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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                  FORM 10-KSB/A

[X]     ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
        ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997

                                       OR
[ ]     TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
        ACT OF 1934 FOR THE TRANSITION PERIOD FROM ___________ TO _____________

                         Commission file number 0-25488
                        THE L.L. KNICKERBOCKER CO., INC.
              (Exact name of Small Business Issuer in its Charter)

         CALIFORNIA                                        33-0230641
(State or Other Jurisdiction of                         (I.R.S. Employer
Incorporation or Organization)                          Identification No.)

25800 COMMERCENTRE DRIVE
LAKE FOREST, CA                                             92630
(Address of Principal Offices)                            (Zip Code)

         ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE: (714) 595-7900
         SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
                                      NONE
         SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
                           Common Stock, No Par Value
                                (title of class)
                         Common Stock Purchase Warrants*
                                (title of class)

Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports) and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]

Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained in this form, and no disclosure will be contained, to the
best of 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 revenues for the most recent fiscal year were $68,290,000.

The aggregate market value of the voting stock of the Registrant held by
non-affiliates of the Registrant, based upon the closing bid price of the Common
Stock on the NASDAQ National Market System on March 18, 1998 was $5.50. Shares
of Common Stock held by each officer and director and by each person who owns 5%
or more of the outstanding Common Stock have been excluded in that such persons
may be deemed to be affiliates. This determination of affiliate status is not
necessarily a conclusive determination for other purposes. The number of shares
outstanding of the registrant's Common Stock, as of March 18, 1998 was
19,004,659.

                       DOCUMENTS INCORPORATED BY REFERENCE
                                      NONE

Transitional Small Business disclosure Format (check one): Yes  [ ]     No  [X]

*The registration of the Common Stock Purchase Warrants was terminated on
January 25, 1997


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                                                  TABLE OF CONTENTS


<TABLE>
<CAPTION>
ITEM                                                                            PAGE
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<S>                                                                             <C>
                                     PART I

1.   BUSINESS ................................................................     1
         A. History ..........................................................     1
         B. General Business .................................................     1

2.   PROPERTY ................................................................    10

3.   LITIGATION ..............................................................    11

4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS .....................    11

                                     PART II

5.   MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ...    12

6.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS ........................................................    13

7.   FINANCIAL STATEMENTS ....................................................    17

8.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
        DISCLOSURE ...........................................................    17

                                    PART III

9.   DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
        COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT ....................    18

10.  EXECUTIVE COMPENSATION ..................................................    21

11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ..........    26

12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ..........................    26

13.  EXHIBITS LIST AND REPORTS ON FORM 8-K ...................................    29

         SIGNATURES ..........................................................    32
</TABLE>



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                                     PART I

This Annual Report on Form 10-KSB contains forward-looking statements within the
meaning of the Securities Act of 1933, as amended, and the Securities Exchange
Act of 1934, as amended, which involve risks and uncertainties, including, but
not limited to, economic, competitive, governmental and technological factors
affecting the Company's operations, markets, products, services and prices, and
other factors discussed herein. The Company's actual results could differ
materially from those projected in the forward-looking statements as a result of
the factors described in this Report.


ITEM 1.  BUSINESS

HISTORY

The L. L. Knickerbocker Co., Inc. (the "Company" or "LLK") was formed in 1985 by
Louis L. Knickerbocker, Chairman, President, and Chief Executive Officer of the
Company, and Tamara Knickerbocker, a Vice President of the Company, under the
name International Beauty Supply, Ltd., a California corporation ("IBS").
Subsequently, in 1987, LaVie Cosmetics, a California corporation ("LaVie"), was
co-founded by Louis L. Knickerbocker with Michael Elam. In 1989, the
Knickerbockers co-founded another company, MLF Enterprises, a California
corporation ("MLF"), with Mr. Elam and Farrah Fawcett, a former director of the
Company. MLF developed replicas of Ms. Fawcett's jewelry collection, which were
sold through the television home shopping industry.

The Knickerbockers next formed Knickerbocker Creations, Ltd., a California
corporation ("Creations"), in 1990 and began developing the products and
celebrity endorsement programs which are now part of the Company. In 1993, due
to Creations' status as a Subchapter S corporation, it was determined that the
operations of Creations and IBS should be consolidated under a single entity in
order to facilitate the contemplated public offering of the Company. However, in
1993, the directors and shareholders of the Company were advised that Creations
would be an unsuitable candidate for a public offering. Therefore, on May 24,
1993, the directors and shareholders of IBS approved an amendment of the
articles of incorporation of the corporation changing the name of the
corporation from "International Beauty Supply, Ltd." to the Company's current
name, "The L. L. Knickerbocker Co., Inc." The Company then consummated an asset
purchase whereby certain operating assets of Creations, including but not
limited to, the marketing and distribution rights to the products and programs
of Creations, were acquired along with certain related liabilities. As of the
date hereof, all current active contracts of Creations have been assumed or
amended to grant those rights and obligations to the Company.

The Company completed an initial public offering of common stock and warrants on
January 25, 1995. The Company issued 471,500 units (including 61,500
overallotment units) comprised of two shares of common stock and one common
stock purchase warrant. On August 30, 1995, the Board of Directors approved a
five for one split of the Company's common stock and the increase of the number
of authorized shares of its common stock to 100,000,000.


GENERAL BUSINESS

The L.L. Knickerbocker Co., Inc. (LLK or the Company) is a diverse international
company, focusing its operations on three strategic divisions, a Collectible
Division, a Jewelry Division, and an Investment Division.

The Collectibles Division markets a wide variety of branded consumer products
through diverse channels of worldwide distribution including an international
distributor base, television shopping sales, direct response sales and wholesale
sales to retailers. The Company strives to deliver genuine value to the consumer
through innovative product design and quality. The Company has developed
relationships with a variety of manufacturers that have consistently delivered
high-quality products. Most of the manufacturing of collectible items is
outsourced.



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The Jewelry Division operations are vertically integrated, and most of the
design, stone sourcing, advanced stone cutting, and jewelry manufacturing is
performed by in-house personnel and facilities. The Jewelry division markets a
wide variety of branded consumer products through diverse channels of worldwide
distribution including an international distributor base, television shopping
sales, and wholesale sales to retailers. The Company's goal is to create and
build each brand to its fullest market potential

The Investment Division selects companies whose innovative products and/or
patented technology have potential to make a significant contribution to the
Company's financial success. Through its investment division, the Company has a
50% interest in Arkenol Asia, Inc., a 30% equity interest, on a fully diluted
basis, in Pure Energy Corporation and a 27.8% interest in Ontro, Inc.


COLLECTIBLE DIVISION

INDUSTRY OVERVIEW

Collectibles are identified as any item that is manufactured and marketed solely
for the enjoyment of the collector. Collectibles include figurines, dolls,
collector plates, plush and die cast toys, sports/entertainment memorabilia,
cottage/village reproductions and other decorative or limited edition items that
are intended for collecting. According to Unity Marketing, a collectible
industry market research firm, 15% of American adults (31.3 million people)
consider themselves collectors. The prime collecting years are from 35 to 64
years old. The Collectible industry as a whole was over $9 billion at wholesale
in 1996, up 11% from 1995 figures. The highest growth is expected in the year
2000 due to the high number of limited editions which will be produced for the
turn of the century.

BRANDS

Georgetown Collection (GCI). The GCI brand consists of high-quality,
exclusive-edition porcelain dolls designed and developed by artists licensed in
conjunction with an in-house development team. Manufacturing is outsourced to
factories in China and Southeast Asia. The dolls retail prices range between $90
and $145. The principal marketing channel is print media, including direct mail
and space ads.

Magic Attic Club (MAC). MAC is a catalog collection that features a series of
vinyl dolls, doll clothing and accessories, all of which are based on
imaginative theme books. The books and MAC catalogs target girls in the U.S.
between the ages of 6 and 12. The items in the catalog do not vary much year to
year, which keeps creative costs low and minimizes inventory difficulties.
Repeat customers are highly profitable. In 1997, MAC mailed almost seven million
catalogs, which was an approximate 40% increase from the year prior.

Magic Attic Press (MAP). MAP sells a series of 25 illustrated novels based on
five girls and their adventures. The books have achieved national distribution
and have penetrated many of the major book store chains. Each Magic Attic Press
book contains a mail-in card to request a free catalog listing products offered
by the Magic Attic Club.

Marie Osmond Fine Porcelain Collector Dolls. This collection consists of a
diverse collection of more than 420 different styles of porcelain dolls at
retail prices ranging from $20 to $600. Marie Osmond is the celebrity
spokesperson and design director for the collection. The Marie Osmond Doll
Collection, celebrating its sixth anniversary, received 19 hours of brand
building programmed air time on QVC in 1997. In addition, Marie Osmond makes
scheduled appearances at retail stores throughout the United States to promote
the collection. In 1997 Marie Osmond made her second appearance on QVC in the
United Kingdom and her first QVC appearance in Germany.

Annette Funicello Collectible Bears Company. This line consists of more than 325
different styles of collectible teddy bears. Retail prices range from $25 to
approximately $200. Annette Funicello is the celebrity image and 



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design director for the collection. In 1997, the Company received the TOBY
(Teddy Bear of the Year) award, sponsored by Teddy Bear and Friends Magazine,
one of two major magazines in the teddy bear industry. Additionally, the Company
received the Golden Teddy award, naming the top teddy bear as voted by the
magazine's subscription base, sponsored by Teddy Bear Review magazine, the other
major teddy bear magazine in the industry. The Annette Funicello Collectible
Bear Company, celebrating its fifth anniversary, received 14 hours of brand
building programmed air time on QVC in 1997.

Bob Mackie Legendary Beauties. This collection of fashion dolls, designed by Bob
Mackie (US), Inc., is sold through direct response advertising. Retail prices
are approximately $300. Bob Mackie is the collection's designer and
spokesperson.

The Knickerbocker Toy Company. The 76 year old Knickerbocker name is well
recognized in the toy and collectible teddy bear industries. The Company began
selling collectible Knickerbocker products in October 1986, and was issued the
trademark "Knickerbocker" for toys, dolls, plush stuffed animals and marionettes
in January 1996. The collection offers quality collectible products that have
primarily been marketed to retail outlets nationwide.
The Knickerbocker Toy Company had 2 brand building appearances on QVC in 1997.


JEWELRY DIVISION

INDUSTRY OVERVIEW

The Jewelry market consists of two major categories, Fine and Fashion. Fine
jewelry is manufactured with precious metals (gold, sterling silver, platinum)
with or without gemstones (precious or semiprecious). Natural and cultured
pearls are also considered fine jewelry. According to the World Gold Council, in
1996 gold jewelry sales in the United States were over $12 billion, a 5%
increase over 1995 figures and unit and dollar sales of gold jewelry in the
United States have increased every quarter for the last 24 quarters through the
third quarter of 1997. According to Accessories Magazine, sterling silver
jewelry experienced double digit annual increases from 1993 to 1996, reaching
1996 United States estimated sales of $2.1 billion. Fashion jewelry is
manufactured with non-precious metals (often gold plated), with or without
imitation stones and pearls, and is the largest category of the women's
accessories market with sales, according to Accessories Magazine, in the United
States estimated at $2.6 billion dollars.

FASHION JEWELRY AND ACCESSORIES BRANDS

The Company's jewelry operations are vertically integrated, with control over
stone sourcing and cutting, design structures, manufacturing and marketing. The
Company markets these high-quality, designer fashion jewelry lines and
accessories primarily through QVC. LLK has its own jewelry manufacturing
facility in Central Falls, Rhode Island. The Company's jewelry and accessories
divisions operate to serve each other. The Company's fashion jewelry and
accessories subsidiary, Krasner Group, Inc., includes the following key
components:

The Kenneth Jay Lane High Society Collection - 450 different styles of fashion
jewelry at retail prices ranging from $17 to $198. Kenneth Jay Lane is the
designer and spokesperson for the collection, which celebrated its sixth
anniversary and received over 24 hours of brand building programmed air time on
QVC in 1997.

The Nolan Miller Glamour Collection - 400 different styles of fashion jewelry at
retail prices ranging from $20 to $280. Nolan Miller is the designer and
spokesperson for the collection, which celebrated its fifth anniversary and
received over 33 hours of brand building programmed air time on QVC in 1997.

The Pilar Crespi Collection - 50 different styles of fashion jewelry at retail
prices ranging from $22 to $79. Pilar Crespi is the designer and spokesperson
for the collection, which started on QVC in 1996 and received 7 hours of brand
building programmed air time in 1997.

Barbara Mandrell's Country Sentiments - 50 different styles of fashion jewelry
at retail prices ranging from $19 to $90. Barbara Mandrell is the designer and
spokesperson for the collection, which started in May 1997 and 



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received 7 hours of brand building programmed air time during the year.

Joyous Jewels with Wendy Gell - 13 different styles of fashion jewelry at retail
prices ranging from $35 to $104. Wendy Gell is the designer and spokesperson for
the collection, which started on QVC in October of 1997.

The Dennis Basso Boutique - 90 different styles of fashion accessories at retail
prices ranging from $20 to $220. Dennis Basso is the designer and spokesperson
for the collection, which celebrated its fourth anniversary and received over 7
hours of brand building programmed air time on QVC in 1997.

World Class Accessories by Mary McFadden - 200 different styles of fashion
accessories at retail prices ranging from $19 to $195. Mary McFadden is the
designer and spokesperson for the collection, which celebrated its third
anniversary and received 12 hours of brand building programmed air time on QVC
in 1997.

Framm - 12 different styles of fashion accessories at retail prices ranging from
$24 to $89. Framm is the designer and spokesperson for the collection, which
started on QVC in April 1997.

Enchanted Evenings with Albert Capraro - 20 different styles of fashion
accessories at retail prices ranging from $30 to $80. Albert Capraro is the
designer and spokesperson for the collection, which started on QVC in September
1997.

Anushka - This line of five skin care products was introduced on QVC in 1997 and
appears approximately once a month on the QVC Beauty Solutions program.
Anushka, of Anushka Day Spa in New York City, is the spokesperson for this line.

FINE JEWELRY BRAND

The Company's fine jewelry operation consists of three entities; The L. L.
Knickerbocker (Thai) Company Ltd., Harlyn International Co., Ltd., and S. L. S.
Trading Co., Ltd. all based in Thailand. The Company plans to consolidate the
three entities by the end of 1998.

The Company manufactures and markets gold, diamonds, emeralds, rubies and other
semi-precious stones through a sales force whose primary geographic focus is in
Western Europe and South America. With expertise in stone sourcing and advanced
cutting techniques of specialty stones, the Company supplies other jewelry
manufacturers with loose cut stones. The Company is also recognized for creating
proprietary technology that enhances the color of gemstones and is known in
particular for its Blue Topaz which is exported all over the world. In
addition, the Company produces an assortment of fine jewelry in both Sterling
Silver and Gold for the television retailer, Home Shopping Network (HSN) and
other worldwide recognized television shopping companies such as TVSN Australia
and QVC England.

CONSUMER BRANDS UNDER DEVELOPMENT

The Richard Simmons Such an Angel Collection (Collectible Brand) - The Company
has an exclusive license agreement to manufacture and distribute the line of
dolls with Richard Simmons and Goodtimes Entertainment. The line, Collection of
the Masters by Richard Simmons, was introduced at the 1998 International Toy
Fair in New York.

The Honeymooners Collection (Collectible Brand) - The Company has a license
agreement to manufacture and distribute porcelain dolls and figurines depicting
the characters from the original Honeymooners television show.
The collection was introduced at the 1998 International Toy Fair in New York.

Universal Studio's Edith Head Collection (Collectible Brand) - The Company has
an exclusive license agreement to manufacture and distribute the line of dolls
with Universal Studio Consumer Products Group under the Edith Head brand name.
The collection is based on fashion dolls from Edith Head's career which spanned
50 years and included over 1,200 screen credits. The collection was introduced
at the 1998 International Toy Fair in New York.



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Candy Spelling's Fantasy Dolls (Collectible Brand) - The Company has an
exclusive license agreement to manufacture and distribute the line of dolls with
Candy Spelling under her Fantasy Dolls name. The collection is based on vinyl
dolls in a variety of sizes and theme costumes. The collection was introduced at
the 1998 International Toy Fair in New York.

Cicely Tyson (Jewelry Brand) - The Company has an exclusive license agreement to
manufacture, and distribute through QVC, a line of fashion jewelry, with Cicely
Tyson as designer and spokesperson. The line is expected to be introduced on QVC
in late Spring of 1998.

Spiroll (Accessory Brand) - The Company has an exclusive license agreement to
manufacture and distribute this patented hair tool, which is scheduled to be
introduced in spring of 1998. Lisa and Maureen Marrese, the inventors of this
product, are spokespersons for the product.

Although the Company currently believes that the above listed products can be
developed and produced as commercially viable product line additions, there can
be no assurance that the new products will be introduced or, if introduced, that
they will be successful.

CONSUMER BRANDS DISCONTINUED

After a review of the Company's brand focus it was determined that it would be
in its best interest to discontinue the product development, manufacturing and
marketing of those programs not meeting certain sales expectations and re-focus
the brand selections on those that better suited the Company's current core
products. In 1997 the Company discontinued the Facial Steamer Systems, Fit &
Firm exercise equipment and Environmental Control Technology Ionizer.


MARKETING STRATEGIES

The Company's marketing strategy is to develop products and build brands for
marketing through diverse channels of distribution. In implementing this
strategy, the Company plans to continue to focus on building brand recognition,
developing new and innovative products, and selling those branded products
through appropriate channels of distribution. Generally, new brand programs are
tested conservatively prior to any roll out.

The diverse channels of distribution of the branded products includes, but are
not limited to, the television shopping industry, direct response print
advertisements, direct mail, catalog and wholesale to retail outlets
domestically and internationally. Each brand has unique distribution strategies
based on the product, however, where possible the distribution channels cross
over from brand to brand. The wide variety of branded items and distribution
channels provides diversification to the Company's risk profile.


THE DIRECT MARKETING INDUSTRY

Direct marketing has five major areas: Television Marketing, Print Media
Advertising, Catalogs, Direct Mail and the Internet.

TELEVISION SHOPPING CHANNELS

Television Shopping Channels, as well as independent Infomercials, make up this
segment of the direct marketing industry.

The largest television shopping cable network is QVC, followed by HSN and a
number of newcomers. The shopping networks purchase products from vendors and
generally require the vendors to ship the products to the networks' warehouses
before the networks will sell the items on the air. Generally, the format of the
home shopping channels is to present approximately 12 items per hour. Each hour
can be comprised of a special 



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program (i.e. all Marie Osmond Dolls), or a mix of products (i.e. a gift hour
with different kinds of gift items). Special programs, such as celebrity
programs, can be given as much as three straight hours of prime time. These
types of programs must be high dollar volume programs to warrant the allocation
of this time. The shopping channels then ship customer orders directly from
their warehouses/fulfillment centers.

The Company's expertise in marketing to home shopping channels has been to
identify its key product segments such as jewelry and collectibles and build
brand recognition within those product segments. Television shopping represents
over 19% of the Company's Collectible sales and 52% of Jewelry sales.
Additionally, sales to QVC accounted for 29% and 43% of the Company's
consolidated revenues in 1997 and 1996, respectively.

