month buyers spend at least $200 per order. The average order from the catalog for the twelve months ended December 31, 1996 and December 31, 1997 was $158 and $160, respectively. The buyer file includes more than 500,000 customers who have made at least two purchases from Lew Magram. In addition to accepting all major credit cards, Lew Magram also sells its merchandise through a private label credit card which was launched in 1993. Approximately 200,000 people have the Lew Magram credit card which accounts for approximately 30% of Lew Magram's sales. Lew Magram's primary customer is the working woman with high disposable income. In 1992, 68.3% of Lew Magram's customers were employed. By 1995, 74.1% of Lew Magram's customers worked outside the home. Moreover, almost 59% of Lew Magram's customers have no children in the household and so have more discretionary income to spend on apparel. Lew Magram's customers typically live in a single-family home, are approximately 40 years old and have a median household income of $57,000. Using a combination of in-studio and on-location photography, Lew Magram has created a catalog that is well-known as an industry trend-setter. Products are carefully photographed with strategic use of both strong and soft lighting to ensure that merchandise appears at its best. To maximize sales per page, catalog spreads are crafted based on the historical performance of carryover items and the merchants' knowledge of consumer buying trends. Brownstone Two of the most significant assets acquired by Brownstone from Jean Grayson's Brownstone Studio, Inc. were (i) the tradename "Jean Grayson's Brownstone Studio" and the related goodwill, and (ii) the Jean Grayson's Brownstone Studio, Inc. customer list from both the Brownstone Studio as well as Studio Collection catalogs. Brownstone acquired the Jean Grayson's Brownstone Studio, Inc. customer database containing approximately 1.6 million names, of which 1.1 million are customers, 150,000 are gift recipients and 350,000 are catalog inquirers. For the Fall 1997 season, Jean Grayson's Brownstone Studio, Inc. was not operational and, as a result, incurred damage to its customer base. Brownstone has begun to rejuvenate the "Jean Grayson's Brownstone Studio" name by resuming publication of fashionable catalogs, producing and shipping orders in a more timely manner, offering gift certificates to potential customers to compensate for amounts owing to customers of Jean Grayson's Brownstone Studio, Inc., and, shortly, offering customers the benefit of a private label credit card similar to the credit card instituted by Lew Magram in 1993. Based on information provided by Jean Grayson's Brownstone Studio, Inc., the average age of its customers is 62, and, based on sales over the past five years, the average order is $140. Over the past two years, approximately 20 million Brownstone Studio and Studio Collection catalogs have been distributed annually. Since the acquisition, Brownstone has mailed a total of approximately 10 million catalogs of five different issues. The average order from these catalogs was approximately $140. The Company has integrated the operations of Lew Magram and Brownstone to reduce duplication of costs and to increase efficiencies by combining fulfillment, inbound telemarketing, creative services, marketing, finance, human resources administration and management information systems. The Company plans to issue 30 million Lew Magram catalogs and 23 million Brownstone catalogs over the next year and to achieve substantial response and increased average orders. The Company believes that it can achieve these objectives through continuing the strong performance of Lew Magram catalogs and strengthening customer relations of Brownstone. Biobottoms 4 Biobottoms is a direct mail catalog company selling apparel and accessories primarily for newborns through preteens. The majority of the products offered for sale by Biobottoms are made of natural fibers and are designed by Biobottoms with an emphasis on comfort and ease of care. Biobottoms mailed over 9 million catalogs to its existing and prospective customers and shipped over $18 million in merchandise during 1996. A new catalog is created four times a year and is mailed as many as 13 times a year to a combination of customers and prospective customers. The catalog is divided into product categories, generally by the age of the child and the size of the products being offered. Biobottoms operated a retail store selling overstocks and out-of-season items. The store was closed in December 1997. Nearly 70% of Biobottoms' products are designed to its specifications and marketed under Biobottoms' brand name. Established national brands, such as CONVERSE and SARA'S PRINTS round out the product offering. Unlike other segments of the apparel industry, the demand for children's clothing is driven by the physical growth of the child, rather than changing fashions. As a result, Biobottoms' staple, or basic, products account for much of the merchandise mix, with low return rates and low markdowns. Management believes that products which carry the Biobottoms' brand name allow the Company to distinguish itself from other catalogs and retailers. The lower cost of these products also gives management more pricing flexibility. Biobottoms has increased its average order size in each of the past few years by increasing the number of items per order while decreasing the average item price. Biobottoms has also significantly expanded the age range to which it appeals. Product development and selection are based upon reliability of vendors, visual appeal, perceived customer value, and uniqueness of design. Biobottoms utilizes customers feedback on products' performance and their reported preferences for new product designs, fabrications and category expansion. Biobottoms' sales are generated from both house file customers (persons who have either previously purchased from Biobottoms or requested a catalog) and rented mailing lists (names of current customers from other catalog companies). Analysis of this segmentation allows Biobottoms to mail frequently and selectively to its most responsive customers. Diplomat/Ecology Kids(TM) Even though the Company has shifted its emphasis to the mail order business, it continues to market the Ecology Kids(TM) line of infant-related products principally to major mass merchandisers. 5 Manufacturing and Sourcing Lew Magram and Brownstone do not have any production facilities. Their product development and sourcing personnel are a significant element in their private label merchandise strategy. They select manufacturers based on such manufacturers' ability to produce high quality products on a cost effective basis. The product design teams select and source fabrics, product patterns, specifications and templates used for cutting fabric and other pre-production work. Lew Magram and Brownstone sell domestically produced and imported branded merchandise from numerous vendors, none of which supplied more than 5% of the merchandise for either Lew Magram or Brownstone for the past fiscal year. A portion of their merchandise is imported directly from the Far East and Europe. Approximately 5% of Lew Magram's and 15% of Brownstone's merchandise is imported directly from outside the United States. Consequently, a portion of the Company's women's apparel segment is subject to the risks generally associated with conducting business abroad, including risks associated with economic events or political instability that might affect imports, including duties, quotas and work stoppages. To date, these factors have not caused any material disruption of the Company's women's apparel operations. As with other companies that denominate purchases in dollars, declines in the dollar relative to foreign currencies could increase the cost to the Company of merchandise purchased in foreign countries which could adversely affect the Company's results of operations. The Company is unable to predict the effect, if any, of the above, however, the Company believes that these risks exist for many other retailers. 6 The Diplomat/Ecology Kids(TM) division obtains substantially all of its raw materials required for the manufacture of its products and ships such materials to contract manufacturers who assemble the products in accordance with Diplomat's specifications and under its supervision, either from facilities at the Company's Rockland County, New York warehouse and distribution facilities, or other locations in New York State. Biobottoms provides for manufacturing and sourcing of products in a number of ways. Private label vendors supply some high volume basics, such as shirts, play pants and knit shorts, where price competitiveness is critical. Other manufacturers, that may be more costly compared to private label vendors, may be used for products requiring shorter lead times or testing fashion trends. This provides greater flexibility for inventory management. Manufacturing groups provide control of the manufacturing process by closely supervising all phases of production with local consultants and contractors. Manufacturing groups are a convenient source for testing new private label product concepts. Branded merchandise from a variety of manufacturers is a further source of products for Biobottoms. Major Customers and Seasonality As a result of the Company's increasing reliance on the direct mail catalog business, the Company is less dependent on major mass merchandisers for its source of revenue. Consistent with most catalog apparel retailers, neither Lew Magram nor Brownstone has a single customer which accounts for a significant portion of its sales. For the fiscal year ended September 30, 1996, three of the Diplomat division's customers, Toys `R' Us, Wal-Mart and Target Stores individually accounted for approximately 17%, 36% and 6%, respectively, of the Diplomat division's net sales. For the fiscal year ended September 30, 1997, such customers individually accounted for 31%, 11% and 21%, respectively, of the Diplomat division's sales. Sales to such customers accounted for approximately 27% of the Company's sales for the nine month period ended September 30, 1996 and 12% of the Company's sales for the year ended September 30, 1997. The loss of these customers would have a material adverse effect on the Company's business. In addition, the Company sold its products to approximately 500 retail accounts consisting primarily of mass merchandisers and toy retailers, and, to a lesser extent, drug store chains, catalog showrooms, mail order operations and food store chains. In addition to Toys 'R' Us and Wal-Mart, the Company's customers include Burlington Coat Factory, Kids `R' Us, Winn-Dixie Supermarkets, American Drug Stores, Eckerd Drugs, Walgreens, Caldor, Target Stores and Publix Supermarkets. A reduction in the number of retail accounts from prior periods reflects 7 a change in customer mix, with an increased emphasis on mass merchandisers and chain stores. The decrease also reflects general economic conditions which include a decrease generally in the number of retailers. Seasonality of product is generally not a factor affecting Diplomat's sales. Sales fluctuations are, however, affected by special seasonal promotional activities of merchandise retailers. The sales of mail order companies are generally affected by seasonality with the winter holiday season being the strongest. Governmental Regulation The Company's direct mail catalog business and the catalog industry in general are subject to regulation by a variety of state and federal laws relating to, among other things, advertising, imports and sales taxes. The U.S. Federal Trade Commission regulates the Company's advertising and trade practices and the Consumer Product Safety Commission has issued regulations governing the safety of the products the Company sells in its catalogs. The Company also is subject to Department of Treasury customs regulations with respect to goods that it directly imports, including customs duties, quotas and other import restrictions. Under current law, catalog retailers are permitted to make sales in states where they do not have a physical presence without collecting sales tax. The Company believes that it collects sales tax in all jurisdictions in which it is currently required to do so. As a seller of infant products, the Company is subject to laws and regulations administered by various states and the Federal Trade Commission. As a seller of bedding products, the Company is also required to maintain licenses in the various states where it conducts business. These licenses subject the Company to compliance with a variety of laws and regulations regarding the labeling and cleanliness of its products. In addition, the Company has all of its bedding products produced to the upholstered product specifications required by the flammability laws of 8 the State of California, which the Company believes to be the most stringent in the United States. The Company believes that it complies with the laws and regulations in all material respects. Management Information Systems The Lew Magram and Brownstone businesses have been fully integrated within the Commercialware Mozart system - a state of the art mail order technology - for order-taking, shipping, credit card authorization and billing, inventory control and maintenance of online perpetual inventory. This system operates on an IBM AS400 which has been recently upgraded to provide for future growth and expansion. Lew Magram's and Brownstone's combined call center operates on a common telephone system which, utilizing special features offered by AT&T, handles over 130 incoming and outgoing telephone lines. Approximately 5,000 calls per day are received in the Company's Teaneck, New Jersey facility. Product Liability The Company currently has an aggregate of $2,000,000 of product liability insurance for its current products with an umbrella policy of up to an aggregate of $3,000,000. Lew Magram has a separate policy covering Lew Magram and Brownstone for $2,000,000 product liability insurance with an umbrella policy up to $10,000,000. The Company does not intend to increase such coverage upon commercialization of any other product under development. There can be no assurance that the existing coverage will be sufficient to cover any liability resulting from any product liability claims or that the Company or any subsidiaries would have funds available to pay any claims over the limit of its insurance. Either an under insured or an uninsured claim could have a materially adverse effect on the Company. Trademarks, Patents and Proprietary Rights The Company's success depends, in part, upon the continued development of strong brand identification for its current and proposed products. The Company has registered trademark protection for the names Ecology Kids(TM), Lew Magram(TM), Jean Grayson's Brownstone Studio(TM) and Fresh Air Ware(TM), with the latter being in connection with the sale of Biobottoms' products, among other trademarks as well as many supporting trade names. The Company may apply to register other trademarks as it deems appropriate. There can be no assurance that future trademark protection will be obtained, or that if obtained, will not be infringed upon by others. In addition, if any of the Company's trademarks are infringed upon, there can be no assurance that the Company can successfully challenge any alleged infringement. In the event that it becomes necessary to establish recognition of alternative trademarks, the cost of such development could be substantial, and, as a result, materially adversely affect the Company's business and prospects. In November 1992 the Company acquired the four-year exclusive license to a United States patented thermochromatic process that can be utilized with a diaper cover to indicate wetness and soiling through heat generated color changes. The Company did not exercise its right to extend the license. 