Infomercial format is different from the format of live home shopping cable
programs, in that the infomercial is filmed, edited and produced rather than
being shown live. Infomercials are generally thirty minutes of programming,
while spot commercials can be thirty, sixty or one hundred twenty seconds.
Infomercials post a toll free number where the consumer responds directly to the
marketer.

DIRECT RESPONSE PRINT AND MAIL ADVERTISING

Direct response print advertising focuses on a narrow product selection with
potentially high dollar volume sales. The Company continues to market the
collectible brands through this channel of distribution. In addition to scores
of mainstream publications such as Woman's Day, McCalls, Woman's World and the
National Enquirer, the Company uses collectible trade specific niche
publications including DOLLS, Doll Crafter, Doll Reader, Contemporary Dolls,
Collectors Mart, Teddy Bear Review and Teddy Bear & Friends.

The Company manages direct mail programs by utilizing an in-house consumer data
base to test and build new concepts for selected Brands and categories. The
Company rents distinct targeted mailing lists to build the growth of the
in-house data base. Direct response sales represent approximately 69% of the
Company's Collectible sales.

TRADITIONAL RETAIL AND INTERNATIONAL DISTRIBUTORS

The Company markets to a wide variety of traditional retail outlets and to the
less traditional catalog retailers and international distributors. Currently,
the Company has over 3,200 Collectible traditional retail accounts representing
approximately 7.7% of the Collectibles sales. International distributors make up
approximately another 4.1% of the Collectible sales and 47% of the Jewelry
sales. This channel of distribution is sold through in-house sales
representatives and trade shows.


PRODUCTION PROCEDURES

CONTRACTED PRODUCTION

The Collectibles and some of the Jewelry brand managers develop products, locate
an appropriate contract manufacturing facility and prepare samples, which are
presented to the customer for approval. Upon approval of the samples, the
Company issues a purchase order to the manufacturer for the desired quantity of
the product. In some cases the purchase order is secured by an irrevocable and
transferable letter of credit from the customer. All goods are inspected for
quality by either in-house quality assurance personnel or by an independent
quality assurance resource prior to shipment.

COMPANY OWNED PRODUCTION

The Company's fashion jewelry is manufactured at its own 26,000 square foot
facility in Rhode Island. Almost all of the fashion jewelry manufacturing is
done against open purchase orders.

The Thailand jewelry operation manufactures fine jewelry for a diverse group of
international distributors and wholesalers, including the television shopping
industry. All goods are manufactured in the Company's fully 



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integrated 35,000 square foot facility. The Company's 3,500 square foot showroom
and the design and development divisions are located in the jewelry district of
Bangkok, making it convenient for customers to visit the showroom, inspect the
product lines and develop future programs with the Company's skilled design
team.


EQUITY INVESTMENTS

The LLK corporate strategy includes searching for investment opportunities that
appear to offer high returns on invested capital. The Company has an equity
interest in three privately held companies:

ARKENOL ASIA, INC.

Arkenol Asia, Inc. is a Delaware corporation joint venture company owned 50% by
LLK and 50% by Arkenol Holdings, LLC. The joint venture acquired an exclusive
license to exploit Arkenol Holdings' technology and related intellectual
property to produce ethanol and other chemicals for sale and consumption in
Thailand, Cambodia, Burma, Vietnam, Laos, India, China and Japan, and
non-exclusive licenses for Indonesia and California.

Under the terms of the joint venture, Arkenol Holdings serves as the Managing
Venturer, with the primary responsibility for all development activities and
services to the joint venture and the projects, all product development
activities, the selection and management of engineering, procurement and
construction provider and the operation of the project facilities. LLK has the
primary responsibility for securing all credit support instruments and other
financing on behalf of the projects and the joint venture and all product
marketing activities. The day-to-day business of the joint venture is conducted
by agents and contractors engaged by the Managing Venturer.

In October 1997 the joint venture was named as the Development Agent for Kra
Isthmus Development Company Ltd. of Thailand and the Southern Seaboard Project
in the implementation of its proposed 1000 MW gas fired electrical power plant
near Songkhla, Thailand and in any future extensions of the plant. There is
presently no consideration specified for the joint venture relative to the
Southern Seaboard Project, and the parties are completing due diligence and
negotiating toward a definitive agreement.

In December 1997 the Joint Venture signed a Memorandum of Understanding (MOU)
with Central Resource Northern Development Co., China and Regal Best Limited,
Hong Kong to build the first biorefinery in China using Arkenol Asia's patented
technology. Subsequently, the Ministry of Agriculture in China notified Arkenol
Asia that it will participate in the project with Central Resource Northern
Development Co. and Regal Best Limited. Central Resource Northern Development
Co., with 20,000 employees, is a wholly owned subsidiary of China Gold
Supervision Bureau and is officially authorized to invest in overseas ventures.
There is presently no consideration specified in the MOU for the joint venture,
and the parties are completing due diligence and feasibility studies and
negotiating toward a definitive agreement.

LLK's decision to enter into the Joint Venture was based on a valuation of
Arkenol's technology prepared by Booz-Allen & Hamilton Inc. in October 1996 and
LLK's presence in Thailand, where the Company has over 300 employees.

PURE ENERGY CORPORATION

The Company holds a 30% equity interest, on a fully diluted basis, in Pure
Energy Corporation (PEC). Other shareholders include PEC's founders and
officers, Donaldson, Lufkin & Jenrette (DLJ), an investment banking firm and
private individuals.

PEC has developed a cleaner-burning alternative automotive motor fuel designed
in response to the more stringent emission standards and vehicle purchase
requirements of the Energy Policy Act of 1992 (EPACT) and the Clean Air Act
Amendment of 1990 (CAAA). The fuel will be produced regionally, substantially
from renewable biomass, and distributed through existing infrastructure.
Currently produced flexible fuel vehicles (FFVs) can 



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operate on the fuel. PEC's strategy is to serve fleet customers initially and
eventually a broader segment of the motoring public. PEC has the exclusive
worldwide license from Princeton University to commercialize the fuel.

In December 1997 PEC was notified that the United States Patent and Trademark
Office had issued a patent on the new, non-petroleum substitute for gasoline
called P-series, U.S. Patent No. 5697987, to Princeton University entitled
Alternative Fuel. The fuel, which is non-petroleum and as much as 70 percent
renewable, is designed to operate in existing flexible fuel vehicles. P-series
is a unique blend of ethanol, natural gas liquids and a co-solvent. Both ethanol
and the co-solvent are derived from renewable resources such as cellulosic
biomass. Use of the fuel as an alternative to gasoline will contribute to
significant reductions in greenhouse gases and lower tailpipe emissions.

In July 1997 PEC filed a formal petition with the Department of Energy (DOE)
seeking a ruling to designate its proprietary, non-petroleum motor fuel as an
alternative fuel under EPACT. The DOE has established three primary criteria for
official certification of an alternative motor fuel (1) substantially not
petroleum, (2) substantial energy security and (3) substantial environmental
benefit. DOE certification is pending.

Due to the development stage nature of Pure Energy Corporation, the cost per
gallon of the product has not been established. Pure Energy Corporation had no
sales during 1997 or for the first six months of 1998. The Company's risk in its
investment in Pure Energy Corporation is that the investment's value could be
severely impacted by two factors: The Department of Energy not approving the
fuel as a designated alternative fuel; and a lack of funding for the development
of refineries in which to produce the fuel.

ONTRO, INC. (FORMERLY SELF-HEATING CONTAINER CORP.)

LLK holds a 27.8% equity interest in Ontro, Inc. (Ontro), engaged in the
development of integrated thermal containers. Ontro has the rights to exploit a
unique propriety technology which it has incorporated into a proposed product
line of fully contained self-heating beverage containers designed to heat liquid
contents such as coffee, tea, hot chocolate, soups and baby formula.


Ontro entered into an evaluation agreement with Nestle which allows Nestle an
exclusive period to review Ontro's designs and technology in order to determine
Nestle's interest in acquiring rights for the commercial use of the self-heating
food and beverage containers and to cooperate with Ontro in evaluating certain
commercial uses and markets for the technology and includes an obligation to pay
for one-half of the cost of certain market research studies that are currently
underway.

In June 1997 LLK signed a Distributorship Agreement with Ontro to market
products packaged in Ontro's thermal containers. The terms of the Agreement call
for Ontro to sell their containers to LLK for their use in manufacturing and
selling of approved products and for LLK to be designated as exclusive
distributor for such approved products. LLK may also contract with manufacturers
to produce approved products for the Company and to package such products using
Ontro's containers purchased by LLK.

Due to the development stage nature of Ontro, Inc., the price of the product has
not been established. The product heats the contents of the container only one
time and is not renewable. The container heats the beverage to a temperature of
180 degrees. Ontro, Inc. had no sales for 1997 or for the first six months of
1998.

SUMMARY OF REVENUE BY PRODUCT LINE

In 1997, revenue for the Company was $68,290,000. The breakdown per product line
for revenue in 1997 is as follows:



                                       8
<PAGE>   11

<TABLE>
<CAPTION>
Category                                                  $000's         Percent
--------                                                  ------         -------
<S>                                                       <C>            <C>  
Collectible dolls and bears                               46,169           67.6%
Fashion jewelry and accessories                           11,707           17.1%
Fine Jewelry                                              10,272           15.0%
Other consumer products                                      142            0.3%
                                                          ------         ------

Total                                                     68,290          100.0%
                                                          ======         ======
</TABLE>

MATERIAL CONTRACTS

RICHARD SIMMONS

On May 1, 1995, the Company entered into a License Agreement with SIM-GT
Licensing Corp. to license the name, likeness and trademarks of Richard Simmons.
The Company has been granted the exclusive license to manufacture and distribute
the line of angel figurines under development with Richard Simmons and Goodtimes
Entertainment. The line of collectible porcelain angel figurines, Such An Angel,
was introduced at the 1998 International Toy Fair in New York.


CELLO, INC.

The Company entered into a License Agreement with Cello, Inc. (Cello) on May 13,
1994 with respect to the services of Annette Funicello. The material terms of
the Agreement provide that the Company will design, develop and manufacture
collectible teddy bears and dolls, and such other products as the parties shall
agree on, with the approval of Cello. Cello retains all intellectual property
rights to the products, and the Company is solely responsible for the costs of
manufacturing, distribution, advertising and sales. The initial term of the
Agreement terminated in January 1998, and the Agreement automatically renewed
for an additional term through January 2001.

MARIE, INC.

The Company entered into a License Agreement with Marie, Inc. on April 1, 1993
with respect to the services of Marie Osmond. The material terms of the
Agreement provide that the Company will design, develop and manufacture dolls,
and such other products as the parties shall agree on, with the approval of
Marie, Inc. The Company retains all intellectual property rights to the products
unless they contain Marie Osmond's name, and the Company is solely responsible
for the costs of manufacturing, distribution, advertising and sales. Marie, Inc.
is bound to provide the services of Marie Osmond as the spokesperson for the
products, subject to Marie, Inc.'s approval of commentary and production, for a
minimum of eight personal appearances per year. The Agreement is for a five year
term, and expires on April 1, 1998. The Company has exercised its option for the
renewal of the Agreement for an additional term through April 2003.


TRADEMARKS AND LOGOS

The Company has the right to use the trademark names of the following
spokespersons and celebrities currently under contract: Marie Osmond, Annette
Funicello, Bob Mackie, Richard Simmons, Gleason , the Honeymooners, Jim Yehl,
Nolan Miller, Mary McFadden, Kenneth Jay Lane, Dennis Basso, Pilar Crespi,
Barbara Mandrell, Anushka, Albert Capraro and Framm. The Company has also been
issued trademarks under the following names: American Dairy Dolls, Portraits of
Perfection, Baby Kisses, Quick Fox, Hearts in Song, 



                                       9
<PAGE>   12

Children of the Great Spirit, Faraway Friends, Artists? Edition, Sweethearts of
Summer, Little Bit of Heaven, and Magic Attic Club.

Trademark applications have been filed for; Adorabell, Beauty Bug Ball, Betsy
Clark, Bob Mackie Legendary Beauties, Collection of the Masters, Folkbook
Friends, Greeting Card Treasures, KL, Knickerbocker, Knickerbocker Direct,
Legendary Beauties, Pendant Collection, Pendant Press, Storybook Bears by
Knickerbocker, Storybook Dolls by Knickerbocker, Teddy Tales by Annette
Funicello and Webbie Debbie.


COMPETITION

The direct marketing business is highly competitive and many of the Company's
competitors have substantially greater financial and personnel resources than
the Company. The Company believes that its primary competitors in direct
marketing are difficult to distinguish because the Company is involved in four
types of direct marketing: Television Shopping, Print Media Advertising,
Catalogs and Direct Mail. The Company feels, however, that its main competitors
are Aston Drake, Hamilton Mint, Franklin Mint, Mattel, the Boyds Bears, and
JMAM, Inc.. The Company also competes with a wide variety of wholesalers,
retailers and other direct marketers.


EMPLOYEES

The Company employs a total of 598 employees.

The Company has 65 full time employees at its main office in Lake Forest,
California as of February 10, 1998. The 65 full time employees are comprised of
4 executives, 16 product development, 6 sales, 13 administrative, 7 customer
service, 5 marketing and 14 warehouse employees. The four part time employees
are comprised of two warehouse and two general office.

The Company has 93 full time employees at its Georgetown Collection, Inc.
offices in Portland, Maine as of February 10, 1998. The 93 full time employees
are comprised of 6 executives, 67 general sales and office administrative and 20
warehouse employees.

The Company has 8 full time employees at its Krasner Group, Inc. office in New
York, New York as of February 10, 1998. The 8 full time employees are comprised
of 2 executives and 6 general sales and office administrative employees.

The Company has 68 full time employees at its Charisma Manufacturing Company,
Inc. factory in Central Falls, Rhode Island as of February 10, 1998. The 68 full
time employees are comprised of 2 executives, 12 general sales and office
administrative and 54 factory employees.

The Company has 307 full time employees at its L.L. Knickerbocker (Thailand)
Co., Ltd., offices in Bangkok, Thailand as of February 10, 1998. The 307 full
time employees are comprised of 6 executives, 111 general sales and office
administrative and 190 factory/warehouse employees.


ITEM 2.  PROPERTY

As of March 15, 1998, the Company had 10 principal facilities where it leased or
owned an aggregate of 253,400 square feet of space. The location, function and
general description of the principal properties owned or leased by the Company
are set forth in the table below:

<TABLE>
<CAPTION>
                                                                                SQUARE
LOCATION                            PRINCIPAL FUNCTION                          FOOTAGE          OWNERSHIP
--------                            ------------------                          -------          ---------
<S>                                 <C>                                         <C>              <C>
         CORPORATE

Lake Forest, CA                     Corporate headquarters, finance,
</TABLE>



                                       10
<PAGE>   13

<TABLE>
<S>                                 <C>                                         <C>              <C>
                                    purchasing, service division
                                    headquarters                                51,000           Leased

         COLLECTIBLE DOLLS AND BEARS


Portland, ME                        Administration, product development,
                                    marketing and warehousing                   45,000           Leased

Portland, ME                        Administration, product development,
                                    marketing and warehousing                   40,000           Leased

Exton, PA                           Product development                          2,900           Leased




         COSTUME JEWELRY

New York, NY                        Administration, product development
                                    and marketing                                5,000           Leased

Central Falls, RI                   Manufacturing                               26,000           Leased

Pawtucket, RI                       Fulfillment and warehousing                 12,000           Leased

Pawtucket, RI                       Fulfillment and warehousing                 30,000           Leased


         FINE JEWELRY

Bangkok, Thailand                   Administration, product development,
                                    marketing and showroom                       3,500           Owned

Bangkok, Thailand                   Manufacturing and administration            35,000           Owned
</TABLE>

The Company believes that the properties are in good condition, suitable for its
operations and adequately insured.


ITEM 3.  LITIGATION

On February 27, 1996 a lawsuit was filed in Orange County Superior Court, Case
No. 759883, naming Louis L. Knickerbocker, Tamara Knickerbocker and the Company
as defendants. The plaintiff, Michael Elam, is a stockholder in La Vie Cosmetics
and MLF, companies in which Mr. Louis Knickerbocker, Chairman, President and
Chief Executive Officer of the Company owns an interest. Mr. Elam's lawsuit
seeks damages for sums allegedly owed to him by Mr. Knickerbocker and the
Company from the operations of that company. The Company has been vigorously
defending the lawsuit, which is currently in the discovery phase. The Company
believes that the outcome of this litigation will not have a material adverse
effect upon the operations or financial condition of the Company.


ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1997.



                                       11
<PAGE>   14

                                     PART II


ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

STOCK MARKET AND OTHER INFORMATION

The Company's common stock is listed on the NASDAQ National Market System under
the symbol "KNIC" and has been so listed since January 25, 1995. Previous to
such date, there was no public trading market for the Company's equity
securities. In addition, warrants to purchase up to 2,357,500 shares of the
Company's Common Stock were listed on the NASDAQ National Market System under
the symbol "KNICW." On January 25, 1997, the warrants expired. The registration
of the warrants under Section 12(g) of the Securities Exchange Act of 1934, as
amended, was terminated on January 25, 1997 and the listing of such warrants on
NASDAQ National Market System was terminated on January 25, 1997. The terms of
the warrants provide that one warrant plus $1.30 was required to purchase one
additional share of the Company's common stock. The warrants were redeemable at
the Company's option commencing March 15, 1995 upon 30 days notice to the
warrant holders at $0.01 per share if the closing bid price of the Common Stock
averaged in excess of 110% of the then current exercise price of the warrants
for a period of 20 consecutive trading days ending within 15 days of the notice
of redemption.

On March 18, 1998, the Common Stock bid price closed at $5.50 per share. The
closing bid price of the Company's stock on December 31, 1997 was $ 5.62 per
share. The total volume of shares traded during the year ended December 31, 1997
was 28,162,900 shares. As of March 18, 1998, there were 118 holders of record of
the Company's Common Stock.

The following table presents information on the high and low prices per share
for the Company's Common Stock for each fiscal quarter in 1996 and 1997 as
reported by the NASDAQ National Market System. The following quotations reflect
inter-dealer prices, without retail mark-up, mark-down or commission, and may
not represent actual transactions.

<TABLE>
<CAPTION>
                                          1996                        1997
                                  High $        Low $         High $         Low $
                                  ------        ------        ------        ------
<S>                               <C>           <C>           <C>           <C> 
            First Quarter           9.44          6.38          7.75          4.93
            Second Quarter         16.25          7.75          6.62          4.62
            Third Quarter          16.25          8.00          9.00          5.87
            Fourth Quarter         11.50          5.75          7.93          5.50
</TABLE>

DIVIDENDS

The Company has never paid any dividends on the Common Stock. The Company
intends to retain earnings and capital for use in its business and does not
expect to pay any dividends within the foreseeable future. Any payment of cash
dividends in the future on the Common Stock will be dependent on the Company's
financial condition, results of operations, current and anticipated cash
requirements, plans for expansion, restrictions, if any, under debt obligations,
as well as other factors that the Board of Directors deems relevant. The
Company's line of credit agreement prohibits the payment of dividends without
the prior written consent of the lender.

TRANSFER AGENT AND REGISTRAR

American Securities Transfer, Inc. of Colorado has been appointed and serves as
transfer agent and registrar of the Company's Common Stock and Warrants.



                                       12
<PAGE>   15

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion should be read in conjunction with the financial
statements and the notes thereto appearing elsewhere in this Form 10-KSB.

Results of operations
<TABLE>
<CAPTION>
                                          Year ended December 31,
                                            1996           1997
<S>                                        <C>            <C>   
            Revenue                        100.0%         100.0%
            Cost of revenue                 51.0%          45.1%
            Gross profit                    49.0%          54.9%
            Operating expenses              39.9%          57.9%
            Operating income(loss)           9.1%          -3.0%
            Other income(expense)           -4.5%          -4.9%
            Net income (loss)                3.3%          -6.4%
</TABLE>


Year ended December  31, 1997 compared to year ended December 31, 1996

Net Sales

Net sales increased to $68,290,000 for the year ended December 31, 1997 from
$42,095,000 for the year ended December 31, 1996, an increase of $26,195,000, or
62.2%. Of the $26,195,000 increase, $22,463,000 was attributable to a full
twelve months of 1997 net sales generated by the Georgetown Collection and Magic
Attic Club product lines that were acquired in October of 1996. The comparative
1996 year included approximately two and one half months of revenues of the
Georgetown Collection and Magic Attic Club lines totaling $12,162,000. The
remaining balance of the increase in sales for 1997 of $3,732,000 consists of an
increase in fashion jewelry sales of $5,902,000, offset by net decreases in
celebrity-driven collectible doll, bear and other consumer products and fine
jewelry sales of $2,094,000 and $76,000, respectively. The increases in fashion
jewelry sales were primarily attributed to the inclusion of a full twelve months
of sales in 1997, versus approximately six months of sales in 1996. The Company
acquired the fashion and fine jewelry subsidiaries in June of 1996.

Gross Profit

Gross profit increased to $37,500,000 for the year ended December 31, 1997 from
$20,644,000 for the year ended December 31, 1996, an increase of $16,856,000, or
81.7%. As a percentage of net sales, gross profit increased to 54.9% in 1997
from 49.0% in 1996. The improvement of 5.9% in gross profit as a percentage of
net sales was primarily attributable to the inclusion in 1997 of a full year of
activity of Georgetown Collection and Magic Attic Club lines. The gross profit
margins generated by the collectible doll sales of Georgetown Collection and the
Magic Attic Club lines were 67.6% during 1997 while the Company's fashion and
fine jewelry lines generated gross profit margins of approximately 40% in 1997.
The net sales generated by the Georgetown Collection and Magic Attic Club lines
which are distributed through catalogs, print advertisements and direct mail
aimed at consumers, will result in higher gross margins than the Company's
historical margins. Approximately one half of the Company's net sales, excluding
the portion contributed by Georgetown Collection and Magic Attic Club lines,
come from wholesale sales that typically carry lower gross margins than do
retail sales. Therefore, the Company's gross profit percentage will vary
depending on the volume of catalog, print advertisement, and direct response
sales in any particular quarter. Correspondingly, should the majority of the
Company's sales come from fine and costume jewelry sales in any period, the
Company's gross profit percentage will be lower due to lower historical margins
associated with wholesale jewelry sales. In the future, the Company expects its
direct response sales to make up a large percentage of its annual sales.



                                       13
<PAGE>   16

Advertising expense

Advertising expense increased to $10,926,000 for the year ended December 31,
1997 from $4,882,000 for the year ended December 31, 1996, an increase of
$6,044,000, or 123.8%. The increase is due primarily to the inclusion in 1997 of
a full year of activity of the Company's direct response lines, Georgetown
Collection and Magic Attic Club. The comparative 1996 year included
approximately two and one half months of activity from the Georgetown Collection
and Magic Attic Club lines. The Company will continue to incur significant
advertising expense through its direct response business. While the Company
enjoys higher gross margins on direct response sales, substantial advertising
expense is incurred in generating direct response sales. The Company will
continue to focus in 1998 on improving returns from advertising dollars spent.
Included in advertising expense are advertisement printing costs, catalog
printing costs, media space in magazines, postage on mailings, infomercial
costs, and advertisement development costs.

Selling, general and administrative expenses

Total selling, general and administrative expenses increased to $28,616,000 for
the year ended December 31, 1997 from $11,912,000 for the year ended December
31, 1996, an increase of $16,704,000, or 140.2%. The $16,704,000 increase is
primarily due to the inclusion of a full year of activity in 1997 from the
Company's 1996 acquisitions of the Georgetown Collection and Magic Attic Club
product lines and fashion and fine jewelry lines. All of the acquisitions were
completed in the second half of 1996. Therefore, the 1996 comparative base did
not include a full year of activity of the entities which were included in 1997.
As a result of the acquisitions completed in 1996, $661,000 of goodwill
amortization is included in 1997 selling, general and administrative expenses .
Further impacting selling, general, and administrative expenses were higher
variable selling costs for royalties and commissions which increased
proportionately to the increase in net sales from 1997 over 1996. The Company
also experienced increases in overhead costs such as higher personnel costs,
higher legal and public relations costs and higher operating costs associated
with the Company's new headquarters in California and its jewelry facility in
Thailand. In addition, the Company has incurred higher travel and lodging costs
due to its expansion of operations into southeast Asia. The percentage of
revenues represented by selling, general and administrative expenses increased
from 28.3% in 1996 to 41.9% in 1997. The Company also incurs general and
administrative expenses in connection with overseeing its investment division
that includes investments in Pure Energy Corporation, Ontro, Inc., and Arkenol
Asia, Inc.

Equity in loss of investee companies

Equity in loss of investee companies increased to $1,857,000 in 1997 from
$629,000 in 1996, an increase of $1,228,000. Equity in loss of investee
companies represents the Company's percentage share of losses, accounted for
under the equity method of accounting, incurred by entities in which the Company
has a greater than 20% percentage ownership, and has the ability to influence
the business decisions of the investee companies.

Other income (expense)

Other income (expense) increased to $3,316,000 for the year ended December 31,
1997 from $(62,000) for the year ended December 31, 1997, an increase of
$3,378,000. The increase of $3,378,000 is primarily comprised of $1,280,000 of
net gains realized by Thailand-based subsidiaries in foreign currency exchanges,
$1,710,000 gain on the sale of shares in Pure Energy Corporation, an investment
held by the Company, offset by losses on infomercial marketing joint ventures.

Interest expense

Interest expense increased to $4,831,000 for the year ended December 31, 1997
from $1,205,000 for the year ended December 31, 1996, an increase of $3,626,000.
Included in the $4,831,000 of 1997 interest expense is $3,099,000 of noncash
charges in the form of noncash conversion discounts associated with the
Company's convertible debenture financings which occurred in September of 1996
and 1997 and a restructuring charge of $1,899,000 in February of 1997 incurred
to refinance the remaining convertible debenture completed in the September 1996
offering. The noncash conversion discount of 10% on conversions of convertible
debt into 



                                       14
<PAGE>   17

common stock is charged as interest expense. The total conversion discount
charged as interest expense in 1997 totaled $644,000. The remaining balance of
interest expense includes $1,732,000 of interest on borrowings from working
capital lines of credit, mortgages on buildings owned by the Company, and
interest paid in cash on the remaining balance of the September 1996 convertible
debentures.

Net Income (Loss)

As a result of the above, net loss increased to $4,376,000 for the year ended
December 31, 1997 from net income of $1,372,000 for the year ended December 31,
1996, a decrease of $5,748,000. The Company's Thailand-based fine jewelry
operations enjoy lower operating costs and overhead and thus generate a higher
percentage of operating income relative to sales than do the Company's domestic
operations. The savings in labor pool and overhead is accomplished by its
location in southeast Asia, where labor and operating costs are typically less
expensive than in the United States.

Liquidity and Capital Resources

The Company has financed its operations from internally generated cash flow,
short-term borrowings and equity financings. As of December 31, 1997 the Company
had working capital of $13,879,000. Working capital has decreased slightly from
$15,702,000 at December 31, 1996.

Throughout 1997, the Company has continued to invest most of the funds generated
from operations and raised in the convertible debenture financing by further
capitalizing its subsidiaries and developing new product categories.

In February 1997, the Company restructured its convertible debentures which had
an unconverted balance of $10,850,000 prior to restructuring. The Company
reached an agreement with the Debenture holders to tender all of the outstanding
Debentures to the Company in exchange for new convertible Debentures (the "New
Debentures"). Under the terms of the agreement, the New Debentures were issued
with a face value of 117.5% of the unconverted balance of the tendered
debentures. The New Debentures are convertible into common stock at the option
of the holder at a fixed price of $8.00 per share. The New Debentures must be
converted by January 1999. As a result of the 17.5% premium given as an
inducement to the Debenture holders to tender the original debentures into New
Debentures, the Company recorded a noncash charge of $1,899,000 in the first
quarter of 1997. As of December 31, 1997, the principal balance outstanding on
the New Debentures was $4,900,000.

The Company has obtained a $20,000,000 line of credit with BankBoston which
replaced existing bank lines of credit to be used for working capital purposes.
The line contains terms and restrictions that are standard to asset-based
lending arrangements. As of December 31, 1997, the Company had borrowings of
$3,650,000 and availability to borrow of $4,271,000 on the line of credit.
Approximately 16% of the Company's 1997 inventory purchases were financed by its
significant customer, which provides a direct or transferable letter of credit
with its purchase orders. The Company is materially dependent on the financing
offered by the customer in order to meet certain orders placed by the customer.

Cash flow used in operations was $2,399,000 due to increases in inventory,
prepaids, and other assets associated with the acquisitions of Georgetown
Collection, Inc., Krasner Group, Inc., Harlyn International, Ltd., and L.L.
Knickerbocker (Thai) Company, Ltd and by decreases in accounts payable and other
accrued expenses. The current ratio for the Company increased from 1.76 at
December 31, 1996 to 1.98 at December 31, 1997. The increase in the Company's
current ratio is primarily attributed to the capital raised from the convertible
debenture offering completed in 1997 and by decreases in accounts payable and
other current liabilities.

Cash used in investing activities was $3,743,000 and $8,249,000 in 1997 and
1996, respectively. Cash paid for acquisition of property, plant and equipment
in 1997 was $2,778,000 compared to $2,018,000 in 1996. The increase in capital
expenditures in 1997 was primarily due to the 1997 purchase of a jewelry
showroom and office in Bangkok, Thailand and increased investment in the
Company's computer systems. Cash paid for investments in 1997 totaled $965,000
and was primarily comprised of advances to Arkenol Asia, Ltd. Cash paid for
investments in 1996 totaled $3,329,000, primarily representing the Company's
investments in Pure Energy Corporation and 



                                       15
<PAGE>   18

Ontro, Inc. During 1996 the Company paid $2,902,000 in connection with the
acquisition of various companies as described in Note 2 to the Consolidated
Financial Statements.

Cash provided by financing activities was $2,923,000 and $11,931,000 in 1997 and
1996, respectively. Proceeds from issuance of convertible debentures, net of
cash paid for deferred issuance costs, was $4,635,000 in 1997 compared to
$14,731,000 in 1996. Net payments on the Company's line of credit decreased from
$5,025,000 in 1996 to $3,358,000 in 1997. During 1997 and 1996 the Company
received proceeds of $793,000 and $2,380,000, respectively, from the exercise of
stock options and warrants. The Company does not anticipate material capital
expenditures for its existing operations in the next 12 months.

Based on current plans and business conditions the Company expects that its
cash, investments and/or available borrowings under its line of credit together
with any amounts generated from operations will be sufficient to meet the
Company's cash requirements for at least the next 12 months. However, there can
be no assurance that the Company will not be required to seek other financing
sooner or that such financing, if required, will be available on terms
satisfactory to the Company.

Seasonality and Quarterly Results

The Company's business is subject to seasonal fluctuations. Georgetown
Collection, Inc., which was acquired effective October 18, 1996, has
historically experienced greater sales in the latter portion of the year.
Because of the seasonality of the Company's business, results for any quarter
are not necessarily indicative of the results that may be achieved for the full
fiscal year.

YEAR 2000 MATTERS

The Year 2000 Issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
computer programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.

The Company has initiated a conversion from existing accounting software to
programs that are year 2000 compliant. Management has determined that the year
2000 issue will not pose significant operational problems for its computer
systems.

The Company will utilize both internal and external resources to reprogram, or
replace, and test the software for Year 2000 modifications. The Company
anticipates completing the Year 2000 project within one year but not later than
October 31, 1999, which is prior to any anticipated impact on its operating
systems. In the third quarter of 1998 the Company decided to outsource a key
data processing function which reduced the Company's estimate of the total cost
of the Year 2000 project to $200,000, which is being funded through operating
cash flows and lease financing. 

The costs of the project and the date on which the Company believes it will
complete the Year 2000 modifications are based on management's best estimates,
which were derived utilizing numerous assumptions of future events, including
the continued availability of certain resources, third party modification plans
and other factors. However, there can be no guarantee that these estimates will
be achieved and actual results could differ materially from those anticipated.
Specific factors that might cause such material differences include, but are not
limited to, the availability and cost of personnel trained in this area, the
ability to locate and correct all relevant computer codes, and similar
uncertainties.

New accounting pronouncements

In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income,
effective for fiscal years beginning after December 15, 1997. This Statement
requires that all items that are required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements. This Statement further requires that an entity




                                       16
<PAGE>   19
display an amount representing total comprehensive income for the period in that
financial statement. This Statement also requires that an entity classify items
of other comprehensive income by their nature in a financial statement. For
example, other comprehensive income may include foreign currency items, minimum
pension liability adjustments, and unrealized gains and losses on certain
investments in debt and equity securities. Reclassification of financial
statements for earlier periods, provided for comparative purposes, is required.
Based on current accounting standards, this Statement is not expected to have a
material impact on the Company's consolidated financial statements. The Company
will adopt this accounting standard effective January 1, 1998, as required.

         In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments
of an Enterprise and Related Information, effective for fiscal years beginning
after December 15, 1997. This Statement establishes standards for reporting
information about operating segments in annual financial statements and requires
selected information about operating segments in interim financial reports
issued to shareholders. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. Operating
segments are defined as components of an enterprise about which separate
financial information is available that is evaluated regularly by the chief
operating decision maker in deciding how to allocate resources and in assessing
performance. This Statement requires reporting segment profit or loss, certain
specific revenue and expense items and segment assets. It also requires
reconciliations of total segment revenues, total segment profit or loss, total
segment assets, and other amounts disclosed for segments to corresponding
amounts reported in the consolidated financial statements. Restatement of
comparative information for earlier periods presented is required in the initial
year of application, at which time comparative information is required. The
Company has not determined the impact that the adoption of this new accounting
standard will have on its consolidated financial statement disclosures. The
Company will adopt this accounting standard effective January 1, 1998, as
required.

Forward-Looking Statements

When used in this document, the words "believes", "anticipates", "expects" and
similar expressions are intended to identify in certain circumstances
forward-looking statements. Such statements are subject to a number of risks and
uncertainties that could cause actual results to differ materially from those
projected, including risks related to the dependence on sales to QVC the
acceptance in the marketplace of new products; the ability to source raw
materials at prices favorable to the Company; currency fluctuations; and other
risks outlined in the Company's previously filed public documents, copies of
which may be obtained without cost from the Company. Given these uncertainties,
prospective investors are cautioned not to place undue reliance on such
statements. The Company also undertakes no obligation to update these
forward-looking statements.

ITEM 7.  FINANCIAL STATEMENTS

The Financial Statements of the Company identified in the Index to Financial
Statements appearing under ITEM 13, EXHIBITS AND REPORTS ON FORM 8-K of this
report are included herein on pages 33 to 56.



ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.



                                       17
<PAGE>   20

                                                      PART III

ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
           COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT

The directors and executive officers of the Company are as follows:

<TABLE>
<CAPTION>
Name                                  Age      Position
----                                  ---      --------
<S>                                   <C>      <C>
    Louis L. Knickerbocker            57       Chief Executive Officer, President and
                                               Chairman of the Board

    Robert L. West, Jr.               39       Chief Operating Officer

    Tamara Knickerbocker              34       Executive Vice President and Director

    Anthony P. Shutts                 34       Chief Financial Officer and Director

    Gerald A. Margolis                68       Director

    William R. Black                  45       Vice President, General Counsel, Secretary and
                                               Director

    F. Rene Alvarez                   59       Director
</TABLE>

All directors hold office until the next meeting of the shareholders of the
Company and until their successors are qualified and elected. Executive officers
of the Company are appointed by the Board of Directors and serve at the
discretion of the Board. All executive officers devote full time to the Company.

MR. LOUIS L. KNICKERBOCKER, CHIEF EXECUTIVE OFFICER, PRESIDENT, AND CHAIRMAN

Mr. Knickerbocker, 57, is the founder and Chairman, President, and Chief
Executive Officer of the Company. He received an AA degree in 1964 from Santa
Monica College with a major in medicine and a minor in economics. From 1965
through 1974 Mr. Knickerbocker worked as a salesman and sales supervisor at M.
Cooper & Son, purchased and sold several liquor stores, and acquired and sold a
total of seven restaurants, four of which comprised a chain of Mexican
restaurants. Between 1974 and 1985, he acted as a private investor and
businessman, investing in real estate and purchasing and selling small
businesses. Mr. Knickerbocker also serves on the Boards of Directors of Pure
Energy Corporation, Ontro, Inc. and Arkenol Asia, Inc.

Mr. Knickerbocker and his wife, Tamara, Executive Vice President of the Company,
formed the Company as International Beauty Supply in 1985, co-founded LaVie
Cosmetics with Michael Elam and comedienne, Phyllis Diller in 1987, co-founded
another company, MLF Enterprises, in 1989 with Michael Elam and Farrah Fawcett
and, in 1990, the Knickerbockers formed Knickerbocker Creations, Ltd. and began
developing the celebrity driven products which are now part of The L. L.
Knickerbocker Co., Inc.

MR ROBERT L. WEST, JR., CHIEF OPERATING OFFICER

Mr. West, 39, joined the Company in February 1997 as acting interim president of
Georgetown Collection, Inc. He assumed the position of Chief Operating Officer
in January 1998. Mr. West has over 16 years experience in consulting, finance
and administration, specializing in direct marketing companies. He holds a BSBA
in Management and Finance from the University of North Carolina, and has
completed graduate work in Organizational Dynamics and Leadership at the
University of Pennsylvania. Mr. West is a member of the American Management
Association, the American Financial Association, the Institute of Management
Accountants, the World Affairs Council and is listed in several Who's Who
publications.