9 Competition The markets in which the Company's segments participate are highly competitive and served by a number of catalog companies and retailers including traditional department stores, discount retailers, and specialty chains. The Company's success is highly dependent upon its ability to maintain its existing customer lists, solicit new customers, identify distinct fashion trends and continue to address the needs and fashion tastes of its customers. Lew Magram competes in the highly competitive retail women's apparel market specifically the retail direct market catalog women's apparel market. Direct competitors include Spiegel, Victoria's Secret, Chadwick's of Boston and J. Crew, each of which have substantially greater resources and market share than Lew Magram. The mature women's apparel and accessories markets are extremely competitive. Brownstone competes in three size categories, petite, missy and large sizes. Brownstone competes with several catalogs serving these markets including Talbot's, Nicole Somers, Damon's & Draper's Papillon, as well as, to various degrees, specialty store catalogs such as Nordstrom's, Sak's and Nieman Marcus. There is a wide range of catalogs selling infant and children's apparel in competition with Biobottoms. These vary from general catalog merchandisers, such as JC Penney, to smaller specialty children's, apparel catalogs. Biobottoms believes it competes primarily with the latter, which group includes: Hanna Anderson, Playclothes, Childrens Wear Digest, Storybook Heirlooms and Wooden Soldier. Companies in the catalog business compete on price, product quality, features, benefits, brand name and customer service. Biobottoms seeks to market a product line that is distinctive from its competitors. Biobottoms also competes with non-mail order children's clothing retailers, including specialty stores, department stores, major chains and discount retailers. Gap Kids, Gymboree and other national retailers are also competitors outside the direct mail industry. Although certain of these direct competitors have greater financial and marketing resources, Biobottoms believes that it has been able to be competitive because of its ability to offer quality products at reasonable prices and outstanding customer service. The infant and toddler products industries are extremely competitive in the United States and Diplomat faces substantial competition in each of its product lines. The Company competes in a variety of segments within these product categories, including disposable diapers, infant and juvenile furnishings, and mature women's apparel and accessories. Competitive factors include quality, price, style, name recognition and service. Although the Company believes that it can compete favorably in these areas, there can be no assurance thereof. Employees 10 As of December 26, 1997, Diplomat had 32 full time employees in its Stony Point facility. Of such employees, four act in executive capacities, two are full time sales and marketing personnel, one is a customer service representative and 25 are administrative and warehouse personnel. None of the employees are covered by a collective bargaining agreement. The Company considers its relations with the employees to be good. Biobottoms employs permanent, full time and part time employees, part time casual (not eligible for benefits), and temporary workers due to seasonal increases in its sales volume. This allows for optimal employment levels during peak and slack times. Also, it allows a portion of the work force the option of flexible working hours. At December 26, 1997, Biobottoms employed 124 employees 85 of which are full time. None of the Biobottoms employees are represented by any labor union. At December 27, 1997, Lew Magram and Brownstone employed a total of 331 employees, including 63 management, 227 full time employees and 41 part time employees utilized almost exclusively for catalog orders. None of the Brownstone or Lew Magram employees are represented by a labor union. Item 2. Properties Properties and Facilities In December 1992, Loshell Realty Corporation ("Loshell"), owner of the real estate and buildings housing the warehouse and distribution facilities for the Diplomat/Ecology Kids (TM) division located at 25 Kay Fries Drive, Stony Point, New York (the "Facilities'), transferred to the Company a fee interest in the Facilities, subject to purchase money mortgage indebtedness. The Facilities consist of five buildings aggregating approximately 40,000 square feet, located on approximately seven acres. The Facilities had an adjusted basis of $1,984,857 when transferred to the Company. Approximately 1,000 square feet of the Facilities are utilized by the Company's contract manufacturers located at the premises. Sheldon R. Rose, the Company's former President and Chief Executive officer and his wife were the sole shareholders of Loshell. In connection therewith, the Company assumed purchase money mortgage indebtedness of Loshell aggregating approximately $1,799,000 ($1,101,000 with respect to a first mortgage note due August 2010, bearing interest at an initial rate of $11.75% adjusted every three years, commencing July 1993 (currently 6.375%) and $698,000 with respect to a subordinated mortgage note originally due July 1995, but extended to January 1998, bearing interest at an initial rate of 11.5% per annum. The Company is currently negotiating the refinance of the mortgages. Mr. Rose and his wife have personally guaranteed payment of the first mortgage, and Mr. Rose and Loshell are co-makers of the subordinated mortgage note. The Company pays approximately $26,000 per month for both mortgage payments and real estate taxes. 11 Biobottoms leases approximately 17,60O square feet of office space and 18,700 square feet of warehouse space in Petaluma, California. Total fixed monthly payments (exclusive of any applicable common area maintenance charges) currently under these leases is $28,632 and the lease agreements provide for fixed annual increases. The office lease expires on July 1, 1998. The warehouse lease has been renewed which will expire July 1, 1999, but may be terminated by Biobottoms on July 1, 1998 if Biobottoms gives notice of termination by March 31, 1998. Other suitable facilities are available at competitive prices and terms. Brownstone has moved from its Secaucus facility and is operating from the facilities of Lew Magram in Teaneck, New Jersey. Lew Magram leases approximately 73,000 square feet of warehouse and office space in Teaneck, New Jersey. Total fixed monthly charges are approximately $49,000 subject to annual escalation clauses. The lease expires in August 1999, subject to two five-year renewal options. Lew Magram also leases approximately 11,000 square feet in New York City at $19,000 per month. Item 3. Legal Proceedings In September 1996, the Company was named as a defendant in an action brought in the Supreme Court of the State of New York, County of Rockland (Richard Tracy and Anne Tracy v. Insulx Product Corporation, Consolidated Rail Corporation, Diplomat Corporation and Bruce M. Smith Contracting Corporation). Mr. Tracy alleges that the defendants' negligent maintenance of a railroad crossing adjacent to the Company's property caused him to collide with a train. Mr. Tracy is seeking $10,000,000 in damages for his injuries, and Mrs. Tracy is seeking an additional $1,000,000 in damages for loss of Mr. Tracy's services. The Company and its insurance carrier intend to defend vigorously against these claims. The ultimate outcome of this litigation cannot presently be determined. Accordingly, no provision for the liability has been made in the accompanying financial statements. In February 1997, Francine Nichols, a former consultant to the Company, commenced an action against the Company in the Supreme Court of the State of New York, New York County, to recover approximately $240,000 allegedly due under a consulting agreement between Ms. Nichols and the Company. The Company disputes each claim and intends to defend vigorously against them. However, should the claimant prevail, the result may have a material adverse affect on the Company. In July 1997, Federal Express commenced an action against Biobottoms claiming approximately $180,000 in unpaid delivery invoices. Biobottoms has disputed this claim and has filed a counter claim on several 12 bases, one of which is nonperformance. Although Biobottoms intends to defend vigorously against the claim, should the claimant prevail, the result may have a material adverse affect on Biobottoms and the Company. In November 1997, Lew Magram was served with a proposed assessment from the State of New York related to a sales tax audit aggregating approximately $2.4 million, including penalties and interest. Lew Magram disputes the assessment and intends to defend vigorously against it. Although the Company is entitled to indemnification by certain selling Lew Magram Ltd shareholders, an unfavorable result could have a material adverse effect on the Company. In January 1998 Erin's Babies, Inc. filed a civil suit against Biobottoms alleging among other claims, breach of contract and fraud, and requesting compensatory damages of approximately $15,000 and punitive damages. Although Biobottoms disputes the allegations, an award of punitive damages may have a material adverse effect on Biobottoms. In March 1998, Paul Russo filed a complaint against the Company alleging that he is entitled to the Unit Purchase Option granted by the Company as part of the Company's initial public offering in November 1993. Mr. Russo demands unspecified compensatory and punitive damages. The Company disputes Mr. Russo's right to any of the Unit Purchase Option. Other than the above claims, the Company has no notice of any pending material litigation. Item 4. Submission of Matters To A Vote Of Security Holders During the fiscal year covered by this report, the Company did not submit any matters to a vote of security holders. 13 PART II Item 5. Market for the Company's Common Stock and Warrants As of the date hereof, the Company has outstanding its Common Stock $.0001 par value ("Common Stock") and Warrants to purchase its Common Stock ("Warrants"). The principal market for the Common Stock and Warrants is the NASDAQ Small Cap Market ("NASDAQ") under the symbols of DIPL and DIPLW, respectively. The following table sets forth the closing high and low bid prices for the Common Stock and Warrants for each calendar quarter.The prices represent inter-dealer quotations without adjustment for retail markups, markdowns or commissions and may not represent actual transactions. NASDAQ quotations do not assume that the market for the Company's securities will be sustained, Common Stock Warrants ------------ -------- Bid --- For Fiscal Year Ending September 30, 1996 High Low High Low - ------------------ ----- ---- ----- --- First Quarter 3 3/8 1 5/8 1/16 1/4 Second Quarter 2 1/2 1 1/8 1/2 1/4 Third Quarter 2 1/8 1 1/16 - 3/16 Fourth Quarter 2 1 5/16 1/4 1/16 September 30, 1997 - ------------------ First Quarter 2 7/8 3/16 3/16 Second Quarter 2 3/8 7/8 7/16 1/4 Third Quarter 3 1/2 1 5/8 15/16 1/4 Fourth Quarter 3 5/8 2 5/8 1 7/16 The Common Stock and Warrants commenced trading on NASDAQ on November 4,1993. The Company believes that there are approximately 2,200 beneficial owners of each of its securities. DIVIDEND POLICY The Company has not paid any dividends on its Common Stock and does not anticipate paying cash dividends in the foreseeable future, The Company intends to retain any earnings to finance the growth of the Company. There can be no 14 assurance that the Company will ever pay cash dividends pursuant to the Company's credit agreement with its commercial lender and the terms of indebtedness incurred in connection with the acquisition of Biobottoms. 15 Item 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS Twelve Months Ended September 30, 1997 Compared to Twelve Months Ended September 30, 1996 NET SALES Consolidated net sales for the Twelve Month Period ended September 30, 1997 ("1997 Period") increased approximately $14,571,000 or 71% from the Twelve Month Period ended September 30, 1996 ("1996 Period"), primarily as a result of the Lew Magram sales of $10,663,000 from July 1, 1997, the date the Company took effective control of Lew Magram even though the aquisition was not completed until February 19, 1998. The sales of Diplomat for the 1997 Period were $6,893,000 as compared to $8,904,000 for the 1996 Period and the sales of Biobottoms were $17,592,000 in the 1997 Period as compared to $17,378,000 in the 1996 Period. Consolidated cost of sales was 47% of net sales in the 1997 Period and 71% in the 1996 Period. The cost of sales of $16,665,000 in the 1997 Period included $5,006,000 from Lew Magram. Cost of sales of Diplomat for the 1997 Period were $3,585,000 as compared to $8,738,000 in the 1996 Period. The reduction of 59% was the result of the restructuring of the Company during the 1997 Period and from lower sales. Cost of sales of Biobottoms decreased 1% even though sales increased less than 1% from the 1996 Period to the 1997 Period. OPERATING EXPENSES Consolidated operating expenses, which include selling, general, administrative, warehouse and distribution expenses increased approximately $3,200,000 from the 1996 Period to the 1997 Period primarily as a result of $5,045,000 of Lew Magram operating expenses not incurred in the 1996 Period. Operating expenses of Diplomat for the 1997 Period were $1,872,000 as compared to $4,809,000 in the 1996 Period. The reduction of 61% 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. Operating expenses of Biobottoms decreased 4% from the 1996 Period. Consolidated operating expenses were 48% of net sales in the 1997 Period and 66% in the 1996 Period. Interest expense decreased 52% from 1996 to 1997 as a result of the conversion of debt to preferred stock by a principal stockholder. The net income for the 1997 Period was $1,328,000 as compared to a net loss of $8,404,000 for the 1996 Period. 16 At September 30, 1997, the Company has recorded deferred tax assets of $1,362,000. The full utilization of such deferred tax assets is dependent upon the Company realizing taxable income in future years. The total amount of future taxable income necessary for utilizing such deferred tax assets will be approximately $3,400,000. Based on the current year's operations, such realization would take approximately three years. Nine Months Ended September 30, 1996 Compared to Nine Months Ended September 30, 1995 NET SALES Consolidated Net Sales for the Nine Month Period ended September 30, 1996 ("1996 Period") decreased approximately $958,000 from the Nine Month Period ended September 30, 1995 ("1995 Period") primarily as a result of lower sales of Diplomat for the period. The lower sales in 1996 were impacted significantly by an adverse retail environment that continued from the last quarter of 1995. The sales of Diplomat decreased 24% and the sales of Biobottoms increased 16% from 1995 to 1996. Consolidated cost of sales were 69% of net sales in 1996 and 52% in 1995. Cost of sales of Diplomat increased 32% primarily from a writedown of inventory from its restructuring. Cost of sales of Biobottoms increased 16% as a result of an increase in sales. For the 1996 period, Toys "R" Us and Wal-Mart represented 11% and 40% respectively of the Diplomat sales as compared to 32% and 22% in 1995. OPERATING EXPENSES Consolidated operating expenses, which include selling, general, administrative, warehouse and distribution expenses, increased $1,400,000 from 1995 to 1996. The increase resulted primarily from increased catalog expenses of Biobottoms. The operating expenses of Diplomat increased by a minor amount from 1995 to 1996. Consolidated operating expenses were 55% of net sales in 1996 and 45% in 1995. The Company restructured its Stony Point, New York operations by eliminating several of its unprofitable retail lines and downsizing its distribution facility. The Company intends to focus its Stony Point operations on its traditional core business. The restructuring expenses totaled approximately $1,739,000 for the period ended September 30, 1996. Interest expenses decreased $141,000 in 1996 as a result of Biobottoms decreased borrowing at lower rates. 17 The net loss for the 1996 Period was $7,225,000 as compared to a net loss of $721,000 for the 1995 Period. Significantly lower sales of Diplomat during 1996, without corresponding reductions in operating expenses and additional interest expenses from the acquisition were the principal components for the loss in 1996, in addition to the restructuring expenses. Biobottoms had a net loss of $1,150,000 from the date of acquisition. The following summary combines the consolidated results of operations of the Company and Biobottoms as if the acquisition of Biobottoms had occurred at the beginning of fiscal 1995, after giving effect to the amortization of goodwill and increased interest expense on the acquisition debt. Nine Months Pro-Forma Ended Nine Months Ended September 30, 1996 September 30, 1995 Net Sales $19,222,801 $20,180,355 Cost of Sales 13,334,588 10,569,150 ---------- ---------- Gross Profit 5,888,213 9,611,205 ----------- ---------- Selling, General & Administrative 10,589,561 9,179,201 Restructuring Expense 1,738,975 0 --------- - Operating Income(Loss) (6,440,323) 432,004 Interest Expense 784,577 933,895 ------- -------- Loss before Income Taxes (7,224,900) (501,891) Income Taxes (Benefit) 0 (173,072) - --------- Net Loss $(7,224,900) $(328,819) 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, 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 additional issuance of its securities in order to fund its operations, including financing the approximately $3,817,000 decrease in cash flow from operations for the twelve months ended September 30, 1997, which was primarily a result in an increase in inventory required for the sale of seasonal products. The Company's principal working capital credit facility is provided by Congress Financial Corporation ("Congress Financial"). 18 In April 1994, the Company entered into an agreement with Congress Financial providing the Company with a maximum $3,000,000 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 without limitation, accounts receivable, inventory and trademarks. The interest rate on loans is two (2%) 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 was increased during the fiscal year ending September 30, 1997 to ($250,000) and $1,500,000, respectively. The Company has been 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% (reduced to 80% in the third quarter of 1997) 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 the Biobottoms acquisition, Biobottoms established an inventory based credit facility with Congress Financial 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 maximum credit available under the facility is $2,000,000. The credit facility is guaranteed by the Company and a default thereunder constitutes a default under the Company's Loan and Security Agreement with Congress Financial. 