Mr. West has provided services relating to both finance and administration to
companies in the United States and



                                       18
<PAGE>   21

abroad. From 1981 to 1984, he worked as Division Controller for Royster Company
in Norfolk, Virginia. He was Manager of Financial Analysis for Rohm and Haas
Company in Philadelphia, Pennsylvania from 1984 to 1987. Mr. West was the Head
of European Operations for the Franklin Mint, headquartered in London, England,
from 1987 to 1990. From 1990 to 1991, he served as Consultant to the Chief
Executive Officer of J. Crew Group in New York, New York, and Consultant and
Vice President of Finance and Operations for Paradise Galleries, Inc. in San
Diego, California. Mr. West was Vice President and Chief Financial Officer of
Georgetown Collection, Inc. in Portland, Maine from 1991 to 1995, and Vice
President of Worldwide Operations for Quantum North America from 1995 to 1996.

MS. TAMARA KNICKERBOCKER, EXECUTIVE VICE PRESIDENT, DIRECTOR

Ms. Knickerbocker, 34, has been with the Company as Vice President since its
inception. In January 1998 she was appointed to the board of directors. She has
over 10 years experience in the field of direct marketing. In 1985, Ms.
Knickerbocker helped to form the Company as International Beauty Supply, and
thereafter LaVie Cosmetics, MLF Enterprises and Knickerbocker Creations, Ltd.
Since 1985, she has worked to develop and market products and programs for the
home shopping industry. Her focus has mainly been the creation and development
of the products, and she has emphasized collectibles.

Ms. Knickerbocker is currently managing all aspects of the Marie Osmond Doll
Collection program, including product and program development, production,
marketing and sales. In addition, she also oversees the other collectible
programs, including the collectable bears. She has had primary responsibility
for the profitability and diversity of the collectible lines and is currently
coordinating expansion in these programs.

MR. ANTHONY P. SHUTTS, C.P.A., CHIEF FINANCIAL OFFICER, DIRECTOR

Mr. Anthony P. Shutts, 34, was hired as a consultant to the Company on April 1,
1993 and became Chief Financial Officer of the Company on June 30, 1993. Mr.
Shutts became a full time employee of the Company on April 1, 1996. He is a
certified public accountant with over 10 years experience in public accounting,
specializing in emerging companies. Mr. Shutts holds a masters degree in
taxation from the University of Southern California. Currently, Mr. Shutts
serves as Chief Financial Officer of the Company, overseeing the financial
records preparation and reporting, and performing the general functions of CFO.
From 1993 to 1996, Mr. Shutts maintained a private accountancy and financial
consulting practice. Prior to his private practice, he worked as Business
Manager with Breslauer, Jacobson, Rutman & Sherman from 1992 to 1993 and with
Allen, Haight & Schurawel as a Senior Accountant from 1991 to 1992. Mr. Shutts
worked with Deloitte & Touche as a Senior Consultant from 1986 to 1991.

MR. GERALD A. MARGOLIS, DIRECTOR

Mr. Margolis, 68, was appointed to the Board of Directors in June 1994, and
served as Secretary of the Company from June 1994 until June 1995. He graduated
from U.C.L.A. Law School in 1954 and has been a licensed attorney in private
practice and a member of the California State Bar since 1955. Mr. Margolis was a
City Council member of the Culver City Counsel from 1962 to 1966. Mr. Margolis
has advised the Company on general corporate matters since its inception in
1985.

MR. WILLIAM R.  BLACK, VICE PRESIDENT, GENERAL COUNSEL, SECRETARY AND DIRECTOR

Mr. Black, 45, was appointed to the Board of Directors in November 1995. He
joined the Company as Vice President and General Counsel in April 1997, and was
appointed Secretary in January 1998. Mr. Black received a BSBA in Business from
the University of Denver in 1978, an MBA from the University of Denver in 1981
and a Juris Doctor from Western State University College of Law in 1987. Mr.
Black is a licensed attorney and a member of the California State Bar, the
Federal District Courts for the Central and Northern Districts of California and
the Ninth Circuit Court of Appeals. He holds a California Real Estate Broker's
license and is a member of the American Bar Association, the Orange County Bar
Association, the American Management Association, the American Employment Law
Council, the Professionals in Human Resources Association, the American
Corporate Counsel Association and has been listed in numerous Who's Who
publications from 1984 to 



                                       19
<PAGE>   22

the present.

Mr. Black worked as an Area Manager for Deere & Company from 1979 through 1984,
Director of Analysis for Management Resource Services Company from 1984 through
1985, and Senior Vice President of Geneva Corporation from 1985 through 1990.
From 1991 through 1997, he maintained a private law practice and served as Vice
President and General Counsel of Sunclipse, Inc. in Buena Park, California. Mr.
Black also serves on the Boards of Directors of Pyraponic Industries, Inc. in
San Diego, California; American Employer Defense, Inc. in Los Angeles,
California, and Arkenol Asia, Inc. in Lake Forest, California.

MR. F. RENE ALVAREZ, JR., DIRECTOR

Mr. Alvarez, 59, was appointed to the Board of Directors in May 1997. Mr.
Alvarez has been the Senior Vice President, Finance of the Pacific Bay Homes
subsidiary of Ford Motor Company since 1995. He worked as a member of the
finance staff for Ford Motor Company from 1969 to 1989, as Director of Internal
Audit for the USL Capital subsidiary of Ford Motor Company from 1989 to 1994 and
as Audit Manager, Finance Staff, for Ford Financial Services Group from 1994 to
1995. Mr. Alvarez attained the rank of Captain in the United States Army, and
was awarded the Bronze Star for service in Vietnam. He received a BS,
Accounting, from Canisius College in 1962 and a Juris Doctor and LLB from State
University of New York at Buffalo in 1967. Mr. Alvarez is a licensed attorney
and a member of the New York State Bar.



                                       20
<PAGE>   23

ITEM 10.  EXECUTIVE COMPENSATION

<TABLE>
<CAPTION>
                                                              Annual Compensation
                                                              -------------------
Name and Principal Fiscal                Fiscal                                                 Long Term
Position                                  Year              Salary              Bonus          Compensation         All Other
Compensation (1)                        ---------          ---------          ---------        ------------         ---------
----------------
<S>                                     <C>                <C>                <C>              <C>                  <C>

Louis L. Knickerbocker,                      1997          $ 300,000          $ 200,000                N/A            500,000
   CEO                                       1996          $ 300,000                N/A                N/A                N/A
                                             1995          $ 175,000          $ 175,000                N/A            500,000

Robert L. West, Jr                           1997                N/A                N/A                N/A                N/A
   COO                                       1996                N/A                N/A                N/A                N/A
                                             1995                N/A                N/A                N/A                N/A

Tamara Knickerbocker                         1997          $  80,000          $  50,000                N/A              2,216
   Executive Vice President                  1996          $  80,000                N/A                N/A             12,362
                                             1995          $  75,000                N/A                N/A                N/A

Anthony Shutts                               1997          $ 120,000          $  72,939                N/A            205,000
   CFO                                       1996          $ 110,000                N/A                N/A                N/A
                                             1995          $  63,046                N/A                N/A             50,000

William R. Black                             1997          $ 109,038                N/A                N/A            250,000
    General Counsel, Secretary               1996                N/A                N/A                N/A             10,000
                                             1995                N/A                N/A                N/A            108,750
</TABLE>

--------------------------------------------------------------------------------


(1) All Other Compensation consists of stock options granted under the Company's
Stock Option Plans to each of the Named Executive Officers. Reflected amounts
consist of the number of options to purchase the Company's common stock.


DIRECTORS FEES

Directors receive a fee of $500 per meeting attended and reasonable travel
expenses.


EMPLOYMENT AGREEMENTS

The Company entered into employment agreements with Louis L. Knickerbocker, its
President, Anthony P. Shutts, its CFO, Tamara Knickerbocker, its Executive Vice
President, Grant King, President of L.L.Knickerbocker (Thai) Co., Inc., and
Martin Krasner, President of Krasner Group, Inc. in 1996. On April 1, 1997, the
Company entered into an employment agreement with William R. Black, Vice
President and General Counsel. The respective terms of the employment agreements
are five years each. The agreements are subject to early termination by the
Company under certain conditions, including breach of the agreement, fraud by
the employee, and/or breach of fiduciary duty owed to the Company by the
employee. The Company has the right to 



                                       21
<PAGE>   24

extend the terms of the employment agreements for an additional five years each
upon written notice to the employees. Under terms of the agreements, each of the
employees agrees to devote his or her full time and effort to the business
affairs of the Company and to use his or her best efforts to promote the best
interests of the Company.

Except for the provisions of the Stock Option Plans, there are no compensatory
plans or arrangements with respect to any of the Named Executive Officers which
are triggered by, or result from, the resignation, retirement or other
termination of such executive officer's employment, a change-in-control of the
Company or a change in the executive officer's responsibilities following a
change-in-control.

During the first year, the employment agreements called for Louis L.
Knickerbocker to receive an annual base salary of $300,000, for Anthony Shutts
to receive an annual base salary of $120,000, for Tamara Knickerbocker to
receive an annual base salary of $80,000, for Grant King to receive an annual
base salary of $140,000, for Martin Krasner to receive a base annual salary of
$225,000, and for William R. Black to receive an annual base salary of $150,000.
In addition to their respective base salaries, Mr. Knickerbocker, Mr. Shutts,
Ms. Knickerbocker and Mr. Black are eligible to receive an annual bonus in an
amount to be determined by a compensation committee and ratified by the Board of
Directors out of a Management Bonus Fund up to a maximum of 10% of the operating
profits of the Company and are entitled to receive certain stock options from
the Stock Option Plans previously adopted by the Company. See "Stock Option
Plans."


STOCK OPTION PLANS

THE L. L. KNICKERBOCKER 1995 AMENDED AND RESTATED STOCK OPTION PLAN

The shareholders approved and the Company adopted a Stock Option Plan on
September 27, 1994 which was amended and restated on June 15, 1995 as the L. L.
Knickerbocker 1995 Amended and Restated Stock Option Plan (the "Plan"). The Plan
is administered by a committee appointed by the Board of Directors and provides
that options may be granted at exercise prices determined by the Board of
Directors in its sole discretion. The Plan is designed as an incentive for
employees, non-employee directors and persons providing services of special
importance to the Company. Unless otherwise specified, the options expire ten
years from the date of grant. The Plan covered an aggregate of 400,000 shares
when granted, which was increased by the five-for-one stock split to a total of
2,000,000 shares. As of the date of this Report, 400,000 pre-split options have
been granted pursuant to the Plan, which has been increased by the five-for-one
stock split to a total of 2,000,000 options granted.

THE L.L. KNICKERBOCKER STOCK INCENTIVE COMPENSATION PLAN

On March 27, 1997, the Company's Board of Directors adopted the L.L.
Knickerbocker Stock Incentive Compensation Plan (the ISO Plan). The ISO Plan was
approved by the vote of the shareholders of the Company in June 1997. The ISO
Plan provides that incentive and nonstatutory options to purchase a total of
5,000,000 shares of common stock may be granted thereunder. The ISO Plan permits
the granting of options intended to qualify as "incentive stock options"
("ISO's") within the meaning of Section 422 of the Internal Revenue Code of
1986, as amended from time to time (the "Code"), the granting of options that do
not so qualify ("NSO's"), and the granting of stock appreciation rights (SAR's).
The Plan is administered by the Board of Directors, or if the Board so elects,
by a committee appointed by the Board of Directors consisting of not less than 2
members of the Board (the "Administrator"). The Administrator has the power to
determine the employees to be granted options and the number of shares to be
granted to each optionee and to interpret the ISO Plan.

The exercise price of any option is established by the Administrator at the time
of grant. The exercise price of any NSO's or ISO's granted under the Plan may
not be less than 100% of the fair market value of one share of common stock on
the date of grant. The exercise price of any ISO granted to an optionee who owns
stock possessing more than 10% of the voting rights of the Company's outstanding
shares must be at least 110% of the fair market value of the shares subject to
the option on the date of grant. So long as the Company's common stock is traded
on the NASDAQ National Market System, the fair market value of one share of
common stock is the closing bid price on the date of valuation.



                                       22
<PAGE>   25

The purchase price is payable in full in United States dollars or by certified
check upon the exercise of the option, provided however, that if the applicable
option agreement so provides, or the Administrator, in its sole discretion
otherwise approves thereof, the purchase price may be paid, (i) by the surrender
of shares of the Company's common stock owned by the person exercising the
option and having a fair market value on the date of exercise equal to the
purchase price, or (ii) in any combination of cash and common stock of the
Company, as long as the sum of the cash so paid and the fair market value of the
common stock so surrendered equals the purchase price. Additionally, if the
optionee is granted SAR's, either in the stock option agreement or in a separate
agreement, such SAR's may be exercised with the exercise of the options to
permit the Company to issue common stock with a fair market value equal to the
difference between the exercise price of one option and the fair market value of
one share of common stock on the date of exercise, multiplied by the total
number of options exercised.

NSO's and ISO's have maximum terms of 10 years. The aggregate fair market value
(determined as of the time the option is granted) of stock for which ISO's are
exercisable for the first time by an optionee during any calendar year may not
exceed $100,000, but the value of stock for which ISO's may be granted to an
Optionee in a given year may exceed $100,000.

In general, if an optionee ceases service to the Company or one or more of its
subsidiary Companies because of death or disability, options shall not be
exercised after the earlier of (i) the term of the option or (ii) twelve months
after the optionee's cessation of service, and such options shall only be
exercisable to the extent vested on the date of cessation of service. If an
optionee is discharged on account of misconduct, all options terminate
immediately and are no longer exercisable. If an optionee ceases service for any
other reason, options shall not be exercised after the earlier of (i) the term
of the option or (ii) three months after the optionee' s cessation of service,
and such options shall only be exercisable to the extent vested on the date of
cessation of service. Options are, during the lifetime of the optionee,
exercisable only by him or her and may not be assigned or transferred other than
by will or by the laws of descent and distribution.

The ISO Plan provides that in the event a "Change in Control" of the Company
should occur, then the exercise dates of all options granted pursuant to the ISO
Plan shall automatically accelerate and all options granted pursuant to the ISO
Plan shall become exercisable in full. To the extent the Internal Revenue Code
would not permit any ISO to be so accelerated, then such option, immediately
upon the occurrence of such Change in Control shall be treated for all purposes
of the Plan as a NSO and shall be immediately exercisable. A "Change in Control"
is defined in the Plan as a change in control of a nature that would be required
to be reported in response to Item I of Form S-K required to be filed pursuant
to the Securities Exchange Act of 1934, as amended ("1934 Act"), and includes,
without limitation if: (i) the Company shall sell, transfer, or otherwise
dispose of fifty percent (50%) or more of its assets and properties (calculated
on the basis of book value); or (ii) any "person" (as such term is used in
Section 13(d) and 14(d) of the 1934 Act), other than the Company, is or becomes
the "beneficial owner" (as defined in Rule 13d-3 under the 1934 Act), directly
or indirectly, of securities of the Company representing 20% or more of the
combined voting power of the Company's then outstanding securities; or (iii)
during the period of two consecutive years during the term of the ISO Plan,
individuals who at the beginning of such period constitute the Board cease for
any reason to constitute at least a majority thereof, unless the election of
each director who was not a director at the beginning of such period has been
approved in advance by directors representing at least two-thirds of the
directors then in office who were directors at the beginning of the period.

The Board may from time to time, with respect to any shares at the time not
subject to options, suspend or discontinue the ISO Plan or revise or amend it in
any respect whatsoever except that, without the approval of the Company's
shareholders, no such revision or amendment shall increase the number of shares
subject to the ISO Plan or change the classes of persons eligible to receive
options. Options may be granted pursuant to the ISO Plan until the expiration of
the Plan on March 27, 2007.



                                       23
<PAGE>   26

OPTIONS GRANTED

The following table sets forth information concerning the grant of stock options
during the fiscal year ended December 31, 1997 to each of the Named Executive
Officers.

            OPTION GRANTS IN THE FISCAL YEAR ENDED DECEMBER 31, 1997

<TABLE>
<CAPTION>
                                             Individual Grants (1)
                              -------------------------------------------------
                                               Percent of
                                              Total Options                                               Potential Realizable
                                                Granted to                                                  Value at Assumed
                                                Employees         Exercise or                                Annual Rates of
                                Options         in Fiscal         Base Price         Expiration          Stock Price Appreciation
Name                            Granted        Year 1997(2)      (per share)(3)        Date(4)               for Option Term
----                          ----------      -------------      --------------      ----------        ----------------------------
                                                                                                         5% (5)            10%(5)
                                                                                                       ----------        ----------
<S>                           <C>               <C>                <C>               <C>               <C>               <C>       
Louis L. Knickerbocker           500,000          39.50%             $5.08              2002            $701,755         $1,550,695
Tamara Knickerbocker               2,216           0.17%             $5.87              2002            $  3,594         $    7,941
Anthony P. Shutts                205,000          16.10%             $4.62              2007            $261,666         $  578,214
William Black                    250,000          19.70%             $4.62              2007            $319,105         $  705,139
</TABLE>

(1)     These options were granted pursuant to the Company's Stock Option Plan.
(2)     In fiscal 1997, 1,265,617 options were granted pursuant to the Company's
        Stock Option Plan. This number was used in calculating the percentages
        in the above table.
(3)     All exercise prices are set at 100% of the market value of the Company's
        stock as of the date of grant, except Louis L. Knickerbocker, whose
        options were granted at 110% of the market value of the Company's stock
        on the date of grant.
(4)     The Options granted as ISO's under the Company's Stock Option Plan
        expire on the fifth anniversary of the date of grant.
(5)     The assumed 5% and 10% annual rates of appreciation over the term of the
        options are set forth in accordance with rules and regulations adopted
        by the Securities and Exchange Commission and do not represent the
        Company's estimate of stock price appreciation.

OPTIONS EXERCISED AND FISCAL YEAR-END VALUES

The following table provides information with respect to the exercise of stock
options during the most recently completed fiscal year by the Named Executive
Officers of the Company together with the fiscal year-end value of unexercised
options.



                                       24
<PAGE>   27

                     Aggregated Option/SAR Exercises in Last
               Fiscal Year and Fiscal Year-End Option/SAR Values

<TABLE>
<CAPTION>
                                                                    Number of securities 
                                                                   underlying unexercised             Value of unexercised in-the-
                                                                options/SARs at fiscal year-end       money options/SARs at fiscal
                                                                               (#)                           year-end ($) (1)
                               Shares
                             acquired on      Value realized
Name                         exercise (#)        ($) (1)         Exercisable       Unexercisable     Exercisable      Unexercisable
------------------------------------------------------------------------------------------------------------------------------------
<S>                          <C>              <C>                <C>               <C>               <C>              <C>
Louis L. Knickerbocker           200,000        $1,050,000           500,000                --        $  272,500                -- 
Tamara Knickerbocker                  --                --            12,362             2,216                --        $      754
Anthony P. Shutts                     --                --           155,000            50,000           155,775            50,250
William Black                         --                --           160,000           100,000           150,750           100,500
</TABLE>


(1) Market value of the securities underlying the "in-the-money" options at
exercise date or year-end, as the case may be, minus the exercise price of such
options.



                                       25
<PAGE>   28

ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

PRINCIPAL SHAREHOLDERS

The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of December 31, 1997 by (i) each
director of the Company, (ii) the CEO of the Company and the four most highly
compensated executive officers of the Company whose annual salary and bonus
compensation exceeded $100,000, (iii) all directors and executive officers as a
group, and (iv) each person known to the Company to own beneficially more than
5% of the outstanding shares of Common Stock:

<TABLE>
<CAPTION>
Name and Address of                            Amount and Nature         Percent
Beneficial Owner (1)                             of Ownership            of Class
--------------------                             ------------            --------
<S>                                            <C>                       <C>  
Louis L. Knickerbocker                             4,292,392               22.8%
Tamara Knickerbocker                               3,446,979               18.3%
Anthony P. Shutts                                    205,400                1.0%
Gerald Margolis                                      220,000                1.1%
William R. Black                                     290,000                1.5%
F. Rene Alvarez, Jr                                   10,000                  *
Directors and Executive Officers
    as a Group                                            (4)               3.8%
</TABLE>

*       Less than 1.0% of the outstanding common stock as of December 31, 1997.

(1)     The address for all persons listed is 25800 Commercentre Drive Lake
        Forest, CA 92630
(2)     Percentage is based on the 3,792,392 shares currently held of record
        plus options issued by the Company to Mr. Knickerbocker that enables Mr.
        Knickerbocker to currently acquire 500,000 shares of the Company's
        common stock.
(3)     Percentage is based on the 3,432,392 shares currently held of record
        plus options issued by the Company to Ms. Knickerbocker that enables Ms.
        Knickerbocker to currently acquire 14,587 shares of the Company's common
        stock.
(4)     Beneficial ownership of the Directors and Executive Officers as a group
        is based on 190,400 shares currently held of record plus options issued
        by the Company to Directors and Executive Officers to currently acquire
        535,000 shares of the Company's common stock and does not include shares
        owned beneficially by Mr. and Ms. Knickerbocker.


ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

LOAN TO SHAREHOLDER

During 1997, the Company made a loan to its president, Louis L. Knickerbocker,
in the principal amount of $1,383,000. The loan was evidenced by promissory
notes providing for payment of interest at the prime rate plus 2 1/2% per annum
due and payable on demand.

Pursuant to a resolution of the Board of Directors of the Company, passed on
September 27, 1994, any ongoing and future transactions between the Company and
its officers, directors, employees, and affiliates, that are outside the scope
of the Company's employment relationship with such persons will be on terms no
less favorable to the Company than can be obtained from unaffiliated parties.
Any such transactions are subject to the approval of a majority of the
disinterested members of the Board of Directors.



                                       26
<PAGE>   29

AFFILIATED AND PREDECESSOR COMPANIES

The L. L. Knickerbocker Co., Inc. (the "Company") was formed by Louis L.
Knickerbocker, Chairman, President, and Chief Executive Officer of the Company,
and Tamara Knickerbocker, his wife and the Executive Vice President of the
Company, under the name International Beauty Supply, Ltd., a California
corporation ("IBS") in 1985. IBS developed a line of cosmetics called "Orchid
Premium" that was initially marketed to professional beauty supply houses and
subsequently expanded to retail stores.

The Knickerbockers next venture was LaVie Cosmetics, a California corporation
("LaVie"), that the Knickerbockers co-founded with Michael Elam, a former
spokesperson for the Company, and comedienne, Phyllis Diller, in 1987. LaVie
introduced a product named Creme de LaVie in both the I. Magnin and Nordstrom
department stores. In October 1988 Creme de LaVie was introduced on The Home
Shopping Network in Tampa, Florida with Mr. Elam and Ms. Diller live on the air.

In 1989 the Knickerbockers co-founded another company, MLF Enterprises, a
California corporation ("MLF") with Mr. Elam and Farrah Fawcett, a former
director of the Company. MLF developed replicas of Ms. Fawcett's jewelry
collection, which were sold through the television home shopping industry.

The Knickerbockers next formed Knickerbocker Creations, Ltd., a California
corporation ("Creations") in 1990 and began developing the products and
celebrity endorsement programs which are now part of the Company.

In 1993 the directors and shareholders of Creations and IBS determined to effect
an initial public offering in order to finance the continued growth of the
different companies. It was determined that the operations of Creations and IBS
should be consolidated under a single entity in order to facilitate the
contemplated public offering. However, because Creations had been switched from
a "C" corporation to a subchapter "S" corporation in 1990, the directors and
shareholders of the Company were advised that Creations would be an unsuitable
candidate for a public offering.

On May 24, 1993, the directors and shareholders of IBS approved an amendment of
the articles of incorporation of the corporation changing the name of the
corporation from "International Beauty Supply, Ltd." to the Company's current
name, "The L. L. Knickerbocker Co., Inc." The Company's name was chosen to
maximize the retention of the goodwill in the home shopping industry associated
with the name "Knickerbocker" by virtue of Creations' business. The Company then
consummated an asset purchase whereby the operating assets of Creations,
including but not limited to the marketing and distribution rights to the
products and programs of Creations, were acquired along with certain
liabilities. As of the date hereof, all current active contracts of Creations
have been assumed or amended to grant those rights and obligations to the
Company. In connection with the initial public offering of the Company's common
stock completed January 25, 1995, the Directors and shareholders of the Company
approved as of June 15, 1994 a 1990.5 for 1 stock split of its outstanding
common stock, and as of September 27, 1994 a .714 for 1 reverse stock split of
its outstanding common stock.


CONFLICTS OF INTEREST

Mr. Knickerbocker has a current interest in LaVie Cosmetics ("LaVie"), MLF
Enterprises ("MLF"), and Knickerbocker Creations, Ltd. ("Creations"). Each of
these companies has previously developed and marketed products which are in
direct competition with the Company's products. The Company has acquired the
trademark rights and the license to market the products of LaVie, and has
acquired certain operating assets and the operations of Creations. Both LaVie
and Creations are currently inactive, but have not been dissolved.

Mr. Knickerbocker and Ms. Farrah Fawcett, a former director of the Company, both
have a current interest in MLF, which previously developed and marketed a line
of jewelry products directly competitive to certain products that the Company is
currently marketing. The operations of MLF have been discontinued and it is
inactive, however MLF has not been dissolved.




                                       27
<PAGE>   30

Because Mr. Knickerbocker is an officer and director of the Company, his
continuing interest in LaVie, Creations, and MLF pose potential conflicts of
interest, should such corporations become active again in the future, and should
they sell or market products which are competitive with the Company's products,
or should the Company negotiate or enter into any significant transaction or
agreements with those companies, then a conflict of interest will exist. The
Company has received assurances that none of the corporations or individuals
named herein have any intention to compete with the Company or enter into any
transactions or agreements which would present a conflict of interest. There can
be no assurance, however, that such a conflict will not develop.



                                       28
<PAGE>   31


ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

 (a)    EXHIBITS

<TABLE>
<CAPTION>
Exhibit
Number                     Description
------                     -----------

<S>      <C>                                                           
3.1      Articles of Incorporation of International Beauty Supply, Ltd. ("IBS")
         dated July 11, 1985.(1)

3.2      Amendment to Articles of Incorporation of IBS dated May 24, 1993.(1)

3.3      Certificate of Amendment to Articles of Incorporation of The L. L.
         Knickerbocker Company Inc. (the "Company") dated June 20, 1994.(1)

3.4      Certificate of Amendment to Articles of Incorporation of the Company
         dated September 27, 1994.(1)

3.5      Bylaws of the Company.(2)

4.1      Qualified Stock Option Plan adopted by the Company on September 27,
         1994 along with form of Stock Option Agreement.(3)

4.2      Form of Warrant Agreement.(3)

4.3      Form of Representative's Warrant issued to W.B. McKee Securities, Inc.
         upon consummation of the Company's offering on January 25, 1995.(3)

4.4      Form of Common Stock Purchase Warrant issued to Shoreline Pacific, the
         Institutional Finance Division of Financial West Group. (6)

4.5      Form of 7% Convertible Debenture.(6)

10.1     Employment Agreement, dated July 1, 1996, between the Company and Louis
         L. Knickerbocker.(10)

10.2     Employment Agreement, dated July 1, 1996, between the Company and
         Tamara Knickerbocker.(10)

10.3     Employment Agreement, dated July 1, 1996, between the Company and
         Anthony P. Shutts.(10)

10.4     Employment Agreement, dated April 1, 1997, between the Company and
         William R. Black.(11)

10.5     Agreement between Marie, Inc. and the Company dated April 1, 1993 re
         the services of Marie Osmond in the design, production, and sale of
         products and licensing to the Company of the use of Marie Osmond's name
         in conjunction with the Company's products.(3)

10.6     Agreement between Bob Mackie (US), Inc. and the Company dated May 1,
         1994 re the services of Bob Mackie in the design, production and sale
         of products and licensing to the Company of the use of Bob Mackie's
         name in conjunction with the Company's products.(3)

10.7     Agreement between Cello, Inc. and the Company dated May 13, 1994 re
         services of Annette Funicello in the design, development, manufacture
         and the sale of products, with Acceptance by Annette Funicello and
         Cancellation of Prior Agreement dated October 30, 1991 between Cello,
         Inc. and Creations.(3)

10.8     Lease Agreement between the Company and Security Capital Industrial
         Trust for 25800 Commercentre Drive, Lake Forest, CA dated February 15,
         1995.(2)

10.9     Agreement between the Company and Grant King International Co., Ltd.,
         dated November 28, 1995 re the acquisition of 49% of the issued and
         outstanding stock of Grant King International Co., Ltd. (5)

</TABLE>

                                       29
<PAGE>   32


<TABLE>
<S>      <C>                                                           
10.10    Agreement between the Company and Grant King Design Co., Ltd., dated
         November 27, 1995 re the distribution of the jewelry products of Grant
         King Design Co., Ltd. (5)

10.11    Agreement of Purchase and Sale of the Capital Stock of Pure Energy
         Corporation between the Company and Pure Energy Corporation, dated
         February 7, 1996 re the acquisition of 40% of the issued and
         outstanding capital stock of Pure Energy Corporation. (5)

10.12    Letter of intent between Pure Energy Corporation and Biofine, Inc.,
         dated March 3, 1996 re the licensing of the patents of Biofine, Inc.
         (5)

10.13    License Agreement between the Company and SIM-GT Licensing Corp., dated
         May 1, 1995 re the licensing of the name, likeness and trademarks of
         Richard Simmons. (5)

10.14    Exhibit omitted.

10.15    Agreement of Purchase and Sale of the Capital Stock of Krasner Group,
         Inc., dated June 15, 1996 re the acquisition of 100% of the issued and
         outstanding capital stock of Krasner Group,. (7)

10.16    Stock Purchase Agreement dated September 30, 1996, by and among Harlyn
         Products, Inc., Harlyn International Company, Ltd. and the Company.(6)

10.17    First Amendment to Stock Purchase Agreement dated October 15, 1996, by
         and among Harlyn Products, Inc., Harlyn International Company, Ltd. and
         the Company.(6)

10.18    Second Amendment to Stock Purchase Agreement dated November 7, 1996, by
         and among Harlyn Products, Inc., Harlyn International Company, Ltd. and
         the Company.(6)

10.19    Agreement of Purchase and Sale of the Capital Stock of Self Heating
         Container, Inc., dated September 17, 1996 by and between Self Heating
         Container Corporation of California and the Company(10)

10.20    Agreement of Purchase and Sale of the Capital Stock of Insta-Heat,
         Inc., dated September 17, 1996, by and between Insta-Heat, Inc. and the
         Company(10)

10.21    Agreement of Purchase and Sale of the Capital Stock of Georgetown
         Collection, Inc., dated November 20, 1996, By and between Consumer
         Venture Partners I, L.P., Vermont Capital Venture Fund, North Atlantic
         Venture Fund, Merchant Partners and the Company.(8)

10.22    Form of Private Securities Subscription Agreement.(6)

10.23    Form of Registration Rights Agreement.(6)

21.1     Subsidiaries of Registrant.(11)

23.0     Consent of Deloitte & Touche LLP, independent auditors. (11)

27.0     Financial Data Schedule (11)
</TABLE>

----------------------

(1)      Filed as part of Exhibit 3.1 to The L. L. Knickerbocker Company, Inc.
         Form SB-2 Registration Statement No. 33-85230-LA as filed with the
         Securities and Exchange Commission on or about October 13, 1994.

(2)      Filed as an exhibit to the L. L. Knickerbocker Company, Inc. Annual
         Report on Form 10-KSB filed with the Securities and Exchange Commission
         on or about March 29, 1995.


                                       30
<PAGE>   33

(3)      Filed as an Exhibit to The L. L. Knickerbocker Company, Inc. Form SB-2
         Registration Statement No. 33-85230-LA as filed with the Securities and
         Exchange Commission on or about October 13, 1994.

(4)      Filed as Exhibit to The L. L. Knickerbocker Company, Inc. report on
         Form 8-K filed with the Securities and Exchange Commission on or about
         March 21, 1995.

(5)      Filed as an exhibit to The L. L. Knickerbocker Company, Inc. Annual
         Report on Form 10-KSB filed with the Securities and Exchange Commission
         on or about April 15, 1996.

(6)      Filed as an Exhibit to The L. L. Knickerbocker Company, Inc. Form
         10-QSB/A as filed with the Securities & Exchange Commission on or about
         November 27, 1996.

(7)      Filed as Exhibit to The L. L. Knickerbocker Company, Inc. report on
         Form 8-K filed with the Securities and Exchange Commission on or about
         July 3, 1996.

(8)      Filed as Exhibit to The L. L. Knickerbocker Company, Inc. report on
         Form 8-K filed with the Securities and Exchange Commission on or about
         December 5, 1996.

(9)      Filed as an exhibit to The L. L. Knickerbocker Company, Inc. Annual
         Report on Form 10-KSB filed with the Securities and Exchange Commission
         on or about April 15, 1997.

(10)     Filed as an exhibit to The L. L. Knickerbocker Company, Inc. Amended
         Annual Report on Form 10-KSB/A filed with the Securities and Exchange
         Commission on or about August 15, 1997.

(11)     Filed as an exhibit to The L.L. Knickerbocker Company, Inc. Form 10-KSB
         filed with the Securities and Exchange Commission on or about March 31,
         1998.



                                       31
<PAGE>   34

                                                     SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.

                                        The L. L. Knickerbocker Company, Inc.
                                        (Registrant)



Date: September 2, 1998                 By: /s/   Louis L. Knickerbocker
                                            ------------------------------------
                                            Louis L. Knickerbocker
                                            Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.


<TABLE>
<CAPTION>
Signature                                            Title                                                Date
---------                                            -----                                                ----
<S>                                           <C>                                                        <C>


       /s/   Louis L. Knickerbocker           Chief Executive Officer,                                   9/02/98
 ----------------------------------------     President and Chairman                                     -------
         Louis L. Knickerbocker               (Principal Executive Officer)
                                              


     /s/   Anthony P. Shutts                  Chief Financial Officer                                    9/02/98
 ----------------------------------------     and Director                                               -------
         Anthony P. Shutts                    (Principal Financial and Accounting Officer)
                                              



     /s/    Robert L. West, Jr.               Chief Operating Officer                                    9/02/98
 ----------------------------------------                                                                -------
         Robert L. West, Jr.



    /s/  William R. Black                     Vice President, General Counsel,                           9/02/98
 ----------------------------------------     Secretary and Director                                     -------
         William R. Black                     



      /s/ Tamara Knickerbocker                Executive Vice President and Director                      9/02/98
 ----------------------------------------                                                                -------
        Tamara Knickerbocker



    /s/    Gerald A. Margolis                 Director                                                   9/02/98
 ----------------------------------------                                                                -------
         Gerald A. Margolis



    /s/  F. Rene Alvarez, Jr.                 Director                                                   9/02/98
 ----------------------------------------                                                                -------
         F. Rene Alarez, Jr.

</TABLE>


                                       32
<PAGE>   35


Independent Auditors' Report
To the Shareholders and Board of Directors of
         The L.L. Knickerbocker Co., Inc.:


We have audited the accompanying consolidated balance sheet of The L.L.
Knickerbocker Co., Inc. and subsidiaries (the Company) as of December 31, 1997,
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the two years in the period ended December 31, 1997.
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 audits 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, such consolidated financial statements present fairly, in all
material respects, the financial position of The L.L. Knickerbocker Co., Inc.
and subsidiaries as of December 31, 1997, and the results of their operations
and their cash flows for each of the two years in the period ended December 31,
1997, in conformity with generally accepted accounting principles.