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, Biobcttoms was not in compliance with certain covenants of the loan agreement, however Congress Financial continued to extend Biobottoms credit under the terms of the original agreement. On February 25, 1997 the violations were waived by Congress Financial, and Congress Financial 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. As of October 30, 1997, Brownstone entered into a loan agreement with Congress Financial providing Brownstone with a maximum $5.5 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 Brownstone and guaranteed by the Company and Lew Magram. The interest rate is two percent (2%) above the prime rate announced by Core States Bank. The loan agreement provides for certain restrictive covenants, including restrictions on Brownstone's debt financing, dividends and distributions, and transactions with the Company and its subsidiaries. The loan agreement also requires Brownstone maintain a net worth (excluding debt subordinated to the Congress Financial loan) of $300,000 until June 30, 1998, and $500,000 thereafter. Prior to the acquisition of Lew Magram, Lew Magram had entered into a loan agreement, dated as of August 13, 1996, with Congress Financial providing Lew 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 and guaranteed by the Company and Brownstone. The interest rate is one and one-half percent (1 1/2%) above the prime rate announced by Core States Bank. The loan agreement provides for certain restrictive covenants, including restrictions on Lew Magram's debt financing, dividends and distributions and transactions with the Company and its subsidiaries. The loan agreement also requires Lew Magram maintain working capital of at least $1,500,000 and net worth (excluding debt subordinated to the Congress Financial loan) of $1,600,000. Upon the acquisition of Lew Magram, these convenants were waived by Congress Financial, and the Company and Congress Financial are currently negotiating revised convenants. The lines of credit between Congress and each of the Company, Brownstone and Magram are each guaranteed by Robert M. Rubin, a director and principle stockholder of the Company, up to an aggregate maximum amount of $500,000. The Company has also financed its operations and acquisitions through loans from Mr. Rubin, including opproximately $2,900,000 in connection with the acquisition of Biobottoms in February 1996, a $600,000 working capital loan in November 1996, a $200,000 working capital loan in February 1997, and, with Jay Kaplowitz, a $2,205,000 loan for the financing of Jean Grayson's Brownstone Studio, Inc. prior to the asset acquisition by Brownstone and working capital for Biobottoms and the Company. Except for the $200,000 working capital loan, each of the above mentioned loans have been converted into the Company's stock. A significant source of financing for the Company was the sale of common stock. 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, $1.00 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, and in May 1997 issued an additional 150,000 options at an exercise price of $2.375 per share. In May 1997, the Company, in connection with a Private Placement, offered 1,250,000 shares of Common Stock at a price of $2.00 per share. 22 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. The Company and Biobottoms have borrowed the maximum amounts available under their respective credit facilities with Congress Financial unless additional collateral is provided. The Company is currently negotiating with Congress Financial to make additional funds available. PART III Item 9. Directors and Executive Officers, Promotors and Control Persons Compliance with Section 16(a) of the Exchange Act Directors and Executive Officers and Key Employees The Directors, Executive Officers and Key Employees of the Company are as follows: Name Age Position ---- --- -------- Robert M. Rubin 57 Chairman of the Board and Director Jonathan Rosenberg 37 President, Chief Executive Officer and Director Stuart A. Leiderman 53 Executive Vice President of Sales and Marketing and Director Warren H. Golden* 55 Executive Vice President, Chief Operating Officer and Director Irwin Oringer 61 Chief Accounting Officer and Controller Howard Katz 56 Director Wesley C. Fredericks, Jr. 49 Director Jonathan Rosenberg was appointed to the Board of Directors in July 1995 and has been President and Chief Executive officer since November 1996. Since 1993, Mr. Rosenberg served as an independent consultant to the Company, providing advice in the operations and finance areas and in long-term strategic planning. From 1987 until 1993, he was President and Chief operating officer of Servtex International, Inc., a New York based company engaged in international sourcing of imports and manufacturing activities on an agency basis for textile related products. Stuart A. Leiderman has served as Executive Vice President of Sales and Marketing since July 1989, and has been a Director of the Company since June 1992. From 1985 to 1989, Mr. Leiderman was a Divisional Vice President for Hasbro, Inc., 24 Playskool Baby Division, a company engaged primarily in the development, sales and marketing of toys. Robert M. Rubin has served as a Director of the Company since June 1992 and has been Chairman since November 1996. In October 1996, Mr. Rubin became a director of Med-Emerg International Inc., an operator of nursing homes and related healthcare services. Mr. Rubin has served as the Chairman of the Board of Directors of Western Power Equipment Corporation ("WPEC"), a construction equipment distributor since November 20, 1992 . Between November 20, 1992 and March 7, 1993, Mr. Rubin served as Chief Executive Officer of WPEC. Between October 1990 and January 1, 1994 Mr. Rubin served as the Chairman of the Board and Chief Executive Officer of American United Global Inc., a technology and software company ("AUGI") and since January 1, 1994, solely as Chairman of the Board of AUGI. Mr. Rubin was the founder, President, Chief Executive Officer and a Director of Superior Care, Inc. ("SCI") from its inception in 1976 until May 1986 and continued as a Director of SCI (now known as Olsten Corporation ("Olsten") until the latter part of 1987. Olsten, a New York Stock Exchange listed company is engaged in providing home care and institutional staffing services and health care management services. Mr. Rubin is also a Director and minority stockholder of Response USA, Inc., a public company engaged in the sale and distribution of personal emergency response systems. Mr. Rubin is also Chairman and a principal stockholder of ERD Waste Corp.("ERD"),a public company specializing in the management and disposal of municipal solid waste, industrial and commercial nonhazardous solid waste and hazardous waste. In September 1997 ERD and its subsidiaries filed a petition under Chapter 11 of the federal bankruptcy laws, which is pending. Warren H. Golden has been with Lew Magram Ltd. since 1991. From 1989 to 1991, he was with S.C. Corporation, most recently as President. From 1983 to 1989, he was Vice President of Operations, CFO and Treasurer of Honeybee, Inc. In 1986, he 25 became a Director of Honeybee. Prior to Honeybee, Mr. Golden was Senior Vice President, Operations and Control, for Plymouth Shops, a New York apparel retailer. Mr. Golden is a graduate of Long Island University. Irwin Oringer, a Certified Public Accountant, has been Chief Accounting Officer and Controller of the Company since September 1992. From October 1991, until he joined the Company in September 1992, Mr. Oringer was Corporate Controller of Trans-National Trade Development Corporation, a company engaged in the business of importing diversified consumer products. From 1968 to 1991 he held a variety of financial management positions with subsidiaries of Kenrich, Inc., a holding company for businesses engaged in the wire and cable business. In February 1991, Kenrich and its subsidiaries filed a petition under Chapter 11 of the Federal bankruptcy laws and was subsequently liquidated. Howard Katz has been a Director of the Company since October 1996. Mr. Katz has been Executive Vice President of American United Global, Incorporated since April 15, 1996. From December 1995 through April 15, 1996 Mr. Katz was a consultant for, and from January, 1994 through December, 1995 he held various executive positions, including Chief Financial Officer with, National Fiber Network (a fiber optics telecommunications company). From January 1991 through December 1993 Mr. Katz was the President of Katlaw Construction Corporation, a company that provides general contractor services to foreign embassies and foreign missions located in the United States. Wesley C. Fredericks, Jr. has been a director of the Company since July 1997. Since 1994, he has been a member of the law firm of Gersten, Savage, Kaplowitz & Fredericks, LLP. From 1990-1994, Mr. Fredericks was a principal in and president of Manufacturers Products Co., an automotive supply company. On December 23, 1997, the Board approved an increase in the size of the Board from five to seven directors. Directors of the Company are elected for one year terms or until their successors are elected, and Officers serve at the pleasure of the Board of Directors. * In accordance with the Agreement and Plan of Merger to acquire Lew Magram, Mr. Golden was appointed as a director and as Executive Vice President and Chief Operating Officer of the Company upon completion of the acquisition of Lew Magram on February 19, 1998. Item 10. Executive Compensation The following table sets forth a summary of the compensation paid to or accrued by the Company during the fiscal period ended September 30, 1997 to the Company's Chief Executive Officer and to each of the other most highly compensated executive officers of the Company determined as of the end of the last fiscal year. Name Annual and Compensation (1) Restricted Principal Position Year Salary Stock Award - ------------------ ---- ------ ----------- Sheldon R. Rose 9/30/96 $159,375 0 CEO 1995 $191,047 26 (Resigned 11/96) Jonathan Rosenberg 9/30/97 $190,769 0 CE0 9/30/96 $130,804 (Elected 11/96) Stuart Leiderman 9/30/97 $150,000 0 Executive Vice 9/30/96 $112,500 President 1995 $139,334 (1) The Company did not issue any bonuses, other annual compensation, stock appreciation rights or long term incentive plan payouts to any of the named individuals in the Summary Compensation Table. In January 1996, Jonathan Rosenberg, a director of the Company, became a full time employee of the Company, serving with the title of chief operating officer. His compensation on an annualized basis for 1996 was $175,000. In addition to benefits generally available to senior level employees of the Company, he receives an automobile allowance of $750 per month. In connection with his employment, he was granted 75,000 incentive stock options, having an exercise price of $1.50 per share, exercisable over a five (5) year period, 15,000 shares per year. OPTIONS/SAR GRANTS IN LAST FISCAL YEAR --------------------------------------
- --------------------------------------------------------------------- Name Number of Percent of Exercise Expiration (a) Securities Total or Date Underlying Options/SARs Base Price (e) options/SARs Granted to ($/Sh) Granted (#) Employees in (d) (b) Fiscal Year (c) - --------------------------------------------------------------------- Jonathan 250,000 100% $1.00 2006 Rosenberg - --------------------------------------------------------------------- Stuart 100,000 100% $1.00 2006 Leiderman - ---------------------------------------------------------------------
27 Employment and Related Agreements Sheldon R. Rose was employed under a three-year employment agreement commencing on or about November 4, 1993, pursuant to which he was paid a base salary of $175,000 per annum. In April 1994 the Board of Directors approved a $37,500 increase to Mr. Rose's employment agreement. In November 1996, the Company entered into a termination agreement with Mr. Rose. The termination agreement provided for the cancellation of Mr. Rose's agreement with the Company and his resignation as a Director of the Company. The agreement provided that the Company will pay Mr. Rose an aggregate of $70,833 over a four month period as severance pay. As part of the agreement, the Company and certain of its affiliates would either purchase or cause to be purchased an aggregate of 1,019,000 shares of the Company's Common Stock for an aggregate of $475,000. Stuart A. Leiderman was employed under a three-year employment agreement commencing on or about November 4, 1993, pursuant to which he was paid a base salary of S150,000 per annum and was entitled to an annual bonus as determined by the Board of Directors. No bonuses have been paid to Mr. Leiderman. The Company also provides and maintains an automobile for Mr. Leiderman. Although the employment agreement has expired, Mr. Leiderman is currently employed under the same terms. In January 1994, the Company entered into a three year financial consulting agreement with Robert M. Rubin, a director and principal stockholder of the Company, pursuant to which he is paid $125,000 per annum. In September 1996, this agreement was extended until December 31, 1998. 28 In September 1996, the Company entered into an arrangement with Gersten, Savage, Kaplowitz & Fredericks, LLP ("GSK&F") which provided that GSK&F will provide certain legal and consulting services to the Company over an extended period of time. As compensation for its services, certain individual members of GSK&F received an aggregate of 350,000 shares of Common Stock and options to purchase an aggregate of 150,000 shares of Common Stock at $2.50 per share. In accordance with the Agreement and Plan of Merger to acquire Lew Magram Ltd., upon completion of the acquistion on February 19, 1998 each of Irving Magram, Warren Golden and Stephanie Sobel entered into employment agreements with the Company or Lew Magram effective February 2, 1998. The employment agreement between the Company and Warren Golden provides that Mr. Golden will be employed as the Company's Executive Vice President and Chief Operating Officer and Lew Magram's Executive Vice President for three years, subject to annual renewals, at an annual salary of $235,000 subject to certain periodic increases based on performance. The employment agreement between Irving Magram and Lew Magram 29 provides that Mr. Magram will be employed as President of Lew Magram for three years, subject to annual renewals, at an annual salary of $235,000 subject to certain periodic increases based on performance. The employment agreement between Stephanie Sobel and Lew Magram provides that Ms. Sobel will be employed as Senior Vice President of Marketing for three years, subject to annual renewals, at an annual salary of $187,500 subject to certain periodic increases based on performance. Messrs. Golden and Magram and Ms. Sobel will also receive cash bonuses based on Lew Magram meeting certain profitability criteria. The maximum aggregate cash bonus to Messrs. Golden and Magram and Ms. Sobel is $185,000 per year. 1992 Stock Option Plan The Company's 1992 Stock Option Plan ("1992 Stock Option Plan") provides for the issuance of up to 200,000 shares of Common Stock upon exercise of incentive stock options and is intended to qualify under Section 422 of the Internal Revenue Service Code of 1986, amended ("Code"). The Stock Option Plan may be administered by the Board of Directors or by a stock option committee of the Board of Directors (the "Committee"). incentive stock options are granted under the Stock Option Plan to employees generally on the basis of the recipient's responsibilities and the achievement of performance objectives. Subject to the limitations set forth in the Stock Option Plan, the Board or the Committee has the authority to determine when the options may be exercised and vest. Under the Plan, the per share exercise price may not be less than the greater of 100% of the fair market value of the shares on the date of grant. With respect to any participant who owns stock possessing more than 10% of the voting rights of the Company's outstanding capital stock, the per share exercise price must be at least 110% of the fair market value on the date of grant and the term may not be longer than five years. As of this date, the Company has outstanding under this plan an aggregate of 130,000 Stock options, exercisable at $1.50 per share, all of which are held by affiliates or employees of the Company at the time of grant. August 1996 Stock Option Plan The Company also established a non-qualified stock option plan providing for the issuance of up to 1,500,000 shares of Common Stock to its directors, officers, key employees and consultants (the "August 1996 Plan"). To date, the Company has granted directors, officers and key employees an aggregate of 150,000 incentive and non-qualified stock options, at an exercise price of $2.00 per share and 500,000 non-qualified stock options issued and exercised by a consultant. Future grants could have an adverse affect on the market price of the Company's securities. November 1996 Stock Option Plan Under the Company's November 1996 Incentive Stock Option Plan (the "November 1996 Plan), options to purchase a maximum of 1,500,000 shares of 30 Common Stock of the Company (subject to adjustments in the event of stock splits, stock dividends, recapitalizations and other capital adjustments) may be granted to employees, officers and directors of the Company and other persons who provide services to the Company. 