/s/ DELOITTE & TOUCHE LLP

March 31, 1998
Costa Mesa, California



                                       33
<PAGE>   36


CONSOLIDATED BALANCE SHEET
AS OF DECEMBER 31, 1997

<TABLE>
<S>                                                                                             <C>         
ASSETS

CURRENT ASSETS:
Cash and cash equivalents                                                                       $     92,000
Restricted cash (Note 1)                                                                             250,000
Accounts receivable, less allowance for doubtful accounts of $1,147,000                            8,021,000
Receivable from stockholder (Note 5)                                                               1,383,000
Inventories (Note 3)                                                                              10,851,000
Prepaid expenses and other current assets, including $4,155,000 of prepaid advertising             7,486,000
                                                                                                ------------
            Total current assets                                                                  28,083,000

PROPERTY AND EQUIPMENT, net (Note 4)                                                               5,537,000
NOTES RECEIVABLE (Note 6)                                                                          1,800,000
INVESTMENTS (Note 6)                                                                               2,585,000
GOODWILL, net of accumulated amortization of $971,000                                              6,393,000
DEFERRED INCOME TAXES (Note 13)                                                                    4,215,000
OTHER ASSETS                                                                                       2,348,000
                                                                                                ------------
                                                                                                $ 50,961,000
                                                                                                ============
LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
Accounts Payable                                                                                $  5,943,000
Accrued expenses                                                                                   1,895,000
Notes payable (Note 7)                                                                             3,650,000
Acquisition payable (Note 2)                                                                           8,000
Commissions and royalties payable                                                                    751,000
Interest payable                                                                                     270,000
Current portion of long-term debt (Note 11)                                                          242,000
Income Taxes Payable                                                                                 123,000
Loan from stockholder (Note 5)                                                                       248,000
Due to shareholders of Krasner Group, Inc. (Note 2)                                                  900,000
Other current liabilities                                                                            125,000
Deferred Income Taxes (Note 13)                                                                       49,000
                                                                                                ------------
            Total current liabilities                                                             14,204,000

LONG-TERM LIABILITIES:
Long-term debt, less current portion (Note 11)                                                       661,000
Convertible debentures, net of discount of $444,000 (Note 8)                                       9,455,000
Deferred gain (Note 6)                                                                             1,642,000
                                                                                                ------------
            Total long-term liabilities                                                           11,758,000

MINORITY INTEREST (Note 1)                                                                           274,000
COMMITMENTS AND CONTINGENCIES (Notes 7 and 10)

STOCKHOLDERS' EQUITY (Note 9):
Common stock, no par value-authorized 100,000,000 shares,
   issued and outstanding, 18,754,693 shares                                                      27,282,000
Additional paid-in capital                                                                         3,904,000
Foreign currency translation adjustment                                                           (5,231,000)
Accumulated deficit                                                                               (1,230,000)
                                                                                                ------------
Total stockholders' equity                                                                        24,725,000

                                                                                                ------------
                                                                                                $ 50,961,000
                                                                                                ============
</TABLE>

                 See Notes to Consolidated Financial Statements


                                       34
<PAGE>   37

CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996

<TABLE>
<CAPTION>
                                                                            1997                   1996
                                                                        ------------           ------------
<S>                                                                     <C>                    <C>         

Net sales                                                               $ 68,290,000           $ 42,095,000
Cost of sales                                                             30,790,000             21,451,000
                                                                        ------------           ------------

Gross profit                                                              37,500,000             20,644,000
Advertising expense                                                       10,926,000              4,882,000
Selling, general and administrative expenses                              28,616,000             11,912,000
                                                                        ------------           ------------

Operating income (loss)                                                   (2,042,000)             3,850,000
Equity in loss of investee companies                                      (1,857,000)              (629,000)
Other income (expense), net                                                3,316,000                (62,000)
Interest expense  (Notes 6 and 12)                                        (4,831,000)            (1,205,000)
                                                                        ------------           ------------

Income (loss) before minority interest in income of subsidiary
                and Income Tax Expense(Note 1)                            (5,414,000)             1,954,000
Minority interest in income of subsidiary (Note 1)                           (10,000)              (132,000)
Income tax (expense) benefit                                               1,047,000               (450,000)
                                                                        ------------           ------------

Net income (loss)                                                       $ (4,377,000)          $  1,372,000
                                                                        ============           ============

Net income (loss) per share:
  Basic                                                                 $      (0.24)          $       0.09
                                                                        ============           ============
  Diluted                                                               $      (0.24)          $       0.09
                                                                        ============           ============

Shares used in computing net income (loss) per share:
  Basic                                                                   18,052,081             14,713,903
                                                                        ============           ============
  Diluted                                                                 18,052,081             16,470,624
                                                                        ============           ============

</TABLE>

                 See Notes to Consolidated Financial Statements


                                       35
<PAGE>   38


CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996

<TABLE>
<CAPTION>
                                                                                                             Foreign
                                                             Common Stock           Additional               currency
                                                                                     paid-in     Retained   translation
                                                          Shares       Amount        capital     earnings   adjustment     Total
                                                       ----------   -----------     ---------   -----------   --------  -----------
<S>                                                    <C>          <C>             <C>         <C>         <C>         <C>        
BALANCE, January 1, 1996                               13,752,285   $ 6,575,000     $ 250,000   $ 1,775,000   $      -  $ 8,600,000

Exercise of stock warrants                                687,472     1,176,000                                           1,176,000

Exercise of stock options                                 885,514       728,000                                             728,000

Exercise of stock options in connection
 with Krasner Group, Inc. purchase                         62,090       903,000      (427,000)                              476,000

Issuance of common stock pursuant to
 Krasner Group, Inc. acquisition (Note 2)                  85,162       516,000                                             516,000

Issuance of common stock in connection
 with convertible debentures (Note 8)                     282,824     1,505,000       (81,000)                            1,424,000

Issuance of stock purchase warrants pursuant to
 investment in Pure Energy Corporation (Note 9)                                     1,875,000                             1,875,000

Issuance of stock purchase warrants pursuant to
 S.L.S. Trading Co., Ltd. acquisition (Note 2)                                        405,000                               405,000

Issuance of stock purchase warrants pursuant to
 Krasner Group, Inc. acquisition (Note 2)                                           1,674,000                             1,674,000

Issuance of common stock pursuant to
 Georgetown Collection, Inc. acquisition (Note 2)         196,377     1,679,000                                           1,679,000

Issuance of stock purchase warrants in connection
 with convertible debenture offering (Note 8)                                         233,000                               233,000

Discount on convertible debenture offering                                          2,735,000                             2,735,000

Tax benefit related to exercise of stock options
 (Note 13)                                                                          1,354,000                             1,354,000

Foreign currency translation gain                                                                               16,000       16,000

Net income                                                                                        1,372,000               1,372,000
                                                       ----------  ------------   -----------   -----------   --------  -----------

BALANCE, December 31, 1996                             15,951,724  $ 13,082,000   $ 8,018,000   $ 3,147,000   $ 16,000  $24,263,000

</TABLE>


                 See Notes to Consolidated Financial Statements


                                       36
<PAGE>   39


CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996

<TABLE>
<CAPTION>
                                                                                         Retained        Foreign
                                                    Common Stock          Additional     earnings       currency
                                                                           paid-in      (Accumulated   translation
                                                 Shares       Amount       capital        deficit)      adjustment       Total
                                               ----------  ------------  ------------   ------------   ------------   ------------
<S>                                            <C>         <C>           <C>            <C>            <C>            <C>         
BALANCE, December 31, 1996                     15,951,724  $ 13,082,000  $  8,018,000   $  3,147,000   $     16,000   $ 24,263,000

Exercise of stock options                         431,250       513,000            --             --             --        513,000

Exercise of stock warrants                        317,237       280,000            --             --             --        280,000

Issuance of common stock in connection
 Krasner Group, Inc. acquisition (Note 2)         243,606     1,253,000            --             --             --      1,253,000

Issuance of common stock in connection
 with convertible debentures (Note 8)           1,620,350    11,262,000            --             --             --     11,262,000

Exchange of stock warrants for common stock
 (Notes 2 and 9)                                  190,526       892,000      (892,000)            --             --             --

Cancellation of stock warrants in connection
 with sale of partial interest in Pure Energy
 Corporation (Note 6)                                  --            --    (1,874,000)            --             --     (1,874,000)

Issuance of stock options in connection with
 convertible debenture offering (Note 8)               --            --       434,000             --             --        434,000

Conversion discount of convertible
 debenture (Note 8)                                    --            --    (1,782,000)            --             --     (1,782,000)

Foreign currency translation loss                      --            --            --             --     (5,247,000)    (5,247,000)
  Net loss                                             --            --            --     (4,377,000)            --     (4,377,000)
                                               ----------  ------------  ------------   ------------   ------------   ------------

BALANCE, December 31, 1997                     18,754,693  $ 27,282,000  $  3,904,000   $ (1,230,000)  $ (5,231,000)  $ 24,725,000
                                               ==========  ============  ============   ============   ============   ============

</TABLE>

              See Notes to Consolidated Financial Statements



                                       37
<PAGE>   40

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996

<TABLE>
<CAPTION>
CASH FLOWS FROM OPERATING ACTIVITIES:                                         1997                   1996
                                                                          ------------           ------------
<S>                                                                       <C>                    <C>         
Net (loss) income                                                         $ (4,377,000)          $  1,372,000
Adjustments to reconcile net (loss)  income to net cash provided
  by (used in) operating activities:
 Depreciation and amortization                                               2,727,000                833,000
Debenture Inducement                                                         1,899,000                     --
 Deferred income taxes                                                      (1,095,000)              (184,000)
 Amortization of deferred revenue                                                   --                (95,000)
 Loss on investment                                                             78,000                238,000
Gain on Sale of Investment - P.E.C                                          (1,710,000)                    --
 Equity in loss of investee companies                                        1,857,000                629,000
Loss on Disposition of Joint Venture                                           302,000                     --
 Minority interest                                                              10,000                132,000
 Amortization of debt discount                                                 644,000                391,000
 Changes in operating accounts, net of effect of acquisitions:
  Accounts receivable, net                                                   5,709,000             (3,612,000)
  Receivable from stockholder                                                 (787,000)              (335,000)
  Note receivable                                                                   --                150,000
  Income tax receivable                                                        733,000                943,000
  Inventories                                                               (2,377,000)               495,000
  Prepaid expenses and other assets                                         (1,823,000)             2,709,000
Other Assets                                                                (1,068,000)                    --
  Accounts payable and accrued expenses                                     (3,116,000)            (1,889,000)
  Commissions and royalties payable                                            (77,000)               121,000
  Income taxes payable                                                         123,000             (1,330,000)
Other long term liabilities                                                    (51,000)                11,000
                                                                          ------------           ------------

  Net cash provided by (used in) operating activities                       (2,399,000)               579,000

CASH FLOWS FROM INVESTING ACTIVITIES:
 Acquisitions of property, plant and equipment                              (2,778,000)            (2,018,000)
 Cash paid for investments                                                    (965,000)            (3,329,000)
 Cash paid for acquisitions, less cash acquired                                     --             (2,902,000)
                                                                          ------------           ------------


Net cash used in investing activities                                       (3,743,000)            (8,249,000)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net Payments on line of credit                                              (3,358,000)            (5,025,000)
Payments on long-term debt                                                    (226,000)              (155,000)
Proceeds from borrowing on long-term debt                                      831,000                     --
Proceeds from exercise of stock options and warrants                           793,000              2,380,000
Deferred debt issue costs                                                     (365,000)              (149,000)
Proceeds from issuance of convertible debentures                             5,000,000             14,880,000
Proceeds from stockholder loan                                               1,400,000                     --
Payments on stockholder loan                                                (1,152,000)                    --
                                                                          ------------           ------------

  Net cash provided by financing activities                                  2,923,000             11,931,000

EFFECT OF FOREIGN CURRENCY TRANSLATION                                      (3,186,000)                16,000
                                                                          ------------           ------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS                        (6,405,000)             4,277,000

CASH AND CASH EQUIVALENTS, beginning of year                                 6,747,000              2,470,000
                                                                          ------------           ------------

CASH AND CASH EQUIVALENTS, end of year                                    $    342,000           $  6,747,000
                                                                          ============           ============

</TABLE>


                                       38
<PAGE>   41

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)


<TABLE>
<CAPTION>
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION-
                                                       1997                  1996
                                                   -----------           -----------
<S>                                                <C>                   <C>        
Cash paid (refunded) during the year for:
  Interest                                         $ 1,643,000           $   899,000
                                                   ===========           ===========

  Income taxes                                     $  (806,000)          $   499,000
                                                   ===========           ===========

</TABLE>

SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITY:

During the year ended December 31, 1997, the Company issued 243,606 shares of
       common stock in payment of 1,253,000 of acquisition payable (Note 2).

During the year ended December 31, 1997 the Company sold a portion of its
       investment in Pure Energy Corporation with a carrying value of $164,000
       in exchange for 397,500 common stock purchase warrants with an ascribed
       value of $1,874,000, resulting in a gain of $1,710,000. Also during the
       year ended December 31, 1997, the Company recorded a deferred gain of
       $1,642,000 in connection with the sale of a portion of its Pure Energy
       Corporation investment with a carrying value of $158,000 in exchange
       for a note receivable of $1,800,000 (Note 6).

During the year ended December 31, 1996, the Company recorded an increase to
       additional paid-in capital of $1,354,000 related to tax benefits
       associated with the exercise of non-qualified stock options.

During the year ended December 31, 1996, the Company issued 400,000 warrants
       in conjunction with the acquisition of an interest on Pure Energy
       Corporation. The warrants have an ascribed value of $1,875,000 (Note
       6).

During the years ended December 31, 1997 and 1996, the Company issued 150,000
       and 46,971 warrants with an ascribed value of $434,000 and $233,000,
       respectively as commission in connection with the convertible debenture
       offering (Note 8).

During the years ended December 31, 1997 and 1996, $11,169,000 and $1,330,000
       of convertible debentures and $93,000 and $175,000 of accrued interest,
       respectively was converted to common stock (Note 8).

During the year ended December 31, 1996, the Company acquired interests in
certain entities as follows (Note 2):


<TABLE>
<S>                                                     <C>        
Fair value of assets acquired                           $34,553,000
Cash paid to sellers, acquisition payables and
 transaction costs                                        4,239,000
Value of common stock and stock purchase
 warrants issued                                          4,274,000
                                                        -----------

Liabilities assumed                                     $26,040,000
                                                        ===========
</TABLE>



                 See Notes to Consolidated Financial Statements


                                       39
<PAGE>   42


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996

1.       ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Line of Business - The L.L. Knickerbocker Co., Inc. (the Company) is in the
businesses of developing and selling celebrity and non-celebrity products which
include collectible items such as porcelain and vinyl dolls, teddy bears,
figurines, fine and costume jewelry, environmental products, and other consumer
products. The Company's customers include major networks in the home shopping
industry, retail and wholesale distributors, and consumers. The dolls, bears,
and environmental products are manufactured by independent manufacturing
facilities to the Company's specifications. The fine and costume jewelry is
manufactured by the Company. The Company's distribution includes home shopping
channels, catalog mailings, direct mailings from customer lists, retail stores,
wholesale distributors, and the internet.

Consolidation - The financial statements presented herein include the accounts
of the Company's subsidiaries, as follows: Krasner Group, Inc.; Harlyn
International, Ltd.; S.L.S. Trading Co., Ltd.; L.L. Knickerbocker (Thai)
Company, Ltd., and Georgetown Collection, Inc. The financial statements reflect
a minority interest associated with Georgetown Collection, Inc. Intercompany
accounts and transactions have been eliminated in consolidation.

Use of Estimates - The preparation of financial statements in conformity with
generally accepted accounting principles necessarily 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 reporting periods. Actual results could differ from these estimates.

Foreign Currency - The Company's primary functional currency is the U.S. dollar,
while the functional currency of the Company's Thailand subsidiaries is the Thai
baht. Assets and liabilities denominated in foreign currencies are translated at
the rate of exchange on the balance sheet date. Revenues and expenses are
translated using the average exchange rate for the period. Gains and losses on
foreign currency transactions are recognized as incurred (Note 12).

Cash and Cash Equivalents - For purposes of the statement of cash flows, the
Company considers all highly liquid instruments with original maturities of
three months or less and with an insignificant interest rate risk to be cash
equivalents.

Restricted Cash - At December 31, 1997 restricted cash represents funds
deposited with a financial institution to serve as collateral for a line of
credit (Note 7).

Inventories - Inventories consist of finished products and related packaging,
work in process, and raw materials, and are stated at the lower of cost
(first-in, first-out basis) or market.

Prepaid Advertising Costs - The Company capitalizes certain direct-response
advertising costs and amortizes such costs over the period during which future
period revenues are expected to be received from each direct-response
advertising campaign, generally 3 to 12 months. The nature of the direct
response advertising costs are primarily production costs associated with media
costs for print advertising, and catalog printing costs.

Property and Equipment - Property and equipment are stated at cost. Depreciation
is being provided on the straight-line method over estimated useful lives of
five to seven years. Depreciation on buildings is being provided on the
straight-line method over an estimated useful life of twenty years.

Intangible Asset - Excess of cost over net assets acquired (goodwill), which
arose from the acquisition of certain entities (Note 2) is being amortized on a
straight-line method over 10 years. The Company evaluates the recoverability of
its goodwill at each balance sheet date. The recoverability of goodwill is
determined by comparing the carrying value of the goodwill to the estimated
operating income of the related entity on an undiscounted cash flow basis. Any
impairment is recorded at the date of determination.


                                       40
<PAGE>   43


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)

In March 1995, the Financial Accounting Standards Board issued Statement No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of (SFAS No. 121). SFAS No. 121 establishes accounting
standards for the impairment of long-lived assets, certain identifiable
intangibles and goodwill related to those assets to be held and used and
long-lived assets and certain identifiable intangibles to be disposed of. The
Company adopted SFAS No. 121 in the first interim period of Fiscal 1996, and
such adoption did not impact its financial position or results of operations.

Deferred Debt Issuance Costs - Deferred debt issuance costs which are included
in other assets, relate to the issuance of Convertible Debentures (Note 8).
These costs totaled $1,801,000 at December 31, 1997, and are being amortized
over the estimated life of the debentures. The accumulated amortization at
December 31, 1997 is $1,005,000.

Investments in Investees - Investments in the common stock of unconsolidated
entities (Note 6) in which the Company's interest is in excess of 20% and in
which the Company has an ability to influence the business decisions of the
investee company, are accounted for using the equity method of accounting.

Fair Value of Financial Instruments - Statement of Financial Accounting
Standards No. 107 (SFAS No. 107), Disclosures About Fair Value of Financial
Instruments, requires management to disclose the estimated fair value of certain
assets and liabilities defined by SFAS No. 107 as financial instruments.
Financial instruments are generally defined by SFAS No. 107 as cash, evidence of
ownership interest in equity, or a contractual obligation that both conveys to
one entity a right to receive cash or other financial instruments from another
entity and imposes on the other entity the obligation to deliver cash or other
financial instruments to the first entity. At December 31, 1997, management
believes that the carrying amount of cash and cash equivalents, accounts
receivable, accounts payable, accrued expenses and short-term debt approximates
fair value because of the short maturity of these financial instruments.

Revenue Recognition - Revenues from sales of products are recognized when
products are shipped to customers. The Company offers credit to its customers
and performs ongoing credit evaluations of its customers.

Income Taxes - The Company accounts for income taxes using Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes, which
requires that the Company recognize deferred tax assets and liabilities based on
the differences between the financial statement carrying amounts and the tax
bases of assets and liabilities, using enacted tax rates in effect in the years
in which the differences are expected to reverse. A valuation allowance related
to deferred tax assets is recorded when it is more likely than not that some
portion or all of the deferred tax asset will not be realized.

Net Income (loss) per share - The Company adopted Statement of Financial
Accounting Standards No. 128 (SFAS No. 128), Earnings Per Share, beginning with
the Company's fourth quarter of fiscal 1997. All prior period earnings per
common share data have been restated to conform to the provisions of this
statement. Basic earnings per common share is computed using the weighted
average number of shares outstanding. Diluted earnings per common share assumes
conversion of convertible debentures, elimination of the related interest
expense, and the issuance of common stock for all other potentially dilutive
equivalent shares outstanding.

Stock-Based Compensation - In October 1995, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards No. 123, Accounting for
Stock Based Compensation. The Company has determined that it will not change to
the fair value method and will continue to use Accounting Principles Board
Opinion No. 25 for measurement and recognition of employee stock-based
transactions. See Note 9 for disclosure of the pro forma effect on net income
and net income per share.



                                       41
<PAGE>   44

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)


Reclassifications - Certain amounts previously reported for 1996 have been
reclassified to conform to the 1997 financial statement presentation.

New Accounting Pronouncements - In June 1997, the FASB issued SFAS No. 130,
Reporting Comprehensive Income and SFAS No. 131, Disclosures About Segments of
an Enterprise and Related Information. SFAS No. 130 and SFAS No. 131 must be
adopted by the Company beginning with fiscal 1998 and will result in an
additional statement that reports comprehensive income and expanded disclosure
regarding the Company's operations on a segmented basis.

2.       ACQUISITIONS

The Company completed a number of acquisitions during 1996. The following
describes the transactions completed during the year ended December 31, 1996.
The funds for the acquisitions were obtained primarily from the proceeds of the
convertible debenture offering described in Note 8, and through the issuance of
the Company's common stock and common stock purchase warrants (Note 9).

Krasner Group, Inc.