1,060,000 of such options have been granted at an exercise price of $1.00, and 150,000 have been granted at an exercise price of $2.375. The options to be granted under the Plan are designated as incentive stock options or non-incentive stock options by the Board of Directors which also has discretion as to the persons to be granted options, the number of shares subject to the options and the terms of the option agreements. Only employees, including officers and part time employees of the Company, and non-employee directors, consultants and advisors and other persons who perform significant service for or on behalf of the Company, may be granted incentive stock options. officers and directors who currently own more than 5% of the issued and outstanding stock are not eligible to participate in the Plan. The Plan provides that options granted thereunder shall be exercisable during a period of no more than ten years from the date of grant, depending upon the specific option agreement, and that, with respect to incentive stock options, the option exercise price shall be at least equal to 100% of the fair market value of the Common Stock at the time of the grant. Employee Pension Plan In 1985, the Company instituted a pension plan (the "Pension Plan"), which is a defined benefit pension plan maintained for all employees. Benefits are payable based on 60% of average compensation for the three highest paid consecutive years of service, reduced for less than 29 years of service prior to retirement. The Pension Plan is funded as required by the Employee Retirement Income Security Act of 1974 ("ERISA") and does not require employee contributions. Full vesting occurs immediately upon joining the Plan. As of this date, Sheldon R. Rose and Stuart A. Leiderman have accrued 22 and 5 years, respectively, of service under the Pension Plan. As of February 1993, the plan was curtailed and no additional pension benefits will accrue. Directors Compensation Wesley C. Fredericks, Jr. and Howard Katz, independent directors of the Company, received options to purchase 100,000 and 125,000 shares of common stock. Mr. Fredericks' options are exercisable at $2.375 per share and expire May 2002. 50,000 of Mr. Katz' options are exercisable at $2.375 and 75,000 at $1.00 which expire in May 2002 and November 2001, respectively. Nonindependent directors receive no compensation for their services as directors. 31 Item 11. Security Ownership of Certain Beneficial Owners and Management The following sets forth as of February 20, 1998, certain information with respect to stock ownership of (i) all persons known by the Company to be beneficial owners of 5% or more of its outstanding common stock and (ii) each director and executive officer. Unless otherwise indicated, the beneficial owners have sole voting and investment power over the securities listed below: Percentage Name and Number of Shares(2)(3) Beneficially Address(l) Beneficially Owned Owned ---------- --------------------- ------- Stuart A. Leiderman(4) 308,000 2.81% Robert M. Rubin(5) 9,130,579 53.65% Jonathan Rosenberg(6) 165,000 1.49% Wesley C. Fredericks, Jr.(7) 258,333 2.35% Warren Golden 418,832 3.72% Howard Katz(8) 66,500 * Irving Magram 933,217 7.95% Jay Kaplowitz 705,549 6.33% All officers and directors as a group (5 persons) 10,347,244 58.32% * less than one percent. (1) Unless otherwise indicated, the address of all officers and directors listed above is in the care of the Company. (2) Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities and includes Shares of Common Stock issuable upon conversion of outstanding preferred stock, or subject to Options, or warrants currently exercisable or convertible, or exercisable or convertible within 60 days. The percentage of stock outstanding for each stockholder is calculated by dividing (i) the number of shares of Common Stock deemed to be beneficially held by such stockholder as of February 20, 1998 by (ii) the sum of (A) the number of shares of Common Stock outstanding as of February 20, 1998 plus (B) the number of shares issuable upon exercise of options or warrants held by such stockholder which were exercisable as of February 20, 1998 or which will become exercisable within 60 days after February 20, 1998. 32 (3) The table includes the beneficial ownership of the Company's Common Stock issued upon the closing of the acquisition of Lew Magram Ltd. In December 1997, the Company entered into an Agreement and Plan of Merger with Lew Magram Ltd., Robert Rubin, Jay Kaplowitz, Irving Magram, Warren Golden and Stephanie Sobel, all of the shareholders of Lew Magram Ltd. (the "Merger"). Prior to the closing, Messrs. Magram and Golden and Ms. Sobel owned all of the outstanding common stock of Lew Magram Ltd. and Messrs. Rubin and Kaplowitz owned all of the outstanding Senior Convertible Preferred Stock of Lew Magram Ltd., which Messrs. Rubin and Kaplowitz acquired in May 1997, which is convertible into one-half of the outstanding common stock of Lew Magram Ltd. after giving effect to the conversion. Upon the closing of the Merger on February 19, 1998, the Company issued 95,000 shares of Series D Preferred Stock to each of the Lew Magram Ltd. shareholders of which Mr. Rubin received 46,253 shares. Mr. Magram received 24,999 shares, excluding 2,497 shares sold to third parties who converted the shares to Common Stock. Mr. Kaplowitz received 5,417 shares. Mr. Golden received 10,556 shares. Ms. Sobel received 5,278 shares. In addition, Mr. Magram, Mr. Golden and Ms. Sobel received 100,000, 66,667 and 33,333 shares of the Company's Common Stock, respectively, excluding 50,000 shares of the Company's Common Stock issued to their counsel at the closing. Each share of the Company's Series D Preferred Stock shall be convertible into 33 1/3 shares of the Company's Common Stock. (4) Represents (i) 268,000 shares of Common Stock currently owned, and (ii) 40,000 shares of Common Stock issuable upon exercise of currently exercisable options granted under the November 1996 Plan. Mr. Leiderman also has an additional 60,000 options under the November 1996 Option Plan which are not currently exercisable and will not become exercisable in the next sixty days. (5) Represents (i) 3,016,750 shares of Common Stock currently owned,(ii) 1,000,000 shares of Common Stock issuable upon conversion of 100,000 shares of the Company's Series A Preferred Stock, (iii) 290,000 shares of Series B Preferred Stock which provide for certain conversion rights and entitle him to 2,900,000 votes, (iv) 60,000 shares of Series C Preferred Stock which provide for certain conversion rights and entitle him to 600,000 votes, (v) 1,541,612 shares of Common Stock issuable upon conversion of 46,253 shares of Series D Preferred Stock, (vi) 20,000 shares of Common Stock issuable upon exercise of currently exercisable options issued pursuant to the 1992 Stock Option Plan, and (vii) 52,217 shares of Common Stock approved for issuance but not yet issued. (6) Represents (i) 65,000 shares of Common Stock issuable upon exercise of currently exercisable options granted pursuant to the 1992 Stock Option Plan , and (ii) 100,000 shares of Common stock issuable upon the exercise of currently exercisable 33 options granted pursuant to the November 1996 Plan. Mr. Rosenberg also has an additional 30,000 options under the 1992 Stock Option Plan and 150,000 options under the November 1996 Option Plan which are not currently exercisable and will not become exercisable in the next sixty days. (7) Represents (i) 157,500 shares of Common Stock currently owned, (ii) 67,500 shares which may be issued upon exercise of currently exercisable options issued pursuant to the August 1996 Stock Option Plan, and (iii) 33,333 shares of Common Stock issuable upon currently exercisable options issued pursuant to the November 1996 Plan. Mr. Fredericks also has an additional 66,664 options under the November 1996 Plan which are not currently exercisable and will not become exercisable within the next sixty days. (8) Includes 66,500 shares of Common Stock issuable upon exercise of currently exercisable options granted pursuant to the November 1996 Stock Option Plan. Mr. Katz also has an additional 58,500 options which are not currently exercisable and will not become exercisable within the next sixty days. Item 12. Certain Relationships and Related Transaction In April 1994, the Company entered into an agreement with Congress Financial Corporation providing the Company with a $3.0 million secured line of credit to be used for loans and trade letters of credit (the "Agreement"). The loans are secured by substantially all of the Company's personal property, including without limitation, accounts receivable, inventory and trademarks. The interest rate on loans is two percent above the prime rate announced by Core States Bank. Under the terms of the Agreement, the Company may borrow up to 80% 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,OO0. At the present time, the Company is fully utilizing its line of credit. On February 9, 1996, the date of closing of the purchase of Biobottoms by Diplomat, Congress entered into a loan and security agreement with Biobottoms providing for a line of credit of $2.0 million limited to 45% of eligible inventory (as defined in the Agreement). In April 1994 and in connection with the Congress agreement, the Company borrowed from Mr. Rubin $590,000 on a secured term loan basis, subordinated to Congress, 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 by Mr. Rubin. The loan from Mr. Rubin was repayable with interest at the prime rate plus 1%, with required principal payment amortization identical to the terms applicable to the Citibank loan terms. Accordingly, the Company 34 was required to make principal payments on the loan from Mr. Rubin of $120,000 in 1994, $120,000 in 1995, $120,000 in 1996 and the balance in 1997. At September 30, 1996 the outstanding balance of $310,000 was converted into preferred stock. Initial borrowings from Congress in the amount of $1,065,192 were used to repay indebtedness to the American Insured Receivables Fund, the Company's former asset based lender. 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 this amendment, Robert Rubin, a director and principal stockholder of the Company, furnished the lender with a personal limited guaranty up to an aggregate maximum liability of $375,000, pertaining to loans made based upon eligible inventory. In January 1994, the Company entered into a three year financial consulting agreement with Robert M. Rubin, a director and principal stockholder of the Company, providing for the payment to him of $125,000 per annum. Mr. Rubin consults with the Company on financial management and long term planning matters, including consideration of acquisitions. The term of the agreement was extended to December 31, 1998 in consideration of Mr. Rubin's subordinated loan to the Company made in connection with the credit agreement described above. In July 1995, pursuant to the Company's 1992 Stock Option Plan, the Company granted each of Jonathan Rosenberg and Robert M. Rubin, options to purchase 20,000 shares of the Company's Common Stock, and Irwin Oringer options to purchase 15,000 shares of the Company's Common Stock, all at an exercise price of $1.50 per share, exercisable over a five year term expiring July 14, 2000. The common shares underlying such options were included in a registration statement that became effective in March 1995. As of the date hereof, none of these options have been exercised. In 1996, pursuant to the Company's 1992 Stock Option Plan, the Company granted Jonathan Rosenberg options to purchase 75,000 shares of the Company's Common Stock at an exercise price of $1.50. To date, none have been exercised. In February 1996, Mr. Rubin loaned the Company $2,353,500 to be used as part of the acquisition price of Biobottoms. In connection with such loan, the Company issued Mr. Rubin 100,000 shares of its Series A Preferred Stock, convertible into 1,000,000 shares of common stock at the option of Mr. Rubin. The holder of such shares of preferred stock will have the right, subject to a subordination and intercreditor agreement by and among Congress, Robert Rubin, American United Global, Inc. and Joan Cooper and Anita Dimondstein as Agents, during any period during which there shall be an Event of Default under the Rubin/American United Loans, as such term is defined therein, to designate a majority of the members of the Board of Directors of the Company. This right of designation continues during the duration of any such Event of 35 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 filed with the Securities and Exchange Commission by the Company within six months of the date of the issue. In the absence of such filing, the Company has agreed, at its sole cost and expense and upon the request of Mr. Rubin, to file and use its best efforts to effect a registration of such shares within three (3) months of his written request. In November 1996, the Company authorized the issuance to 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 providing an additional loan 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. The Series C Preferred Stock, which has a liquidation value of $10.00 per Share, is convertible into Common Stock at 75% of the current market price based on the average closing price for the Common Stock for the 10 days preceding the conversion. Each share of Series C Preferred Stock entitles the holder to 10 votes per share. The Series C Preferred Stock pays an annual dividend of 9%, based on the per Share liquidation value. In the event that the dividend, which is payable monthly, is not paid for three consecutive months , Mr. Rubin shall be entitled to an additional 100,000 Shares of Common Stock for each month that the dividend is not paid. As of September 30, 1996, Robert Rubin, a director and principal stockholder of the Company, converted an aggregate of approximately $2,900,000 in outstanding debt into an aggregate of 290,000 Shares of Series B Preferred Stock. The Series B Preferred Stock, which has a liquidation value of $10 per share, is convertible into Common Stock at 75% of the current market price based on the average closing price for the Common Stock for the 10 days preceding the conversion. In addition, each share of Series B Preferred entitles the holder thereof to 10 votes per share. The Series B Preferred Stock pays an annual dividend of 9%, based on the per Share liquidation value. In the event that the dividend, which is payable monthly, is not paid for three consecutive months, Mr. Rubin shall be entitled to an additional 100,000 Shares of Common Stock for each month that the dividend is not paid. In March 1997, the Company approved the issuance of 52,217 shares of Common Stock to Mr. Rubin in lieu of the dividend payments due under the Series B and Series C Preferred Stock, as well as for an adjustment in salary, for the period from January 1, 1997 through March 31, 1997. On September 9, 1996, the Company entered into an arrangement with Gersten, Savage, Kaplowitz & Fredericks , LLP ("GSK&F") which provided that GSK&F will provide certain legal and consulting services to the Company over an extended 36 period of time. As compensation for its services, certain individual members of GSK&F received an aggregate of 350,000 shares of Common Stock and options to purchase an aggregate of 150,000 shares of Common Stock at $2.50 per share. Of such securities, 157,500 shares of Common Stock and 67,500 options were issued to Wesley C. Fredericks who has since then become a director of the Company. In November 1996, the Company issued an aggregate of 1,060,000 options to 35 employees of the Company, including two executive officers and one outside director, pursuant to the November 1996 Plan. The Options are exercisable at $1.00 per share, vest over a period of five years, and expire ten years from the date of grant, if not sooner due to termination or death of the employee. In May 1997, the Company issued an aggregate of 150,000 options pursuant to the November 1996 Plan, 50,000 of which were issued to Howard Katz, a director of the Company, and 100,000 of which were issued to Mr. Fredericks in connection with his agreeing to become a member of the Company's board of directors, In May 1997, the Company authorized the issuance of 200,000 shares of Common Stock to Mr. Rubin in consideration of Mr. Rubin extending loans to the Company as well as extending a personal guarantee to Congress on behalf of the Company. Between May and July 1997, the Company issued an aggregate of 158,408 shares of Common Stock and options to acquire 200,000 shares of Common Stock to six consultants. Of the 200,000 options, 50,000 are exercisable at $1.75 per share and 150,000 are exercisable at $1.875 per share. From May 1997 through September 1997, the Company sold 1,250,000 shares of its Common Stock in a private placement of its securities in which it raised $2,500,000. In addition to these shares, the Company issued to European Community Capital a placement agent's warrant exercisable to purchase up to 200,000 shares of Common Stock at $3.3125 per share. The Company issued an option to a principle of the placement agent to purchase up to 100,000 shares of on Stock at $2.00 per share. In September 1997, Robert Rubin and Jay Kaplowitz advanced $2,205,000 for the financing of Jean Grayson's Brownstone Studio, Inc. prior to the asset acquisition by Brownstone and for working capital for Biobottoms and the Company. In October 1997, in part to raise capital for the Company's acquisition out of bankruptcy of the assets of Brownstone, the Company completed a private offering of its securities which raised $3,480,000 from accredited investors. The private placement consisted of units, each unit consisting of ten shares of Series E Preferred Stock and 7,500 shares of Common Stock at a purchase price of $10,000 per unit. As a result the Company has issued an aggregate of 3,480 shares of Series E Preferred Stock and 2,610,000 shares of Common Stock. Robert Rubin and Jay Kaplowitz purchased 220.5 of the units for $2,205,000, the proceeds of which repaid the $2,205,000 advance by Messrs. Rubin and Kaplowitz made in September 1996. 37 In December 1997, the Company entered into an Agreement and Plan of Merger with Lew Magram Ltd., Robert Rubin, Jay Kaplowitz, Irving Magram, Warren Golden and Stephanie Sobel, all of the shareholders of Lew Magram Ltd. ("Merger"). Simultaneous with the closing of the Merger on February 19, 1998, Lew Magram Ltd. merged with Magram Acquisition Corp. resulting in Lew Magram becoming a wholly owned subsidiary of the Company. Prior to the closing Messrs. Magram and Golden and Ms. Sobel owned all of the outstanding common stock of Lew Magram Ltd. and Messrs. Rubin and Kaplowitz owned all of the outstanding Senior Convertible Preferred Stock of Lew Magram Ltd., which Messrs. Rubin and Kaplowitz acquired in May 1997, which was convertible into one-half of the outstanding common stock of Lew Magram Ltd. after giving effect to the conversion. At the closing of the Merger, the Company issued 95,000 shares of the Series D Preferred Stock to each of the Lew Magram Ltd. shareholders of which Mr. Rubin received 46,253 shares, Mr. Magram received 24,999 shares (excluding 2,497 shares sold to third parties who converted the shares to Common Stock), Mr. Kaplowitz received 5,417 shares, Mr. Golden received 10,556 shares, and Ms. Sobel received 5,278 shares. In addition, Mr. Magram, Mr. Golden and Ms. Sobel received 100,000, 66,667 and 33,333 shares of the Company's Common Stock, respectively, excluding 50,000 shares of the Company's Common Stock issued to their counsel at the closing. Each share of the Company's Series D Preferred Stock is convertible into 33 1/3 shares of the Company's Common Stock. Each of the stockholders have agreed to indemnify the Company for any material breach of the representations made by Lew Magram Ltd. in the Merger Agreement limited to $9,500,000 and which claims for indemnification must be brought within one year of the closing date of the Merger. Messrs. Rubin and Kaplowitz assigned to the Company their rights to any claim either of them may have for breach of any warranty made by Lew Magram Ltd. in the May 1997 Senior Convertible Preferred Stock Purchase Agreement in return for a release of their indemnification obligations under the Merger Agreement. 38 Item 13. Exhibits, Lists and Reports an Form 8-K (a). Exhibits (numbered in accordance with Item 601 of Regulation S-B). Exhibit No. Description --- ----------- 3a Certificate of Incorporation, as amended(1) 3b By-laws, amended(1) 3c Amendment to Certificate of Incorporation(1) 4a Form of Common Stock Certificate(1) 4b Form of Warrant Agency Agreement between the Registrant and North American Transfer Company(1) 4c Revised form of Unit Purchase Option(1) 4d Common Stock Purchase Warrant(1) 4e Certificate of Designation of Series B and Series C Preferred Stock(5) 4f Amended and Restated Certificate of Designation of Series D Preferred Stock(9) 4g Certificate of Designation of Series A Preferred Stock(10) 4h Certificate of Designation of Series E Preferred Stock(10) 5 Opinion of Gersten, Savage, Kaplowitz, Fredericks & Curtin, LLP(1) 10a Employment Agreement with Stuart A. Leiderman(1) 10b Stock Option Plan(1) 10c November 1996 Stock Option Plan(5) 10f Loshell Realty mortgages with Union State Bank and Stony Point Technical Park, Inc. and related Mortgage Notes, including Sheldon Rose guarantee of Union State Bank(1) 10g Agreement dated as of March 1, 1994 by and between Francine H. Nichols and Diplomat Corporation(2) 39 10i Collateral Assignment of Trademarks and Trademark Licenses (Security Agreement) by and between Congress Financial Corporation and Diplomat Corporation(2) 10l Amendments No. 1, No. 2 and No. 3 to Loan and Security Agreement by and between Congress Financial Corporation and Diplomat Corporation.(4) 10m Loan and Security Agreement made as of February 9, 1996 by and among Robert M. Rubin, American United Global, Inc., Diplomat Corporation and Biobottoms, Inc.(4) 10r Loan and Security Agreement dated February 9, 1996 by and between Congress Financial Corporation and Biobottoms, Inc.(4) 10s Diplomat Corporation Guarantee dated February 9, 1996 to Congress Financial Corporation of Biobottoms, Inc. Indebtedness.(4) 10t Collateral Assignment of Trademarks and Trademark Licenses dated February 9,1996 between Biobottoms, Inc. and Congress Financial Corporation.(4) 40 10u Security Agreement (Rights in Agreement and Plan of Merger) dated February 9, 1996 between Biobottoms, Inc. Diplomat Corporation and Congress Financial Corporation.(4) 10v Agreement and Plan of Merger by and among Diplomat Corporation, Diplomat Acquisition Corporation, Biobottoms, Inc. and Principal Stockholders, together with Amendment No. I thereto.(4) 10y Asset Purchase Agreement dated as of September 24, 1997 by and among Diplomat Corporation and Jean Grayson's Brownstone Studio, Inc. and Wilroy Inc.(7) 10z Bill of Sale provided by Jean Grayson's Brownstone Studio, Inc. and Wilroy, Inc.(7) 10aa Assignment and Assumption Agreement dated October 30, 1997 between Brownstone Holdings, Inc., Jean Grayson's Brownstone Studio, Inc. and Wilroy, Inc.(7) 10bb Loan and Security Agreement by and among Congress Financial Corporation and Jean Grayson's Brownstone Studio, Inc. dated February 28, 1997, as amended September 17, 1997.(7) 10cc Junior Participation Agreement between Congress Financial Corporation, Robert M. Rubin and Jay M. Kaplowitz dated September 27, 1997.(7) 10dd Agreement and Plan of Merger by and among Diplomat Corporation, Magram Acquisition Corp and Lew Magram Ltd.(8) 10ee Employment Agreement between Irving Magram and Lew Magram Ltd. dated February 2, 1998(9) 10ff Employment Agreement between Warren Golden and Diplomat Corporation dated February 2, 1998.(9) 10gg Employment Agreement between Stephanie Sobel and Lew Magram Ltd. dated February 2, 1998.(9) 10hh Lease Agreement between Franklin Associates and Lew Magram Ltd. dated May 15, 1992.(9) 10ii Loan and Security Agreement by and between Congress Financial Corporation and Lew Magram Ltd. dated August 13, 1996(9) 21 Subsidiaries of the Registrant(10) 27 Financial Data Schedule(10) (1) Incorporated by reference to Diplomat Corporation Registration Statement No. 33-66910 NY (2) Incorporated by reference to Diplomat Corporation Annual Report on Form 10-KSB for the year ended January 1, 1994. (3) Incorporated by reference to Diplomat Corporation Registration No33-95986 41 (4) Incorporated by reference to Diplomat Corporation Annual Report on Form 10-KSB for the year ended December 31, 1995. (5) Incorporated by reference to Diplomat Corporation Annual Report on Form 10-KSB for the year ended September 30, 1996. (6) Incorporated by reference to Diplomat Corporation report on Form 8-K dated November 15, 1997. (7) Incorporated by reference to Diplomat Corporation Registration Form SB-2 dated November 17, 1997. (8) Incorporated by reference to Diplomat Corporation report on Form 10-KSB dated January 13, 1998. (9) Incorporated by reference to Diplomat Corporation report on Form 8-K dated March 6, 1998. (10) Included in this Form 10-KSB/A2 (b) Reports on Form 8-K No reports were filed on Form 8-K during the last quarter of the Company's fiscal year ending September 30, 1997. 42 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form 10-KSB/A2 to be signed on its behalf by the undersigned, thereunto duly authorized. DIPLOMAT CORPORATION By:/s/ Jonathan Rosenberg ----------------------- Jonathan Rosenberg President, Chief Executive Officer Dated: March 16, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons, which include the Chief Executive Officer, the Chief Financial Officer and a majority of the Board of Directors, on behalf of the Registrant and in the capacities and on the dates indicated: Name Title Date ---- ----- ---- /s/ Jonathan Rosenberg President, Chief Executive March 16, 1998 - ---------------------- Officer and Director Jonathan Rosenberg (Principal Exec Officer) /s/ Robert M. Rubin Chairman of the Board March 16, 1998 - ------------------- Robert M. Rubin /s/ Stuart Leiderman Executive Vice President of March 16, 1998 - -------------------- Sales and Marketing and a Stuart Leiderman Director /s/ Warren Golden Executive Vice President, March 16, 1998 - -------------------- Chief Operating Officer Warren Golden and a Director /s/ Howard Katz Director March 16, 1998 - ---------------- Howard Katz /s/ Wesley C. Fredericks, Jr. Director March 16, 1998 - ---------------------------- Wesley C. Fredericks, Jr. /s/ Irwin Oringer Principal Accounting Officer March 16, 1998 - ----------------- and Controller Irwin Oringer 43 DIPLOMAT CORPORATION AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS INDEX Page Number ------------- INDEPENDENT AUDITORS' REPORT F - 2 CONSOLIDATED BALANCE SHEET F - 3 CONSOLIDATED STATEMENTS OF OPERATIONS F - 4 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY F - 5 CONSOLIDATED STATEMENTS OF CASH FLOWS F - 6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F - 7 F - 1 INDEPENDENT AUDITOR'S REPORT ---------------------------- To the Board of Directors and Stockholders Diplomat Corporation Stony Point, New York We have audited the accompanying consolidated balance sheet of Diplomat Corporation and Subsidiaries as of September 30, 1997 and the related consolidated statements of operations, stockholders' equity, and cash flows for the year ended September 30, 1997 and the nine months ended September 30, 1996.These financial statements are the responsibility of the Company's management.Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards.Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Diplomat Corporation and Subsidiaries as of September 30, 1997 and the results of its operations and its cash flows for the year ended September 30, 1997 and the nine months ended September 30, 1996 in conformity with generally accepted accounting principles. /s/ Feldman Radin & Co., P.C. Feldman Radin & Co., P.C. Certified Public Accountants New York, New York January 13, 1998 and February 19, 1998 as to Note 3 and Note 10(d) F - 2 DIPLOMAT CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET SEPTEMBER 30, 1997 ASSETS CURRENT ASSETS: Cash and cash equivalents $ 59,750 Accounts receivable, net of allowance of $147,001 2,212,856 Inventories 10,005,057 Prepaid catalogs 2,452,858 Prepaid expenses 1,396,881 Other current assets 938,802 ------------ TOTAL CURRENT ASSETS 17,066,204 PROPERTY AND EQUIPMENT, net 3,465,493 OTHER ASSETS: Goodwill 10,879,788 Customer List 4,875,000 Other 728,437 ------------ $ 37,014,921 ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable and accrued expense $11,713,554 Loans payable - Stockholder 1,435,000 Loans payable - Congress Financial Corp. 4,130,136 Open prepaid orders 335,948 Outstanding merchandise credits 2,981,521 Current maturities of long term debt 893,936 ------------ TOTAL CURRENT LIABILITIES 21,490,095 LONG TERM DEBT, less current maturities 1,235,754 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock, $.10 par value, 1,000,000 shares authorized 505,000 shares issued and outstanding 12,883,048 Common stock, $.0001 par value, 50,000,000 shares authorized, 8,001,933 shares issued and outstanding 801 Paid-in capital 9,266,908 Accumulated deficit (7,861,684 ------------ TOTAL STOCKHOLDERS' EQUITY 14,289,073 ------------ $ 37,014,921 ============ See notes to financial statements. F - 3 DIPLOMAT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Nine Year ended months ended September 30, September 30, 1997 1996 ------------- ------------- NET SALES $ 35,147,333 $ 19,222,801 COST OF GOODS SOLD 16,665,203 13,334,588 ------------- ------------ GROSS PROFIT 18,482,130 5,888,213 ------------- ------------ SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES 16,720,829 10,589,561 RESTRUCTURING AND REORGANIZATION COSTS -- 1,738,975 ------------- ------------ OPERATING INCOME (LOSS) 1,761,301 (6,440,323) INTEREST EXPENSE (644,233) (784,577) ------------- ------------ INCOME (LOSS) BEFORE INCOME TAXES 1,117,068 (7,224,900) INCOME TAXES (BENEFIT) (210,433) -- ------------- ------------ NET INCOME (LOSS) 1,327,501 (7,224,900) PREFERRED STOCK DIVIDENDS (362,892) -- ------------ ------------ NET INCOME (LOSS) TO COMMON SHAREHOLDERS $ 964,609 $(7,224,900) ============ ============ NET INCOME (LOSS) PER COMMON SHARE $ 0.16 $ (1.59) ============ ============ AVERAGE NUMBER OF SHARES USED IN COMPUTATION 5,892,454 4,549,525 ============ ============ See notes to financial statements. F - 4 DIPLOMAT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEAR ENDED SEPTEMBER 30, 1997 AND NINE MONTHS ENDED SEPTEMBER 30, 1996
Common Stock Preferred Stock ------------------ ---------------------- Paid-in Accumulated Shares Amount Shares Amount Capital Deficit Total ---------- ------ -------- ------------ ----------- ------------ ------------ Balance at December 30, 1995 4,493,525 $ 458 - $ - $ 5,201,441 $ (1,675,393) $ 3,526,507 Exercise of options, issuance of 500,000 shares of common stock par .0001 @ .95 500,000 50 474,950 475,000 Issuance of common stock 400,000 400,000 Issuance of preferred stock 410,000 4,100,000 4,100,000 Net loss (7,224,900) (7,224,900) ---------- ------ -------- ------------ ----------- ------------ ------------ Balance at September 30, 1996 4,993,525 508 410,000 4,100,000 6,076,391 (8,900,293) 1,276,607 Private placements 1,250,000 125 2,174,875 2,175,000 Exercise of warrants 500,000 50 499,950 500,000 Issuance of shares 1,258,408 118 515,692 515,810 Preferred stock issued for Magram acquisition 95,000 8,691,668 8,691,668 Preferred stock issued for interest 91,380 91,380 Net income 1,327,501 1,327,501 Preferred stock dividends (288,892) (288,892) ---------- ------ -------- ------------ ----------- ------------ ------------ Balance at September 30, 1997 8,001,933 $ 801 505,000 $ 12,883,048 $ 9,266,908 $ (7,861,684) $ 14,289,073 ========== ====== ======== ============ =========== ============ ============
See notes to financial statements. F - 5 DIPLOMAT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
For the For the nine year ended months ended September 30, September 30, 1997 1996 ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 1,327,501 $ (7,224,900) Adjustment to reconcile net income (loss) to net cash provided by (used in) operating activities: Amortization 375,333 -- Depreciation 384,857 211,237 Issuance of stock for expenses 91,380 400,000 CHANGES IN ASSETS AND LIABILITIES: (Increase) decrease in accounts receivable 297,154 (282,507) (Increase) decrease in inventories (3,076,019) 2,551,187 (Increase) decrease in prepaid expenses 512,723 1,041,372 (Increase) decrease in prepaid catalogs (1,982,124) (641,132) (Increase) decrease in other current assets (205,824) 702,866 (Increase) decrease in other assets (92,373) 500,202 Increase (decrease) in accounts payable and accrued expenses (1,685,718) 2,054,897 Increase (decrease) outstanding merchandise credits 214,242 -- Increase (decrease) prepaid orders 22,130 -- ------------- ------------- NET CASH USED BY OPERATING ACTIVITIES (3,816,738) (686,778) ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Cash paid for Biobottoms, Inc. (net of cash acquired) -- (2,899,211) Cash acquired in Magram acquisition 2,051,007 -- Purchase of trademark (75,000) -- Purchase of property and equipment (189,780) (211,096) ------------- ------------- NET CASH FLOWS PROVIDED BY (USED) BY INVESTING ACTIVITIES 1,786,227 (3,110,307) ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of Biobottoms aquisition loan (1,500,000) -- Proceeds of loans payable, affiliate -- 450,000 Revolving credit loans (735,145) 583,650 Preferred stock dividends paid (288,892) -- Issuance preferred and common stock 3,190,809 475,000 Borrowings from stockholder 1,435,000 2,620,000 Repayment of long term debt and loan payables (80,769) (393,678) ------------- ------------- NET CASH PROVIDED BY FINANCING ACTIVITIES 2,021,003 3,734,972 ------------- ------------- NET DECREASE IN CASH (9,508) (62,113) CASH AND CASH EQUIVALENTS, at beginning of period 69,258 131,371 ------------- ------------- CASH AND CASH EQUIVALENTS, at end of period $ 59,750 $ 69,258 ============= ============= SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid during the year for: Interest $ 764,000 $ 706,000 ============= ============= Income taxes $ -- $ -- ============= =============