Effective June 18, 1996, the Company acquired all of the outstanding capital
stock of Krasner Group, Inc. (TKG) which designs, manufactures, and markets
costume jewelry. The aggregate acquisition cost of $3,205,000 includes the
issuance of the Company's common stock valued at $1,440,000, the issuance of
250,628 stock purchase warrants with an ascribed value of $1,674,000(determined
utilizing the Black-Scholes option-pricing model) and related acquisition costs.
As of December 31, 1997, 328,768 shares of common stock with an intrinsic value
of $1,769,000 had been issued. During the year ended December 31, 1997, the
Company exchanged 70,000 unexercised stock purchase warrants with an intrinsic
value of $240,000 for 50,526 shares of the Company's common stock. The purchase
agreement also provides for the issuance of additional shares (Additional
Shares) of common stock or stock purchase warrants with an intrinsic value equal
to 110% of the proceeds from the liquidation of TKG inventory on hand at the
date of acquisition.

During the year ended December 31, 1997, the Company issued 243,606 shares of
common stock in payment of $1,253,000 of acquisition payable due to the former
shareholders of Krasner Group, Inc., which included $330,000 for additional
shares related to the liquidation of TKG inventory. During the year ended
December 31, 1997, the Company recorded an increase to goodwill of approximately
$900,000 related to the 1997 liquidation of TKG inventory. At December 31, 1997,
this amount is included in due to shareholders of Krasner Group, Inc.

Grant King International, Ltd.

Effective July 1, 1996, the Company acquired the remaining 51% interest in Grant
King International Co., Ltd. (GKI) that the Company did not previously own (Note
9), in exchange for the forgiveness of $414,000 owed by GKI to the Company. This
transaction increased the Company's investment to $664,000. The operations and
assets of GKI have been merged with S.L.S Trading Co., Ltd., a subsidiary of the
Company.

S.L.S. Trading Co., Ltd.

Effective July 1, 1996, the Company acquired certain assets and assumed certain
liabilities of S.L.S. Trading Co., Ltd., (S.L.S.) which sources gemstones and
develops certain proprietary stone cutting technologies. The aggregate
acquisition cost of $555,000 includes $150,000 cash, the issuance of 108,000
warrants to purchase common stock of the Company with an ascribed value of
approximately $405,000 (determined utilizing the Black-Scholes option-pricing
model) and related acquisition costs. During the year ended December 31, 1997,
the Company exchanged 108,000 unexercised stock purchase warrants with an
intrinsic value of $402,000 for 80,000 shares of the Company's common stock.



                                       42
<PAGE>   45

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)


Harlyn International, Ltd.

Effective July 1, 1996, the Company acquired all of the outstanding capital
stock of Harlyn International, Ltd. (Harlyn) which manufactures and markets fine
jewelry. The aggregate acquisition cost of $2,711,000 includes cash payments to
the former shareholder of $2,358,000 and related acquisition costs. In addition,
the Company repaid $234,000 of Harlyn's bank debt concurrent with consummation
of the purchase transaction.

Georgetown Collection, Inc.

Effective October 18, 1996, the Company acquired approximately 82% of the
outstanding capital stock of Georgetown Collection, Inc. (GCI) which markets
collectible dolls through direct response mediums. The aggregate acquisition
cost of $3,199,000 includes issuance of 196,377 restricted shares of the
Company's common stock with an intrinsic value of $1,679,000 at the acquisition
date plus related acquisition costs. In addition, the Company repaid $1,500,000
of GCI's bank debt concurrent with consummation of the purchase transaction. The
purchase agreement also provides for future consideration in an amount equal to
15% of GCI's pretax earnings during calendar year 1997 and 4.5% of pretax
earnings in each of calendar years 1998 through 2001. Future contingent payments
based on pretax earnings, if payable, will be recorded as additional purchase
price consideration and will increase goodwill recorded in conjunction with this
acquisition. As of December 31, 1997, the Company recorded an increase to
goodwill of $8,000. The Company guaranteed the value of the 196,377 restricted
shares of the Company's common stock issued in conjunction with this acquisition
to be $1,679,000 at the first anniversary of the acquisition. In accordance with
this guarantee an additional 32,735 shares of the Company's common stock are
issuable at December 31, 1997.

Each of the acquisitions was accounted for under the purchase method of
accounting and, accordingly the operating results of each of the subsidiaries
are included in the Company's consolidated financial statements since the
respective acquisition dates.

3.   INVENTORIES

As of December 31, 1997 inventories consist of the following:


<TABLE>
<S>                      <C>        
Finished Goods           $ 8,968,000
Work-in-process              342,000
Raw materials              1,541,000
                         -----------
                         $10,851,000
                         ===========

</TABLE>


                                       43
<PAGE>   46

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)


4.    PROPERTY AND EQUIPMENT

    As of December 31, 1997, property and equipment consist of the following:



<TABLE>
<S>                                                 <C>        
         Land, buildings and improvements           $ 2,064,000
         Computer equipment and software                932,000
         Production models, molds, and tools          1,228,000
         Autos                                          194,000
         Office furniture and equipment               1,331,000
         Machinery and equipment                      1,738,000
                                                    -----------
                                                      7,487,000
         Accumulated depreciation                    (1,950,000)
                                                    ===========
                                                    $ 5,537,000
                                                    ===========
</TABLE>


5.       RECEIVABLE FROM STOCKHOLDER/LOAN FROM STOCKHOLDER

Receivable from stockholder bears interest at the prime rate plus 2.5% and is
repayable to the Company upon demand. Subsequent to December 31, 1997, the
$1,383,000 receivable was repaid to the Company.

Loan from stockholder of $248,000 at December 31, 1997 bears interest at the
prime rate plus 2% and is due on demand.

6.       INVESTMENTS

At December 31, 1997, the Company had the following equity investments:

The Company owns 400,000 and 1,000 shares of Tracker Corporation and Camelot
Corporation, respectively, which were received in exchange for marketing
services provided to these companies. The shares represent an ownership interest
of less than 10% in each of these companies and are restricted as to the
Company's ability to sell them. The aggregate estimated carrying value of these
shares at December 31, 1997 is $24,000 which approximates fair value.

During 1996 the Company acquired a 38.3% interest in Pure Energy Corporation
(PEC) in exchange for $2 million in cash and the issuance of stock purchase
warrants with an ascribed value of $1,875,000(determined utilizing the
Black-Scholes option-pricing model). Additionally, the Company agreed to fund up
to $1,000,000 of PEC expenses. Through December 31, 1997 the Company had
fulfilled its funding commitment and funded a total of $507,000, which increased
the Company's investment to $4,382,000.

During the year ended December 31, 1997, the Company sold a portion of its
investment in Pure Energy Corporation with a carrying value of $164,000 in
exchange for 397,500 previously issued Company common stock purchase warrants
with an ascribed value of $1,874,000(determined utilizing the Black-Scholes
option-pricing model). The sale resulted in a gain to the Company of $1,710,000,
which is included in other income. Also during the year ended December 31, 1997,
the Company recorded a deferred gain of $1,642,000 in connection with the sale
of a portion of its investment in Pure Energy Corporation with a carrying value
of $158,000 in exchange for a note receivable of $1,800,000. The note receivable
is secured by the underlying securities sold and accrues interest at 7.5% per
annum. The note receivable and accrued interest are due and payable on December
30, 1999. The resulting gain has been deferred on the accompanying balance sheet
until such time that the note is repaid. As a result of these transactions the
Company's interest in PEC was reduced to 34.6% as of December 31, 1997.



                                       44
<PAGE>   47

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)

At December 31, 1997 the Company held 27.8% of the outstanding shares of Ontro,
Inc. (formerly Self-Heating Container Corporation) acquired during 1996 for
$650,000 in cash. In connection with the acquisition and a related royalty
agreement, the Company will receive exclusive worldwide distribution rights to
market and distribute celebrity-driven products using certain patents owned by
the corporation.

During 1997 the Company entered into a joint venture, Arkenol Asia, Inc., a
Delaware corporation owned 50% by LLK and 50% by Arkenol Holdings, LLC. The
joint venture acquired an exclusive license to exploit Arkenol Holdings
technology and related intellectual property to produce ethanol and other
chemicals for sale and consumption in Thailand, Cambodia, Burma, Vietnam, Laos,
India, China and Japan, and non-exclusive licenses for Indonesia and California.

Under the terms of the joint venture, Arkenol Holdings serves as the Managing
Venturer, with the primary responsibility for all development activities and
services to the joint venture and the projects, all product development
activities, the selection and management of engineering, procurement and
construction provider and the operation of the project facilities. LLK has the
primary responsibility for securing all credit support instruments and other
financing on behalf of the projects and the joint venture and all product
marketing activities. The day-to-day business of the joint venture is conducted
by agents and contractors engaged by the Managing Venturer. The carrying value
of the investment in this joint venture totaled $231,000 at December 31, 1997.

The Company's investees accounted for under the equity method are each in the
development stage and as of December 31, 1997 have generated no sales. The net
loss of Pure Energy Corporation and for all investees in the aggregate for the
year ended December 31, 1997 was $3,670,000 and $6,099,000, respectively.

7.       LINE OF CREDIT AND NOTES PAYABLE

The Company has available to use for working capital purposes and to post
letters of credit, a line of credit totaling $20,000,000, subject to certain
limits. The line of credit encompasses the L.L. Knickerbocker Co., Inc.(LLK),
Georgetown Collection, Inc. (GCI) and Krasner Group, Inc.(TKG) and expires in
July 1999. Certain credit limits are established for each company. The credit
limits are $4,000,000 for LLK, $13,000,000 for GCI and $3,000,000 for TKG.
Borrowing availability is determined by an advance rate on eligible accounts
receivable and inventory. The line of credit includes sublimits for letters of
credit and bankers acceptances aggregating $13,000,000, $4,000,000 and
$3,000,000 for GCI, LLK and TKG, respectively. Borrowings bear interest at the
bank's base rate (8.5% at December 31, 1997) plus 2% for GCI and TKG borrowings
and plus 1% for LLK borrowings or, at the Company's option, an adjusted LIBOR
rate. In addition, the Company is charged an Unused Line fee of .25% of the
unused portion of the revolving loans.

At December 31, 1997, the Company had $3,650,000 of cash borrowings outstanding
and outstanding letters of credit totaling $115,000. Available borrowings under
the line of credit aggregated $4,271,000 at December 31, 1997. Borrowings are
collateralized by substantially all assets of the Company. The line of credit
agreement contains, among other things, restrictive financial covenants which
require the Company to maintain certain leverage and current ratios (computed
annually and quarterly), an interest coverage ratio (computed annually) and to
achieve certain levels of annual income. The agreement also limits GCI annual
capital expenditures and prohibits the payment of dividends. At December 31,
1997, the Company was in compliance with these covenants or had received a
waiver from the bank for certain covenant violations through the next annual or
quarterly measurement date.

S.L.S. and Harlyn have available lines of credit aggregating 72,000,000 Thai
baht (approximately $1,532,000 at December 31, 1997). Outstanding borrowings
bear interest at rates ranging from 15% to 18.75%. One such line of credit is
secured by a $250,000 standby letter of credit.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



                                       45
<PAGE>   48

FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)

8.       CONVERTIBLE DEBENTURES

In September 1996 the Company issued Convertible Debentures (the Debentures)
with a face value of $15,500,000 in a private placement to institutional
investors. This private placement yielded net proceeds to the Company totaling
$14,731,000 after deducting costs associated with issuing the Debentures. The
Debentures accrued interest of the rate of 7% per year, payable quarterly. The
Debentures were convertible at the option of the holder into shares of the
Company's common stock at a price equal to 85% of the closing price of the
Company's common stock at the date of conversion, subject to a minimum and
maximum conversion price of $5.25 and $12.00 per share, at any time through the
second anniversary of the original date of issuance. Through December 31, 1997,
the Company issued a total of 1,903,174 shares of its common stock in connection
with the conversion of $12,499,000 of the original principal amount of the
Debentures, plus interest accrued through the conversion date of $268,000.

The conversion of the notes at 85% of the closing price of the Company's common
stock resulted in the Debentures being issued at a discount (the conversion
discount). The conversion discount is being recognized by the Company as
non-cash interest expense over the term of the Debentures with a corresponding
increase to the original principal amount of the Debentures. Upon conversion of
the Debentures any portion of the conversion discount not previously recognized
is recorded as interest expense on the conversion date. During the years ended
December 31, 1997 and 1996, a total of $644,000 and $391,000, respectively, of
non-cash interest expense was recorded relating to the Debentures, including
$537,000 and $220,000, respectively, relating to the additional conversion
discount recorded upon conversion.

In January 1997, the Company reached agreement with the debenture holders to
tender all outstanding Debentures to the Company in exchange for new convertible
Debentures (the New Debentures). Under the terms of the agreement, New
Debentures were issued with a face value of 117.5% of the face value of the
tendered debentures. The New Debentures bear interest at 7% per year, payable
quarterly. The New Debentures are convertible at the option of the holder into
shares of the Company's common stock at $8.00 per share. The New Debentures must
be converted by January 1999. As a result of the 17.5% premium given as in
inducement to the Debenture holders to tender the original debentures into New
Debentures, the Company recorded a non-cash charge of $1,899,000 in the first
quarter of 1997.

In September 1997, the Company issued Convertible Debentures (the 1997
Debentures) with a face value of $5,000,000 in a private placement to an
institutional investor. This private placement yielded net proceeds to the
Company totaling $4,675,000 after deducting costs associated with issuing the
1997 Debentures. The 1997 Debentures accrue interest at the rate of 6% per
annum, payable upon conversion of the related debt or at debt maturity,
September 7, 2000. The 1997 Debentures are convertible at the option of the
holder into shares of the Company's common stock at a graduated discounted price
ranging from 97% to 90% of an average of the 7 lowest trading days of the 30
consecutive trading days prior to conversion. The discounted price of 90%
applies if the investor does not convert prior to the two year anniversary of
the closing date. As of December 31, 1997, none of the 1997 Debentures had been
converted.

The conversion of the notes at a maximum of 90% of the closing price of the
Company's common stock resulted in the 1997 Debentures being issued at a
discount (the conversion discount). The conversion discount is being recognized
by the Company as non-cash interest expense over the estimated term of the 1997
Debentures (two years) with a corresponding increase to the original principal
amount of the 1997 Debentures. Upon conversion of the 1997 Debentures any
portion of the conversion discount not previously recognized is recorded as
interest expense on the conversion date. During the 12 months ended December 31,
1997, a total of $188,000 of non-cash interest expense was recorded relating to
the 1997 Debentures.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



                                       46
<PAGE>   49

FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)


9.       STOCKHOLDERS' EQUITY

Warrants - On November 21, 1995, the Company issued warrants to purchase 200,000
shares of common stock to Shamrock Partners, Ltd., in consideration of financial
and business consulting services to be provided to the Company. The warrants
vest as of the grant date with an exercise price of $5.00 per share, which was
equivalent to the fair market value of the Company's common stock at the date of
grant and are valid for five years from the date of the grant.

On November 28, 1995, the Company entered into an agreement to issue warrants to
purchase 300,000 shares of common stock to Grant G. King in consideration of the
purchase by the Company of 49% of the issued and outstanding capital stock of
Grant King International Co., Ltd. The warrants vest as of the grant date with
an exercise price of $5.50 per share, which was equivalent to the fair market
value of the Company's common stock at the date of grant and are valid for five
years from the date of the grant. The warrants have an ascribed value of
$250,000 (determined utilizing the Black-Scholes option-pricing model), which
was recorded as an investment and additional paid-in capital. During the year
ended December 31, 1997, the company exchanged the 300,000 unexercised warrants
for 60,000 shares of the Company's common stock.

On March 13, 1996, the Company entered into an agreement to issue warrants to
purchase 200,000 shares each of common stock to two individuals in consideration
of the purchase by the Company of 40% of the outstanding capital stock of Pure
Energy Corporation. The warrants vest as of April 30, 1996 with an exercise
price of $8.50 per share (200,000 warrants) and $12.00 per share (200,000
shares). The warrants are valid through April 30, 2001. The warrants have an
ascribed value of $1,875,000, which was recorded as an investment and additional
paid-in-capital. As of December 31, 1997, 2,500 of the warrants were exercised.
During the year ended December 31, 1997, the remaining 397,500 warrants were
cancelled in connection with the sale of a portion of the Company's investment
in PEC (Note 6).

During the years ended December 31, 1997 and 1996, the Company issued 150,000
and 46,971 warrants as commission in connection with the 1997 and 1996
convertible debenture offerings, respectively (Note 8). The 1997 warrants vest
as of the grant date with an exercise price of $5.60, which was equivalent to
the fair market value of the Company's common stock at the date of grant and are
valid for three years from the date of grant. The 1996 warrants vest as of the
grant date with an exercise price of $11.87, which was equivalent to the fair
market value of the Company's common stock at the date of grant and are valid
for five years from the date of grant. The 1997 and 1996 warrants have an
ascribed value, determined utilizing the Black-Scholes option-pricing model, of
$434,000 and $233,000, respectively, which was recorded as deferred debt issue
costs and additional paid-in capital. As of December 31, 1997, none of the
warrants had been exercised.

In conjunction with the acquisitions described in Note 2 the Company issued
stock purchase warrants as part of the consideration paid for these
acquisitions. The following table summarizes the warrants issued:


<TABLE>
<CAPTION>
                                                           Exercised as   Outstanding
                               Warrants        Exercise     of December   at December         Expiration
     Acquisition                issued          Price        31, 1996       31, 1996             Date
     -----------                ------          -----        --------       --------             ----
<S>                            <C>             <C>         <C>            <C>               <C>
Krasner Group, Inc.             250,628        $  7.75         62,090        188,538        April 10, 2004
S.L.S. Trading Co., Ltd.        108,000        $  7.75             --        108,000        April 10, 2004
</TABLE>


During 1997, 70,000 and 108,000 warrants issued in conjunction with the TKG and
S.L.S. acquisitions, respectively, were exchanged for shares of the Company's
common stock (Note 2). There were no warrants exercised during 1997.



                                       47
<PAGE>   50


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)

As more fully discussed in Note 2, in conjunction with certain acquisitions, the
Company may be required to issue additional stock purchase warrants at future
dates.

The L.L. Knickerbocker 1995 Amended and Restated Stock Option Plan - The
shareholders approved and the Company adopted a Stock Option Plan on September
27, 1994 which was amended and restated on June 15, 1995 as the L.L.
Knickerbocker Amended and Restated Stock Option Plan (the Plan). The Plan is
administered by a committee appointed by the Board of Directors and provides
that options may be granted at exercise prices determined by the Board of
Directors at its sole discretion. The Plan is designed as an incentive for
employees, non-employee directors and persons providing services of special
importance to the Company. Unless otherwise specified, the options expire ten
years from the date of grant. The Plan covered an aggregate of 2,000,000 shares
when granted. In 1996 the Board of Directors authorized an increase in the
number of shares covered by the Plan to a total of 5,000,000. Non-employee
directors of the Company are automatically granted options to purchase 10,000
shares of common stock at the fair market value at the date of grant each year
that such person remains a director of the Company.

The L.L. Knickerbocker Stock Incentive Compensation Plan - On March 27, 1997,
the Company's Board of Directors adopted the L.L. Knickerbocker Stock Incentive
Compensation Plan (the ISO Plan). The ISO Plan provides that incentive and
nonstatutory options to purchase a total of 5,000,000 shares of common stock may
be granted thereunder. The ISO Plan permits the granting of options intended to
qualify as "incentive stock options" ("ISO's"), the granting of options that do
not so qualify ("NSO's"), and the granting of stock appreciation rights (SAR's).