See notes to financial statements. F - 6 DIPLOMAT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THE YEAR ENDED SEPTEMBER 30, 1997 AND NINE MONTHS ENDED SEPTEMBER 30, 1996 1. SIGNIFICANT ACCOUNTING POLICIES: A. The financial statements include the accounts of 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 10 years for machinery, furniture and equipment. D. The Company follows SFAS 109 for income taxes. Pursuant to SFAS 109 deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis 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 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 F - 7 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. 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 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. 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, included in the accompanying statement of operations were $16,804,708 for the year ended September 30, 1997 and $3,033,000 for nine months ended September 30, 1996. Included in current assets at September 30, 1997, is $2,452,858 of prepaid catalog costs. K. Revenue is recognized at the time merchandise is shipped to customers. Proceeds received for merchandise not yet shipped are reflected as "customers' unshipped orders," a current liability. L. Magram issues merchandise credits for certain returns of merchandise sold with substantial discounts. Unused credits are periodically written off into income. 2. BUSINESS: The Company is engaged in two 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 merchants. As of 1995, the Company reported its results of operations on a fifty-two/fifty-three week year ending on the Saturday closest to December 31. However, on November 12, 1996, the Company has changed its reporting date to September 30. F - 8 3. ACQUISITION OF LEW MAGRAM, LTD.: On February 19, 1998, the Company (through its wholly-owned subsidiary, Magram Acquisition Corp.) acquired Lew Magram, Ltd.(Magram), a New York corporation with a place of business in Teaneck, New Jersey, which is in the business of mail order catalogue sales of womens' clothing. For accounting purposes, the acquisition was effected as of July 1, 1997, the date that the Company assumed effective control of Magram. The acquisition was accounted for as a purchase and the consideration consisted of the issuance of 95,000 shares of the Company's $.10 par value, Series D, convertible preferred stock. The Series D preferred stock is 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. 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 a certain selling stockholder of Magram who is also a principal stockholder of the Company. The net fair market of identifiable assets acquired was approximately $1.9 million, and included customer lists valued at $5 million. The customer lists are being amortized over a period of 10 years. Goodwill amounted to approximately $7.4 million and is being amortized over 25 years. The following unaudited pro-forma summary combines the consolidated results of operations of the Company and Magram as if the acquisition had occurred at the beginning of 1996, after giving effect to certain adjustments, including amortization. Nine months Year ended ended September 30, September 30, --------------- --------------- 1997 1996 (unaudited) (unaudited) Net sales $ 72,764,211 $ 55,546,294 Net loss (4,900,554) (8,321,654) Net loss per common share (.80) (1.73) 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. 4. ACQUISITION OF BIOBOTTOMS, INC. AND RELATED FINANCING: F - 9 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 Corp., 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. One such note is due six months from the acquisition date and the second note is 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 on the notes within 270 days, or be subject to enforcement action. On February 25, 1997, the former Biobottoms shareholders agreed not to initiate enforcement action under this or susequent defaults until not earlier than December 31, 1997. In connection with obtaining this agreement, Diplomat agreed to pay the Biobottoms shareholders ten installemnts 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. In July 1997, the Company received proceeds from a private placement and pursuant to an agreement with the Biobottoms shareholders paid $1,500,000 in full satisfaction of all amounts due under the acquisition notes, and also amended its consulting agreement with Joan Cooper and Anita Dimondstein to provide for additional compensation of 29,204 shares each of the Company's common stock. 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 into 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 F - 10 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. Year ended December 30, 1995 --------------- (unaudited) Net sales $ 27,137,857 Net loss (1,719,030) Net loss per common share (0.38) 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 paid in full on May 4, 1997. 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 director and principal stockholder. The holder of such shares of preferred stock will have the right, subject to a 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. F - 11 5. RESTRUCTURING OF OPERATIONS: During the quarter ended September 30, 1996, management instituted various actions designed to significantly cut costs in the Company's manufacturing operation located in Stony Point, New York, and to refocus the operation on its most profitable product lines and channels of distribution. Towards this end, the following significant decisions were made: (i) the former Chief Executive Officer's contract, which expired in October 1996, was not renewed, and all ties with this officer were severed; (ii) certain royalty agreements, specifically those related to products which the Company is discontinuing, were not renewed by the Company; (iii) a decision was made to target primarily mass merchant customers; and (iv) significant permanent cutbacks in personnel and other operating costs were made. As a result of the actions taken, the Company incurred restructuring charges of approximately $1,738,975. The restructuring charges include approximately $568,000 primarily for write-offs and other costs associated with the discontinuance of various products and $771,000 for severance pay and professional and consulting fees payable in connection with the restructuring plan. 6. CONVERSION OF STOCKHOLDER DEBT AND ISSUANCE OF SERIES B PREFERRED STOCK: Effective September 30, 1996, a significant stockholder and member of the Company's Board of Directors converted $3,500,285 of indebtedness into 290,000 shares of Series B preferred stock of the Company and 60,000 shares of the Company's Series C preferred stock. Both the Series B and C shares of preferred stock have a liquidation preference of $10 per share ("Liquidation Value") and a normal dividend of 9% of Liquidation Value, payable monthly. Should the Company not pay the dividends on either the Series B or C preferred stock for three consecutive months, the holder will be entitled to receive 100,000 shares of the Company's common stock for each month that the dividend has not been paid as a penalty. The preferred stock, based on Liquidation Value is convertible into common stock of the Company at 75% of the average market value of the common stock for the ten trading days immediately preceding the day of conversion. The preferred stock also has voting rights equal to 3,500,000 shares of common stock on all matters on which common stock votes, including election of directors. As part of the consideration for the conversion the holder was issued 500,000 shares of the Company's common stock. The issuance of the common stock was valued at approximately $0.80 per share, the estimated fair value of such shares at the time of issuance. In September 1997, this significant shareholder loaned the Company an additional $1.2 million, with interest at 9%. 7. INVENTORIES: F - 12 Inventories consist of the following at September 30, 1997: Raw materials and packaging $ 375,510 Work-in-process 365,333 Finished goods 9,264,214 ---------------------- $ 10,005,057 ====================== 8. PROPERTY AND EQUIPMENT: Property and equipment consist of the following at September 30, 1997: Land $ 420,000 Building 1,517,600 Equipment 6,659,639 ---------------------- 8,597,239 Less accumulated depreciation 5,131,746 ---------------------- $ 3,465,493 ====================== 9. OTHER ASSETS: Other assets consist of the following at September 30, 1997: Noncurrent deferred tax asset $ 581,535 Other 146,902 ---------------------- $ 728,437 ====================== F - 13 10. REVOLVING CREDIT AGREEMENTS: (a) In April 1994, the Company entered into an agreement with Congress Financial Corporation ("Congress") providing the Company with a $3,000,000 collateralized line of credit to be utilized for loans and trade letters of credit. The loan is collateralized by substantially all of the Company's personal property, including accounts receivable, inventory, and trademarks. The interest rate on loans is 2% above the prime rate announced by Philadelphia National Bank. The prime rate was 8.5% and 8.25% at September 30, 1997 and 1996, respectively. The outstanding balance was $820,186 at September 30, 1997. Pursuant to the amended terms dated October 1995, the Company may borrow up to an amount equal to the sum of: (i) 80% of eligible accounts receivable (as defined) (ii) 100% of cash collateral (iii) the lesser of 35% of eligible inventory (as defined) or $1,250,000, less (iv) any availability reserves. The revolving credit agreement contains restrictions relating to the payment of dividends, and the maintenance of working capital and stockholders' equity. Up to $375,000 of such loan is guaranteed by a director and significant stockholder. (b) On February 9, 1996, the Company's wholly owned subsidiary (Biobottoms), entered into a new financing arrangement with Congress which includes a $2,000,000 revolving credit line, restricted to the lesser of 45% of the value of eligible inventory or 80% of the value of an orderly liquidation of such inventory. Borrowings on the line of credit bear interest at the prime rate plus 2% and it expires on February 9, 1999. Fees are paid on the unused line of credit at the rate of 1/2%. The line of credit is collateralized by substantially all of the Company's assets. The balance on this loan was $1,046,240 at September 30, 1997. (c) In August 1996, Magram entered into a committed line of credit with Congress Financial Corp. The agreement provides for borrowings subject to a borrowing base formula consisting of 50% of inventory and is secured by substantially all the assets of the Company. Interest on borrowings under the agreement is at 1.5% over the bank prime rate and is calculated on a minimum borrowing of $2,000,000. As of September 30, 1997, the outstanding balance under this agreement was $2,263,711 at a current rate of interest of 10.00%. (d) In connection with the February 19, 1998 closing of the Lew Magram acquisition, a certain principal shareholder and director guarranteed the above agreements up to an aggregare of $500,000. The above agreements impose certain restrictions on the Company's ability to pay dividends. F - 14 11. LONG-TERM DEBT: Long-term debt consists of the following at September 30, 1997: Note payable - bank, payable in monthly installments of $10,018 which includes interest at 8.375%, due August 2010. The note is collateralized by land and buildings and is guaranteed by a stockholder. $ 952,806 Note payable - bank, payable in monthly installments of $7,201 which includes interest at 12%. The note is collateralized by land and buildings and is cosigned by a stockholder.(b) 564,540 Equipment Loans - payable in monthly installments 450,851 Other 161,493 Acquisition notes payable(a) - ---------------- 2,129,690 Current maturities 893,936 ---------------- Long - term debt $ 1,235,754 ================ The maturities of long term debt is as follows: 1998 $ 893,936 1999 215,976 2000 50,233 2001 55,733 Thereafter 913,812 ------------------ $2,129,690 ================== (a) 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 F - 15 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. In July 1997, the Company received proceeds from a Private Placement and pursuant to an agreement with the Biobottoms shareholders paid $1,500,000 in full satisfaction of all amounts due under the acquisition notes, and also amended its consulting agreements with Joan Cooper and Anita Dimondstein to provide for additional compensation of 29,204 shares each of the Company's common stock. Additionally, the Company incurred notes 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. (b) Full payment of this mortgage was due on January 26, 1997. The lender agreed to extend the mortgage for an additional twelve months in exchange for an extension fee of $15,000 and the agreement to bring certain past due amounts current. 12. STOCKHOLDERS' EQUITY: A. On December 31, 1992, the Board of Directors adopted a stock option plan which allows for the grant of option to employees and non-employees to purchase up to 200,000 shares of the Company's common stock. The exercise price per share cannot be less than the fair market value of the Company's common stock on the date of grant. During each of 1996 and 1995, the Company issued 75,000 options exercisable at $1.50 per share. There were no options exercised or canceled during either of the years presented. B. There are currently 581,175 warrants outstanding to purchase shares of the Company's common stock at $3.50 per share. The warrants, which were issued in connection with the Company's initial public offering of its common stock, are exercisable until November 4, 1998. To date, these warrants have not been exercised. C. During 1995, warrants to purchase 1,500,000 shares of common stock were granted; 500,000 of these warrants, exercisable at $1.37 per share, were exercised during 1995 resulting in net proceeds to the Company of $628,000. The remaining 1,000,000 warrants were exercisable as follows, (i) 500,000 at $3.00 per share expiring on July 18, 1996 and (ii) 500,000 at $1.00 per share expiring on July 18, 1997, which were exercised during 1997. The warrants expiring July 18, 1996 were not exercised. D. In September 1996, the Company issued 500,000 common shares at $0.95 per share to previously unrelated investors from the exercise of options. Net proceeds to the Company were $475,000. F - 16 E. In May 1997, the Company issued to Mr. Rubin of 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 providing an additional loan to the Company in the aggregate amount of $600,000 during 1996. F. In March 1997, the Company approved the issuance of 52,217 shares of Common Stock to Mr. Rubin in lieu of the dividend payments due under the Series B and Service C Preferred Stock, as well as for an adjustment in salary, for the period from January 1, 1997 through March 31, 1997. G. In September 9, 1996, the Company entered into an arrangement with Gersten, Savage, Kaplowitz & Fredericks, LLP ("GSK&F") which provided that GSK&F will provide certain legal and consulting services to the Company over an extended period of time. As compensation for its services, certain individual members of GSK&F received an aggregate of 350,000 shares of Common Stock and options to purchase an aggregate of 150,000 shares of Common Stock at $2.50 per share. Of such securities, 157,500 shares of Common Stock and 67,500 options were issued to Wesley C. Fredericks who has since then become a director of the Company. H. In November 1996, the Company issued an aggregate of 1,060,000 options to 35 employees of the Company, including two executive officers and one outside director, pursuant to the November 1996 Plan. The Options are exercisable at $1.00 per share, vest over a period of five years, and expire ten years from the date of grant, if not sooner due to termination or death of the employee. I. In May 1997, the Company issued an aggregate of 150,000 options pursuant to the November 1996 Plan, 50,000 of which were issued to Howard Katz, a director of the Company, and 100,000 of which were issued to Mr. Fredericks in connection with his agreement to become a member of the Company's board of directors. Such options are exercisable at $2.38 per share. J. In May 1997, the Company authorized the issuance of 200,000 shares of Common Stock to Mr. Rubin in consideration of Mr. Rubin extending loans to the company as well as extending a personal guarantee to Congress on behalf of the Company. K. Between May and July 1997, the Company issued an aggregate of 158,408 shares of Common Stock and options to acquire 200,000 shares of Common Stock to six consultants. Of the 200,000 options, 50,000 are exercisable at $1.75 per share and 150,000 are exercisable at $1.875 per share. L. From May 1997 through September 1997, the Company sold 1,250,000 shares of its Common Stock in a private placement of its securities in which it raised $2,500,000. In addition to these shares, the Company issued to European Community Capital a placement agent's warrant exercisable to purchase up to 200,000 shares of Common Stock at $3.3125 per share. The Company issued an option to a principal of the placement agent to purchase up to 100,000 shares of Common Stock at $2.00 per share. F - 17 M. In September 1997, Mr. Rubin made an additional loan to the Company in the amount of $1,200,000. N. In October 1997, in part to raise capital for the Company's acquisition out of bankruptcy of the assets of Brownstone, the Company completed a private offering of its securities which raised $3,480,000 from accredited investors. The private placement consisted of units, each unit consisting of ten shares of Series E Preferred Stock and 7,500 shares of Common Stock at a purchase price of $10,000 per unit. As a result the Company will be issuing an aggregate of 3,480 shares of Series E Preferred Stock and 2,610,000 shares of Common Stock. 13. CONCENTRATION OF CREDIT RISKS: Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of trade accounts receivable. Concentrations of credit risk with respect to trade receivables include concentrations of trade accounts in the juvenile products industry. 14. NET SALES: For the year ended September 30, 1997 and the nine months ended September 30, 1996 two customers of Diplomat accounted for 6% and 4% and 6% and 15% of net sales, respectively. 15. COMMITMENTS AND CONTINGENCY: A. Sales tax audit In November 1997, Magram was served with a proposed assessment related to a sales tax audit aggregating approximately $2.4 million, (including penalties and interest). Magram is vigorously contesting this assessment and believes this matter will ultimately be settled for an immaterial amount and has accrued $50,000 at September 30, 1997 as an estimated loss. The Company's acquisition agreement with Magram's former shareholders indemnifies it for any amounts in excess of $100,000 that could ultimately be due from this matter. B. Merchandise credits Because of Magram's policy of periodically writing off into income unused merchandise credits issued without expiration dates in connection with the return of sale merchandise, it may be liable for future claims on such amounts previously written off. F - 18 C. Employment agreements In connection with the Magram acquisition, the Company will enter into three year employment agreements with three former principals of Magram to serve in executive capacities with the acquired Company. Aggregate annual compensation under these agreements is $657,000 for the first two years and $692,500 for the third year. D. Leases The Company rents real and personal property under long-term lease agreements which expire at various dates through December 2004. Future minimum rentals under noncancellable operating leases are as follows: Fiscal year ending Amount ------------------ ------ 1998 $ 553,861 1999 570,309 2000 574,291 2001 570,064 2002 and thereafter 1,031,945 Rent expense amounted to approximately $823,277 and $226,000 for the year ended September 30, 1997 and the nine months ended September 30, 1996, respectively. E. Litigation In September 1996, the Company was named as a defendant in an action brought in the Supreme Court of New York. The plaintiff alleges that the defendants' (including the Company) negligent maintenance of a railroad crossing adjacent to the Company's property caused him to collide with a train. The plaintiff is seeking $10,000,000 in damages for his injuries, and his spouse is seeking an additional $1,000,000 in damages for loss of the plaintiff's services. The Company and its insurance carrier intend to vigorously defend this action. The ultimate outcome of the litigation cannot be presently determined. The Company does maintain $1,000,000 of insurance coverage which could be applied to any liability posed by this matter. In February 1997, Francine Nichols, a former consultant to the Company, commenced an action against the Company in the Supreme Court of the State of New York, New York County, to recover approximately $240,000 allegedly due under a consulting agreement between Ms Nichols and the Company. The Company disputes F - 19 each claim and intends to vigorously defend against them and believes that it will prevail. In July 1997, Federal Express commenced an action against Biobottoms claiming approximately $180,000 in unpaid delivery invoices. Biobottoms has disputed this claim and has filed a counter claim on several bases, one of which is nonperformance. Biobottoms intends to vigorously defend against the claim, and believes that it will prevail. 16. INCOME TAXES: The following analyzes the deferred tax assets at September 30, 1997: Deferred tax asset: Net operating loss carry forward $ 2,915,000 Depreciation 102,000 Inventory 1,016,000 Other items 164,000 ------------------ 4,197,000 Less: Valuation allowance (2,835,000) ------------------ Deferred tax asset $ 1,362,000 ================== A valuation allowance is provided to reduce the deferred tax assets to a level which, more likely than not, will be realized. The net deferred tax asset reflects management's estimates of the amount which will be realized from future profitability which can be predicted with reasonable certainty. The valuation allowance was $2,835,000 at September 30, 1997, which represents a decrease of $212,000 over the amount reported at September 30, 1996. The current portion of the deferred tax asset amounts to $780,464, and is included with other current assets. The long term portion amounts to $581,536 and is included with other assets. As of September 30, 1997, the Company has net operating loss carry forwards for Federal income tax purposes of approximately $7,300,000 which are available to offset future Federal taxable income through 2009. F - 20 The provision for income taxes differs from the amount computed by applying the 34% federal statutory income tax rate to the net loss before provision for income taxes as follows:
Nine Year ended months ended September 30, September 30, 1997 1996 ------------------- ------------------ Income tax benefit computed at statutory rate $ 451,000 $ (2,456,000) Tax benefit of net operating loss carry forward (451,000) State tax benefit, net of federal tax benefit 1,567 (313,000) Adjustment to valuation allowance (212,000) 2,769,000 ------------------- ------------------ Income tax (benefit) as reported $ (210,433) $ - =================== ===================
17. BUSINESS SEGMENT INFORMATION: Summarized financial information by business segment for nine months ending September 30, 1997 is as follows: Year ended September 30, 1997 ----------------------- Net sales: Specialty catalog retail $ 28,254,609 operations Mass merchant manufacturing 6,892,724 and distribution ----------------------- 35,147,333 ----------------------- Operating income: Specialty catalog retail 324,867 operations Mass merchant manufacturing 1,436,434 and distribution ----------------------- 1,761,301 ----------------------- F - 21 Total assets: Specialty catalog retail 31,599,588 operations Mass merchant manufacturing 5,415,333 and distribution ----------------------- 37,014,921 ----------------------- Depreciation and amortization: Specialty catalog retail 655,066 operations Mass merchant manufacturing 105,124 and distribution ----------------------- 760,190 ----------------------- Capital expenditures: Specialty catalog retail 176,206 operations Mass merchant manufacturing 20,138 and distribution ----------------------- $ 196,344 ----------------------- 18. YEAR ENDED SEPTEMBER 30, 1996 (UNAUDITED): The following summarizes the Company's results of operations for year ended September 30, 1996: Year ended September 30, 1996 ----------------------- Net sales $ 20,576,697 Cost of sales 14,579,343 ----------------------- Gross profit 5,997,354 F - 22 Operating expenses 13,543,927 ----------------------- Operating loss (7,546,573) Other income 3,980 Interest expense (908,664) ----------------------- Loss before income taxes (8,451,257) Income taxes 47,000 ----------------------- Net loss $ (8,404,257) ----------------------- Net loss per share $ (1.97) ----------------------- Number of shares used in 4,267,640 computation 19. STOCK OPTION PLANS The Company's 1992 Stock Option Plan ("1992 Stock Option Plan") provides for the issuance of up to 200,000 shares of Common Stock upon exercise of incentive stock options and is intended to qualify under Section 422 of the Internal Revenue Service Code of 1986, amended ("Code"). The Stock Option Plan may be administered by the Board of Directors or by a stock option committee of the Board of Directors (the "Committee"). Incentive stock options are granted under the Stock Option Plan to employees generally on the basis of the recipient's responsibilities and the achievement of performance objectives. Subject to the limitations set forth in the Stock Option Plan, the Board or the Committee has the authority to determine when the options may be exercised and vest. Under the Plan, the per share exercise price may not be less than the greater of 100% of the fair market value of the shares on the date of grant. With respect to any participant who owns stock possessing more than 10% of the voting rights of the Company's outstanding capital stock, the per share exercise price must be at least 110% of the fair market value on the date of grant and the term may not be longer than five years. As of this date, the Company has outstanding an aggregate of 130,000 Stock options, exercisable at $1.50 per share, all of which are held by affiliates or employees of the Company at the time of grant. August 1996 Stock Option Plan -- The Company also established a non-qualified stock option plan providing for the issuance of up to 1,500,000 shares of Common Stock to its directors, officers, key employees and consultants (the "August 1996 Plan"). To date, the Company has granted directors, officers and key employees an aggregate of 150,000 incentive and non- F - 23 qualified stock options, at an exercise price of $2.00 per share and 500,000 non-qualified stock options issued and exercised by a consultant. Future grants could have an adverse affect on the market price of the Company's securities. November 1996 Stock Option Plan -- Under the Company's November 1996 Incentive Stock Option Plan (the "November 1996 Plan"), options to purchase a maximum of 1,500,000 shares of Common Stock of the Company (subject to adjustments in the event of stock splits, stock dividends, recapitalizations and other capital adjustments) may be granted to employees, officers and directors of the Company and other persons who provide services to the Company. As of the date of this Prospectus, 1,060,000 of such options have been granted at an exercise price $1.00, and 150,000 have been granted at an exercise price of $2.375. The options to be granted under the Plan are designated as incentive stock options or non-incentive stock options by the Board of Directors which also has discretion as to the persons to be granted options, the number of shares subject to the options and terms of the option agreements. Only employees, including officers and part time employees of the Company, and non-employee directors, consultants and advisors and other persons who perform significant service for or on behalf of the Company, may be granted incentive stock options, officers and directors who currently own more than 5% of the issued and outstanding stock are not eligible to participate in the Plan. The Plan provides that options granted thereunder shall be exercisable during a period of no more than ten years from the date of grant, depending upon the specific option agreement, and that, with respect to incentive stock options, the option exercise price shall be at least equal to 100% of the fair market value of the Common Stock at the time of the grant. In fiscal 1997, the Company adopted the disclosure provisions of SFAS No. 123, "Accounting for Stock-Based Compensation". For disclosure purposes, the fair value of options is estimated on the date of grant using the Black-Scholes option option pricing model with the following weighted average assumptions used for stock options granted during the years ended September 30, 1997 and 1996: annual dividends of $0; expected volatility of 94.99%; risk-free interest rate of 7% and expected life of five years. The weighted average fair value of stock options granted during the years ended September 30, 1997 and 1996 was $1.17 and $1.48, respectively. If the Company had recognized compensation cost for stock options in accordance with SFAS No. 123, the Company's proforma net loss and net loss per share would have been $328,099 and $.06 per share for the fiscal year ended September 30, 1997 and $8,298,400 and $1.82 per share for the nine months ended September 30, 1996. 20. SUBSEQUENT EVENT In October 1997, the Company acquired out of bankruptcy all of the assets of Brownstone Studios, Inc., a mail-order catalog company. F - 24 EXHIBIT INDEX Exhibit No. Description --- ----------- 3a Certificate of Incorporation, as amended(1) 3b By-laws, amended(1) 3c Amendment to Certificate of Incorporation(1) 4a Form of Common Stock Certificate(1) 4b Form of Warrant Agency Agreement between the Registrant and North American Transfer Company(1) 4c Revised form of Unit Purchase Option(1) 4d Common Stock Purchase Warrant(1) 4e Certificate of Designation of Series B and Series C Preferred Stock(5) 4f Amended and Restated Certificate of Designation of Series D Preferred Stock(9) 4g Certificate of Designation of Series A Preferred Stock (10) 4h Certificate of Designation of Series E Preferred Stock (10) 5 Opinion of Gersten, Savage, Kaplowitz, Fredericks & Curtin, LLP(1) 10a Employment Agreement with Stuart A. Leiderman(1) 10b Stock Option Plan(1) 10c November 1996 Stock Option Plan(5) 10f Loshell Realty mortgages with Union State Bank and Stony Point Technical Park, Inc. and related Mortgage Notes, including Sheldon Rose guarantee of Union State Bank(1) 10g Agreement dated as of March 1, 1994 by and between Francine H. Nichols and Diplomat Corporation(2) 10i Collateral Assignment of Trademarks and Trademark Licenses (Security Agreement) by and between Congress Financial Corporation and Diplomat Corporation(2) 10l Amendments No. 1, No. 2 and No. 3 to Loan and Security Agreement by and between Congress Financial Corporation and Diplomat Corporation.(4) 10m Loan and Security Agreement made as of February 9, 1996 by and among Robert M. Rubin, American United Global, Inc., Diplomat Corporation and Biobottoms, Inc.(4) 10r Loan and Security Agreement dated February 9, 1996 by and between Congress Financial Corporation and Biobottoms, Inc.(4) 10s Diplomat Corporation Guarantee dated February 9, 1996 to Congress Financial Corporation of Biobottoms, Inc. Indebtedness.(4) 10t Collateral Assignment of Trademarks and Trademark Licenses dated February 9,1996 between Biobottoms, Inc. and Congress Financial Corporation.(4) 10u Security Agreement (Rights in Agreement and Plan of Merger) dated February 9, 1996 between Biobottoms, Inc. Diplomat Corporation and Congress Financial Corporation.(4) 10v Agreement and Plan of Merger by and among Diplomat Corporation, Diplomat Acquisition Corporation, Biobottoms, Inc. and Principal Stockholders, together with Amendment No. I thereto.(4) 10y Asset Purchase Agreement dated as of September 24, 1997 by and among Diplomat Corporation and Jean Grayson's Brownstone Studio, Inc. and Wilroy Inc.(7) 10z Bill of Sale provided by Jean Grayson's Brownstone Studio, Inc. and Wilroy, Inc.(7) 10aa Assignment and Assumption Agreement dated October 30, 1997 between Brownstone Holdings, Inc., Jean Grayson's Brownstone Studio, Inc. and Wilroy, Inc.(7) 10bb Loan and Security Agreement by and among Congress Financial Corporation and Jean Grayson's Brownstone Studio, Inc. dated February 28, 1997, as amended September 17, 1997.(7) 10cc Junior Participation Agreement between Congress Financial Corporation, Robert M. Rubin and Jay M. Kaplowitz dated September 27, 1997.(7) 10dd Agreement and Plan of Merger by and among Diplomat Corporation, Magram Acquisition Corp and Lew Magram Ltd.(8) 10ee Employment Agreement between Irving Magram and Lew Magram Ltd. dated February 2, 1998(9) 10ff Employment Agreement between Warren Golden and Diplomat Corporation dated February 2, 1998.(9) 10gg Employment Agreement between Stephanie Sobel and Lew Magram Ltd. dated February 2, 1998.(9) 10hh Lease Agreement between Franklin Associates and Lew Magram Ltd. dated May 15, 1992.(9) 10ii Loan and Security Agreement by and between Congress Financial Corporation and Lew Magram Ltd. dated August 13, 1996(9) 21 Subsidiaries of the Registrant(10) 27 Financial Data Schedule(10) (1) Incorporated by reference to Diplomat Corporation Registration Statement No. 33-66910 NY (2) Incorporated by reference to Diplomat Corporation Annual Report on Form 10-KSB for the year ended January 1, 1994. (3) Incorporated by reference to Diplomat Corporation Registration No33-95986 (4) Incorporated by reference to Diplomat Corporation Annual Report on Form 10-KSB for the year ended December 31, 1995. (5) Incorporated by reference to Diplomat Corporation Annual Report on Form 10-KSB for the year ended September 30, 1996. (6) Incorporated by reference to Diplomat Corporation report on Form 8-K dated November 15, 1997. (7) Incorporated by reference to Diplomat Corporation Registration Form SB-2 dated November 17, 1997. (8) Incorporated by reference to Diplomat Corporation report on Form 10-KSB dated January 13, 1998. (9) Incorporated by reference to Diplomat Corporation report on Form 8-K dated March 6, 1998. (10) Included in this Form 10-KSB/A2 EX-99.4(G) 2 CERTIFICATE OF DESIGNATION OF SERIES A PREFERRED STOCK DIPLOMAT CORPORATION CERTIFICATE OF DESIGNATIONS, POWERS PREFERENCES AND RIGHTS OF THE SERIES A PREFERRED STOCK, $.01 par value ------------ Pursuant to Section 151 of the General Corporation Law of the State of Delaware Diplomat Corporation, a Delaware Corporation (the "Company") by its President and Assistant Secretary hereby certify that the following resolution has been duly adopted by the Board of Directors of the Company: Resolved, that pursuant to the authority expressly granted to and vested in the Board of Directors of the Company by the provisions of the Certificate of Incorporation, there is hereby created, out of the 1,000,000 shares of Preferred Stock authorized in Article Fourth of the Certificate of Incorporation, a series of 100,000 shares, which seris shall have the following designations, powers, preferences, rights, qualifications, limitations, and restrictions set forth in the Certificate of Incorporation which are applicable to the Preferred Stock. The designation of said series of the Preferred Stock shall be Series A Preferred Stock. The number of shares of Series A Preferred Stock shall be 100,000 and shall be issued as full shares having a par value of $.01 per share. 1. The holders of Series A Preferred Stock shall be entitled at the option of the holder to convert at any time each share of Series A Preferred Stock into ten (10) shares of the Company's common stock ("Conversion Rate"), which shares, when issued, will be duly authorized, fully paid for and nonassessable, subject to adjustment as hereinafter provided: (a) In case of any consolidation with or merger of the Company with or into another corporation, or in case of any sale, lease or conveyance to another corporation of the assets of the Corporation as an entirety or substantially as an entirety, each share of Series A Preferred Stock shall after the date of such consolidation, merger, sale, lease or conveyance be convertible into the number of shares of stock or other securities or property (including cash) to which the common stock issuable (at the time of such consolidation, merger, sale, lease or conveyance) upon conversion of such share of Series A Preferred Stock would have been entitled upon such consolidation, merger, sale, lease or conveyance; and in any such case, if necessary, the provisions set forth herein with respect to the rights and interests thereafter of the holder of the shares of Series A Preferred Stock shall be appropriately adjusted so as to be applicable, as nearly as may reasonably be, to any shares of stock of other securities or property thereafter deliverable on the conversion of the shares of Series A Preferred Stock. (b) If the Corporation shall (i) declare a dividend or make a distribution on its Common Stock in shares of its common stock, (ii) subdivide or reclassify the outstanding shares of common Stock into a greater number of shares, or (iii) combine or reclassify the outstanding common stock into a smaller number of shares, the Conversion Rate in effect at the time of the record date for such dividend or distribution or the effective date of such subdivision, combination or reclassification shall be proportionately adjusted so that the holder of any shares of Series A Preferred Stock surrendered for conversion after such date shall be entitled to receive the number of shares of common stock which he would have owned or been entitled to receive had such Series A Preferred Stock been converted immediately prior to such date. Successive adjustments in the conversion Rate shall be made whenever any event specified above shall occur. Shares of Common Stock issuable upon conversion of the Series A Preferred Stock shall bear a legend stating that such shares of common stock are subject to a voting agreement by and between the registered holders thereof and Sheldon R. Rose and Lola Rose. A copy of such agreement shall be maintained at the principal offices of the Company. 2. The holders of a majority of the shares of the Company's Series A Preferred Stock shall have the right, by vote or action upon written consent in lieu of a meeting, during any period during which there shall be an Event of Default under the Secured Subordinated Term Note dated February 9, 1996 from the Corporation to Robert M. Rubin (as such term is therein defined), after all applicable grace periods shall have expired, to designate a majority of the members of the Board of Directors of the Company, and such right and the authority of any such persons so designated to serve as directors, shall continue for the duration of any such Event of Default and only for such period. 3. If at any time after the date hereof the Company proposes to register any of its equity securities under the Securities Act on Forms SB-2, S-1, S-2 or S-3 or any other form which include substantially the same information as would be required to be included on such forms as presently constituted or any other registration form at the time in effect on which the shares of common stock issuable upon conversion of the Series A Preferred Stock could be registered for sale by the holders thereof (other than a registration in connection with an acquisition of or merger with another entity or the sale of shares registered on Form S-8), the Company shall give written notice to the holders of the Series A Preferred Stock. Upon the written request of a majority of the holders of such shares, given within 10 days after receipt of any such notice, the Company shall include the shares of common stock issuable upon conversion of the Series A Preferred Stock in such registration statement, file the registration statement and use its best efforts to effect the registration under the Securities Act of 1933 (the "Securities Act") of all of such shares that the holders thereof have requested. The Company shall only be obligated to file one (1) such registration statement provided that such registration statement shall have become effective under the Securities Act. 4. In the event that the Company shall not have filed any registration statement described under Section 3 hereof within six months of the date hereof, as would have enabled the holders of the Series A Preferred Stock to include the shares of common stock issuable upon conversion thereof in such registration statement in accordance with Section 3 hereof, then, in such event, upon the request of a majority of the holder of the Series A Preferred Stock, the Company shall file a registration statement under the Securities Act covering the shares of common stock issuable upon such conversion of the shares of Series A Preferred Stock owned by such holders or a portion thereof, and the Company shall use its best efforts to, within 90 days of receipt of the request by a majority of such holders, effect the registration of any of such securities which the Company has been requested to register. The Company shall not be obligated to file more than one (1) such registration statement provided that such registration statement shall have become effective under the Securities Act. 5. With respect to the registration of shares pursuant to either Section 3 or Section 4 hereof, the Company shall pay all Registration Expenses, except for underwriting discounts and selling commissions applicable to the sale of the shares. As used herein, the term Registration Expenses shall mean all expenses incidental to the Company's performance of its obligation to register shares under said Sections 3 and 4 and shall include all fees and disbursements of counsel for the Company and of its independent public accountants, including the expenses of any special audits required by or incident to such performance, and all other fees, costs and expenses which may be incurred in effecting the registration of shares of stock of the bolder: of the Series A Preferred Stock, including, any state or federal transfer taxes payable with respect to the sales of such shares, all registration and filing fees, all fees and expenses of complying with securities of blue sky laws and all printing expenses, but shall not include the fees and disbursements of counsel to the holders of the Series A Preferred Stock, or underwriting discounts and selling commissions applicable to the sale of shares. The certificate of designation herein certified has been duly adopted by the Board of Directors of the Company in accordance with Section 151 of the General Corporation Law of the State of Delaware pursuant to authority vested in the Board of Directors by the Certificate of Incorporation of the Company, as amended. Signed and attested to on February 27, 1996 /s/ Sheldon R. Rose ---------------------------------- Sheldon R. Rose, President Attest: /s/ Irwin Oringer, Asst. Sec. - ----------------------------- Irwin Oringer, Ass't Secretary EX-99.4(H) 3 CERTIFICATE OF DESIGNATION OF SERIES E PREFERRED STOCK EXHIBIT 4(h) CERTIFICATE OF DESIGNATION OF SERIES E PREFERRED STOCK OF DIPLOMAT CORPORATION Pursuant to Section 151 of the Delaware General Corporation Law, Diplomat Corporation (the "Corporation"), a corporation organized and existing under and by virtue of the provisions of the Delaware General Corporation Law that pursuant to authority conferred upon the Board of Directors of the Corporation (the "Board") by the Certificate of Incorporation of the Corporation, the Board, by a Unanimous Written Consent dated September 23, 1997, adopted the following resolution authorizing the creation and issuance of a series of 3,480 shares of Series E Preferred Stock, (the "Series E Preferred Stock" or the "Series"), which resolution is as follows: RESOLVED, that pursuant to authority expressly granted to and vested in the Board of Directors by the Certificate of Incorporation, as amended, of the Corporation, the Board hereby creates a series of 3,480 shares of Series E Preferred Stock, of the Corporation and authorizes the issuance thereof, and hereby fixes the designation thereof, preferences and relative, participating, optional and other special limitations or restrictions thereon (in addition to the designations, preferences and relative, participating and other special rights, and the qualifications, limitations or restrictions thereof, set forth in the Certificate of Incorporation, as amended, of the Corporation, which are applicable to the preferred stock of all series, if any) as follows: 1. DESIGNATION. The shares of the Series shares shall be designated "Series E Preferred Stock", and the number of shares constituting the Series shall be 3,480. 2. DIVIDENDS. Holders of the Series E Preferred Stock (the "Holders") shall be entitled to an annual cumulative dividend of six percent (6%) of the Liquidation Value of the Series E Preferred Stock for a period of three years commencing on the date of issuance, and twelve percent (12%) thereafter, all dividends being payable annually in arrears. Dividends will be payable in cash or, at the option of the Company, in Common Stock. Dividends payable for any period less than a full year, will be computed on the basis of a 360 day year with equal months of 30 days. 3. LIQUIDATION. (a) Liquidation Preference. Upon any liquidation, dissolution, or winding up of the Corporation, whether voluntary or involuntary, and after provision for the payment of creditors, the Holders shall be entitled to be paid an amount equal to $1000.00 per share ("Liquidation Value") of Series E Preferred Stock held, before any distribution or payment is made upon any shares of Common Stock and any other series of stock junior to the Series E Preferred Stock but subject to the prior preferences of any series or class of stock of the Corporation senior to the Series E Preferred Stock. (b) Ratable Distribution. If upon any liquidation, dissolution or winding up of the Corporation, the net assets of the Corporation to be distributed among the Holders shall be insufficient to permit payment in full to the Holders of such Series E Preferred Stock, then all remaining net assets of the Corporation after the provision for the payment of the Corporation's debts and distribution to any senior stockholders shall be distributed ratably in proportion to the full amounts to which they would otherwise be entitled to receive among the Holders. (c) Corporate Changes. The sale, lease or exchange of all or substantially all of the Corporation's assets or the merger or consolidation of the Corporation which results in the holders of Common Stock of the Corporation receiving in exchange for such Common Stock cash, notes, debentures or other evidences of indebtedness or obligations to pay cash, or preferred stock of the surviving entity which ranks on a parity with or senior to the Series E Preferred Stock as to dividends or upon liquidation, dissolution or winding-up shall be deemed to be a liquidation, dissolution or winding up of the affairs of the Corporation within the meaning of this Section 3(c). In the case of mergers or consolidations of the Corporation where holders of Common Stock of the Corporation receive, in exchange for such Common Stock, common stock or preferred stock in the surviving entity (whether or not the surviving entity is the Corporation) of such merger or consolidation, or common stock or preferred stock of another entity (in either case, such preferred stock to be received in exchange for common stock is herein referred to as "Exchanged Preferred Stock"), which is junior as to dividends and upon liquidation, dissolution or winding up to the Series E Preferred Stock, the merger agreement or consolidation agreement shall expressly provide that the Series E Preferred Stock shall become preferred stock of such surviving entity or other entity, as the case may be, with the same annual dividend rate and equivalent rights to the rights set forth herein; provided however that if the Exchanged Preferred Stock is to be mandatorily redeemed in whole or in part through the operation of a sinking fund or otherwise the merger or consolidation agreement shall expressly provide that, or other provisions shall be made so that, all shares of the Series E Preferred Stock shall be mandatorily redeemed prior to the first mandatory redemption of the Exchanged Preferred Stock; and provided further, that in the event the Corporation or an affiliate of the 2 Corporation optionally redeems or otherwise acquires any or all of the then outstanding shares of Exchanged Preferred Stock, the Corporation shall redeem all shares of Series E Preferred Stock. In the event of a merger or consolidation of the Corporation where the consideration received by the holders of common stock consists of two or more types of the consideration set forth above, the holders of the Series E Preferred Stock shall be entitled to receive either cash or securities based upon the foregoing in the same proportion as the holders of common stock of the Corporation are receiving cash or debt securities, or equity securities in the surviving entity or other entity. 4. REDEMPTION. The Company may at any time it may lawfully do so, redeem in whole or in part the Series E Preferred Stock by paying in cash therefore a sum equal to $1,000 per share of Series E Preferred Stock (as adjusted for any stock dividends, combinations or splits with respect to such shares) plus all unpaid dividends on such shares ("Redemption Price"). 5. VOTING RIGHTS. Except as required under Delaware law, the Holders shall not have any right or power to vote on any question or in any proceeding or to be represented at or to receive notice of any proceeding or meeting of the stockholders. 6. CONVERSION RIGHTS. The Series E Preferred Stock shall not be convertible into Common Stock. 7. NO PREEMPTIVE RIGHTS. No holders of Series E Preferred Stock, whether now or hereafter authorized, shall, as such holder, have any preemptive right whatsoever to purchase, subscribe for or otherwise acquire, stock of any class of the Corporation nor of any security convertible into, nor of any warrant, option or right to purchase, subscribe for or otherwise acquire, stock of any class of the Corporation, whether now or hereafter authorized. 8. EXCLUSION OF OTHER RIGHTS. Except as may otherwise be required by law, the shares of Series E Preferred Stock shall not have any preferences or relative, participating, optional or other special rights, other than those specifically set forth in this resolution (as such resolution may be amended from time to time) and in the Corporation's Certificate of Incorporation. The Shares of Series E Preferred Stock shall have no preemptive or subscription rights. 9. HEADINGS OF SUBDIVISIONS. The headings of the various subdivisions hereof are for convenience of reference only and shall not affect the interpretation of any of the provisions hereof. 3 10. SEVERABILITY OF PROVISIONS. If any right, preference or limitation of the Preferred Stock set forth in this Certificate (as such Certificate may be amended from time to time) is invalid, unlawful or incapable of being enforced by reason of any rule of law or public policy, all other rights, preferences and limitations set forth in this Certificate (as so amended) which can be given effect without the invalid, unlawful or unenforceable right, preference or limitation shall, nevertheless, remain in full force and effect, and no right, preference or limitation herein set forth shall be deemed dependent upon any other such right, preference or limitation unless so expressed herein. 11. STATUS OF REACQUIRED SHARES. Shares of Series E Preferred Stock which have been issued and reacquired in any manner shall (upon compliance with any applicable provisions of the laws of the State of Delaware) have the status of authorized and unissued shares of Series E Preferred Stock issuable in series undesignated as to series and may be redesignated and reissued. 4 IN WITNESS WHEREOF, the Corporation has caused this Certificate to be signed in its name and on its behalf by its President and attested to this 15th day of December, 1997. DIPLOMAT CORPORATION By: /s/ JONATHAN ROSENBERG -------------------------- Jonathan Rosenberg, President ATTESTED /s/ STUART A. LEIDERMAN - ----------------------- Stuart A. Leiderman 5 EX-21 4 LIST OF SUBSIDIARIES Biobottoms, Inc. Brownstone Holdings, Inc. Lew Magram. Ltd. EX-27 5 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AND CONSOLIDATED STATEMENTS OF OPERATIONS INCLUDED IN THE REGISTRANT'S FORM 10-KSB/A2 FOR THE YEAR ENDED SEPTEMBER 30, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. YEAR SEP-30-1997 OCT-01-1996 SEP-30-1997 59,750 0 2,359,857 147,001 10,005,057 17,066,204 8,597,239 5,131,746 37,014,921 21,490,095 1,235,754 0 12,883,048 801 1,405,224 37,014,921 35,147,333 35,147,333 16,665,203 16,665,203 0 0 644,233 1,117,068 (210,433) 1,327,501 0 0 0 1,327,501 .16 .00
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