The exercise price of any option is established by the Administrator, who is
appointed by the Board of Directors, at the time of grant. The exercise price of
any NSO's or ISO's granted under the Plan may not be less than 100% of the fair
market value of one share of Common Stock on the date of grant. The exercise
price of any ISO granted to an optionee who owns stock possessing more than 10%
of the voting rights of the Company's outstanding shares must be at least 110%
of the fair market value of the shares subject to the option on the date of
grant. Options granted under the ISO Plan have a maximum term of 10 years.


The Board may from time to time, with respect to any shares at the time not
subject to options, suspend or discontinue the ISO Plan or revise or amend it in
any respect whatsoever except that, without the approval of the Company's
shareholders, no such revision or amendment shall increase the number of shares
subject to the ISO Plan or change the classes of persons eligible to receive
options. Options may be granted pursuant to the ISO Plan until the expiration of
the Plan on March 27, 2007.



                                       48
<PAGE>   51

Option activity under the plans is as follows:


<TABLE>
<CAPTION>
                                                                       WEIGHTED
                                                                        AVERAGE
                                                    NUMBER OF          PRICE PER
                                                     SHARES              SHARE
<S>                                                 <C>               <C>       
Outstanding, January 1, 1996                        2,000,000         $     0.75

Granted                                               273,309               7.65
Exercised                                            (885,514)              0.82
Canceled                                              (32,500)              0.75
                                                   ----------             

Outstanding, December 31, 1996                      1,355,295               2.10

Granted                                             1,315,617               4.81
Exercised                                            (431,250)              1.21
Canceled                                                 (250)              7.75
                                                   ----------                   

Outstanding, December 31, 1997                      2,239,412               3.86
                                                   ==========                   
</TABLE>


At December 31, 1997 and 1996, 1,692,545 and 652,040 options were exercisable at
a weighted average exercise price of $4.33 and $2.92, respectively.

Additional information regarding options outstanding as of December 31, 1997 is
as follows:

<TABLE>
<CAPTION>
                                           WEIGHTED AVG.
                                            REMAINING          WEIGHTED AVG.                          WEIGHTED AVG.
   RANGE OF              NUMBER            CONTRACTUAL          EXERCISE             NUMBER             EXERCISE
EXERCISE PRICES        OUTSTANDING            LIFE               PRICE             EXERCISABLE            PRICE
-----------------------------------------------------------------------------------------------------------------
<S>                    <C>                 <C>                 <C>                 <C>                <C>       
        $0.75             710,000          7.03 years          $     0.75             333,750          $     0.75
$4.62 - $8.00           1,529,412          7.52 years          $     5.30           1,358,795          $     5.38
                       ------------------------------------------------------------------------------------------
                        2,239,412          7.36 years          $     3.86           1,692,545          $     4.47
</TABLE>


At December 31, 1997, 6,443,824 shares were available for future grants under
the Option plans.


As discussed in Note 1, the Company continues to account for its stock-based
awards using the intrinsic value method in accordance with Accounting Principles
Board Opinion No.25, Accounting for Stock Issued to Employees, and its related
interpretations. Accordingly, no compensation expense has been recognized in the
financial statements for employee stock arrangements.

Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation, (SFAS No. 123) requires the disclosure of pro forma net income and
earnings per share had the Company adopted the fair value method as of the
beginning of fiscal 1995. Under SFAS No. 123, the fair value of stock-based
awards to employees is calculated through the use of option pricing models, even
though such models were developed to estimate the fair value of freely tradable
fully transferable options without vesting restrictions, which significantly
differ from the Company's stock option awards. These models also require
subjective assumptions, including future stock price volatility and expected
time to exercise, which greatly affect the calculated values. The Company's
calculations were made using the Black-Scholes option pricing model with the
following weighted



                                       49
<PAGE>   52

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)

average assumptions: expected life, 10 years; stock volatility, 85 % in 1996 and
68 % in 1997; risk free interest rates, 6.5% in 1996 and 5.5% in 1997; and no
dividends during the expected term. The Company's calculations are based on an
option valuation approach and forfeitures are recognized as they occur. If the
computed fair values of the 1996 and 1997 awards had been amortized to expense
over the vesting period of the awards, pro forma net (loss) income would have
been $335,000 ($.02 per share) in 1996 and ($6,657,000) ($.37 per share) in
1997.

10.      COMMITMENTS AND CONTINGENCIES

Leases - The Company is committed under operating lease agreements for
facilities and equipment. The facility leases contain provisions for annual
rental increases.

Minimum annual rental commitments under operating leases are as follows:

<TABLE>
<CAPTION>
    Year ending December 31:
<S>                                                                   <C>       
           1997                                                       $  522,000
           1998                                                          436,000
           1999                                                          386,000
           2000                                                          329,000
           2001                                                          354,000
           Thereafter                                                  1,704,000
                                                                      ----------

                                                                      $3,731,000
                                                                      ==========
</TABLE>


Rent expense for the years ended December 31, 1997 and 1996 was $578,00 and
$650,000, respectively.

Contractual Arrangements - The Company has contractual arrangements with several
celebrities and other third parties, including Marie Osmond, Annette Funicello
and Bob Mackie. Under the terms of these contracts, the celebrities agree to act
as spokesperson for their respective products, promote the product, approve the
design and make a minimum number of public appearances. The Company is obligated
to manufacture a safe product approved by the celebrity, hold the celebrity
harmless from liability, maintain specified levels of liability insurance and
pay royalties ranging from 5% to 10% of net wholesale and retail sales. Each
contract has a termination clause in the event certain minimum annual sales are
not attained (ranging from $50,000 to $500,000). In certain instances, the
celebrity or other third party has the right to terminate the contract if the
minimum sales level is not attained for any single year. The contracts run from
18 months to 5 years and contain audit clauses, with penalties for errors or
omissions.

Letters of Credit - The Company finances certain collectible program purchases
and other product utilizing irrevocable, transferable letters of credit. These
letters of credit are issued to the Company by its major customer's bank, with
the Company as the beneficiary. The Company then transfers a portion of the
letter of credit to the Company's supplier to secure payment of the purchase.
The Company and the supplier draw down the letter of credit when the supplier
ships the product directly to the Company's customer. At December 31, 1997,
there was approximately $88,000 outstanding (drawn down) under these letters of
credit agreements.

Employment Contracts - The Company has entered into six employment agreements
with Company officers with five-year terms. The agreements call for aggregate
annual compensation of $1,015,000 and a discretionary bonus of up to 10% of
operating income.

Litigation - The Company is subject to litigation in the normal course of
business, none of which management believes is material to the financial
statements at December 31, 1997.



                                       50
<PAGE>   53

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)

11.      LONG - TERM DEBT


<TABLE>
<S>                                                                                    <C>
Long-term debt at December 31, 1997 consists of:

Building mortgage, interest at 15.5% per annum,
  payable in monthly installments of $6,000, including
  interest, secured by real estate                                                     $ 349,000

Building mortgage, interest at 14.75% per annum,
  payable in monthly installments of $17,000 including
  interest, secured by real estate                                                       263,000

Equipment leases, interest ranging from 4.90% to 24.93% per annum, payable in
  aggregate monthly installments of $13,000, including interest, secured
  by equipment                                                                           291,000
                                                                                       ---------
                                                                                         903,000
Less current portion                                                                    (242,000)
                                                                                       ---------
                                                                                       $ 661,000
                                                                                       =========
</TABLE>

Principal payments on long term debt are due approximately as follows:

<TABLE>
<S>                                          <C>     
        1998                                 $242,000
        1999                                  219,000
        2000                                   73,000
        2001                                   71,000
        2002                                   60,000
Thereafter                                    238,000
                                             --------
                                             $903,000
                                             ========
</TABLE>


12.      SIGNIFICANT CONCENTRATIONS AND RISKS

Customer Concentration - During the years ended December 31, 1997 and 1996, the
Company conducted business with one customer whose aggregate sales volume
comprised approximately 29% and 43% of the Company's revenues, respectively. A
reduction in sales to this customer could adversely impact the financial
condition and operations of the Company.

Merchandise Risk - The Company's success is largely dependent on its ability to
provide to its customers merchandise that satisfies consumer tastes and demand.
Any inability to provide appropriate merchandise in sufficient quantities and in
a timely manner could have a material adverse effect on the Company's business,
operating results, and financial condition.

Foreign Currency - approximately 13% of the Company's revenues are derived from
subsidiaries operating in Thailand. In an attempt to reduce economic risks
associated with devaluations of the Thai baht, the Company's Thailand
subsidiaries require their customers to remit payment in U.S. dollars. Included
in other income for the year ended December 31, 1997 is $1,094,000 in
transaction gains associated with this strategy. In the event the



                                       51
<PAGE>   54


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)

Thai baht strengthens in value against the U.S. dollar in the future, the
Company will be exposed to foreign currency transaction losses under this
strategy.


13.        INCOME TAXES

<TABLE>
<CAPTION>
Provision (benefit) for income taxes consists of:               1997                  1996
<S>                                                         <C>                   <C>        
Current federal and state income taxes                      $    37,000           $   227,000
Current foreign taxes                                            11,000               408,000
Deferred federal and state income taxes                      (1,095,000)             (185,000)
                                                            -----------           -----------
Provision (benefit) for income taxes                        $(1,047,000)          $   450,000
                                                            ===========           ===========
</TABLE>

A reconciliation of the statutory federal rate and the provision (benefit) for
income taxes is as follows:

<TABLE>
<CAPTION>
                                                                1997                  1996
<S>                                                         <C>                   <C>        
Federal tax at statutory rate                               $(1,895,000)          $   684,000
State taxes                                                     (28,000)               (8,000)
Goodwill Amortization                                           125,000                59,000
Residual U.S. tax on foreign earnings                          (883,000)             (313,000)
Valuation allowance                                             325,000                    --
Non-deductible interest on
     convertible debentures                                   1,219,000                    --
Other                                                            90,000                28,000
                                                            -----------           -----------

                                                            $(1,047,000)          $   450,000
                                                            ===========           ===========
</TABLE>



                                       52
<PAGE>   55

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)

Significant components of the Company's deferred tax liabilities and assets for
federal and state income taxes consists of the following:

<TABLE>
<CAPTION>
                                                                 December 31, 1997
<S>                                                              <C>        
Deferred tax assets
 Bad debt reserve                                                   $   261,000
 Uniform Capitalization                                                 154,000
 Other Reserves                                                         796,000
 Returns and allowances                                                 419,000
 Pre-acquisition net operating loss carryforward                      2,370,000
 Post-acquisition net operating loss carry forward                    4,585,000
 Valuation allowance                                                 (2,187,000)
                                                                    -----------

Total deferred tax assets                                             6,398,000


Deferred tax liabilities
 Difference between book and tax basis of fixed assets              $  (271,000)
 Prepaids                                                            (1,563,000)
 State income taxes                                                    (308,000)
 Other                                                                  (90,000)
                                                                    -----------

Total deferred tax liabilities                                       (2,232,000)

                                                                    -----------
                                                                    $ 4,166,000
                                                                    ===========
</TABLE>


The Company has not provided any residual U.S. tax on approximately $2,467,000
of the Company's foreign subsidiaries' undistributed earnings as the Company
intends to indefinitely reinvest such earnings in the foreign subsidiaries.

The Company recorded a credit to equity of $1,354,000 as a result of the tax
benefit from the exercise of stock options in 1996. During 1997 the Company had
a tax deduction from exercises of stock options in the amount of $2,162,000.
Since the Company does not have sufficient taxable income or carry back
potential to utilize the deductions generated from the exercise of the options,
approximately $5,319,000 of deductions for the current and prior year have not
been recorded in the accompanying financial statements. As these losses are
utilized in future years, the tax benefit will be recorded to equity.

The Company has an approximate $4,395,000 loss carryforward related to GCI and
TKG which can be used to reduce future taxable income. Sections 382 and 383 of
the Internal Revenue Code of 1986 place certain limitations on the use of these
acquired losses. A maximum of $405,000 of the net operating loss carryforward
can be utilized annually in 1998 and subsequent years. Any net operating loss
not utilized will begin expiring in 2010.



                                       53
<PAGE>   56

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)

14.      DOMESTIC AND THAILAND OPERATIONS

A summary of domestic and Thailand operations is as follows:


<TABLE>
<CAPTION>
                                                    Years ended December 31
                                                  1997                   1996
<S>                                           <C>                    <C>         
Net sales to unaffiliated customers:
Domestic                                      $ 59,230,000           $ 32,858,000
Thailand                                         9,060,000              9,237,000
                                              ------------           ------------
     Consolidated                             $ 68,290,000           $ 42,095,000
                                              ============           ============

Operating Income (Loss):
Domestic                                      $ (3,167,000)          $  1,135,000
Thailand                                         1,125,000              2,715,000
                                              ------------           ------------
Consolidated                                  $ (2,042,000)          $  3,850,000
                                              ============           ============

Identifiable Assets:
Domestic                                      $ 41,597,000           $ 40,883,000
Thailand                                         9,364,000             16,689,000
                                              ------------           ------------
Consolidated                                  $ 50,961,000           $ 57,572,000
                                              ============           ============
</TABLE>


(1)     Operating income is net sales less cost of goods sold and operating
        expenses.
(2)     Identifiable assets are those assets of the Company that are located in,
        or related to operations in, each geographic area.



                                       54
<PAGE>   57

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)

15.     EARNINGS PER SHARE

        Earnings per common share (EPS) data were computed as follows:

Options and warrants to purchase 246,971 shares of common stock at $12 per share
were outstanding during 1996 but were not included in the computation of diluted
EPS because the options' exercise price was greater than the average market
price of the common shares.


<TABLE>
<CAPTION>
                                                             1997                                          1996
                                          ------------------------------------------     -----------------------------------------
                                                                          Per-Share                                     Per-Share
                                            Income          Shares         Amount          Income         Shares         Amount
                                          ------------------------------------------     -----------------------------------------
<S>                                       <C>             <C>            <C>             <C>            <C>            <C>        
Net Income (Loss)                         $(4,377,000)             --             --     $ 1,372,000             --             --

Basic EPS
Income (loss) available to
  common shareholders                      (4,377,000)     18,052,081    $     (0.24)    $ 1,372,000     14,713,903    $      0.09
                                                                         ===========                                   ===========
Effect of Dilutive Securities
Options and Warrants                               --              --             --              --      1,373,584             --
Convertible debentures                             --              --             --         148,000        383,137             --
                                                                                         --------------------------               

Diluted EPS
Income (loss) available to common
  stockholders and assumed conversions    $(4,377,000)     18,052,081    $     (0.24)    $ 1,520,000     16,470,624    $      0.09
                                                                         ===========                                   ===========
</TABLE>

16.   EMPLOYEE BENEFIT PLAN

Georgetown Collection, Inc. maintains a defined contribution plan (401(K))
covering employees who have completed six months of service. Matching Company
contributions are made based upon 50% of participant contributions to a maximum
of 2% of participant compensation. During the years ended December 31, 1997 and
1996, the Company made contributions of $37,000 and $32,000, respectively.



                                       55
<PAGE>   58


                                 EXHIBIT INDEX
                                 -------------
<TABLE>
<CAPTION>
Exhibit
Number                     Description
------                     -----------

<S>      <C>                                                           
3.1      Articles of Incorporation of International Beauty Supply, Ltd. ("IBS")
         dated July 11, 1985.(1)

3.2      Amendment to Articles of Incorporation of IBS dated May 24, 1993.(1)

3.3      Certificate of Amendment to Articles of Incorporation of The L. L.
         Knickerbocker Company Inc. (the "Company") dated June 20, 1994.(1)

3.4      Certificate of Amendment to Articles of Incorporation of the Company
         dated September 27, 1994.(1)

3.5      Bylaws of the Company.(2)

4.1      Qualified Stock Option Plan adopted by the Company on September 27,
         1994 along with form of Stock Option Agreement.(3)

4.2      Form of Warrant Agreement.(3)

4.3      Form of Representative's Warrant issued to W.B. McKee Securities, Inc.
         upon consummation of the Company's offering on January 25, 1995.(3)

4.4      Form of Common Stock Purchase Warrant issued to Shoreline Pacific, the
         Institutional Finance Division of Financial West Group. (6)

4.5      Form of 7% Convertible Debenture.(6)

10.1     Employment Agreement, dated July 1, 1996, between the Company and Louis
         L. Knickerbocker.(10)

10.2     Employment Agreement, dated July 1, 1996, between the Company and
         Tamara Knickerbocker.(10)

10.3     Employment Agreement, dated July 1, 1996, between the Company and
         Anthony P. Shutts.(10)

10.4     Employment Agreement, dated April 1, 1997, between the Company and
         William R. Black.(11)

10.5     Agreement between Marie, Inc. and the Company dated April 1, 1993 re
         the services of Marie Osmond in the design, production, and sale of
         products and licensing to the Company of the use of Marie Osmond's name
         in conjunction with the Company's products.(3)

10.6     Agreement between Bob Mackie (US), Inc. and the Company dated May 1,
         1994 re the services of Bob Mackie in the design, production and sale
         of products and licensing to the Company of the use of Bob Mackie's
         name in conjunction with the Company's products.(3)

10.7     Agreement between Cello, Inc. and the Company dated May 13, 1994 re
         services of Annette Funicello in the design, development, manufacture
         and the sale of products, with Acceptance by Annette Funicello and
         Cancellation of Prior Agreement dated October 30, 1991 between Cello,
         Inc. and Creations.(3)

10.8     Lease Agreement between the Company and Security Capital Industrial
         Trust for 25800 Commercentre Drive, Lake Forest, CA dated February 15,
         1995.(2)

10.9     Agreement between the Company and Grant King International Co., Ltd.,
         dated November 28, 1995 re the acquisition of 49% of the issued and
         outstanding stock of Grant King International Co., Ltd. (5)

</TABLE>

                                       
<PAGE>   59


<TABLE>
<S>      <C>                                                           
10.10    Agreement between the Company and Grant King Design Co., Ltd., dated
         November 27, 1995 re the distribution of the jewelry products of Grant
         King Design Co., Ltd. (5)

10.11    Agreement of Purchase and Sale of the Capital Stock of Pure Energy
         Corporation between the Company and Pure Energy Corporation, dated
         February 7, 1996 re the acquisition of 40% of the issued and
         outstanding capital stock of Pure Energy Corporation. (5)

10.12    Letter of intent between Pure Energy Corporation and Biofine, Inc.,
         dated March 3, 1996 re the licensing of the patents of Biofine, Inc.
         (5)

10.13    License Agreement between the Company and SIM-GT Licensing Corp., dated
         May 1, 1995 re the licensing of the name, likeness and trademarks of
         Richard Simmons. (5)

10.14    Exhibit omitted.

10.15    Agreement of Purchase and Sale of the Capital Stock of Krasner Group,
         Inc., dated June 15, 1996 re the acquisition of 100% of the issued and
         outstanding capital stock of Krasner Group,. (7)

10.16    Stock Purchase Agreement dated September 30, 1996, by and among Harlyn
         Products, Inc., Harlyn International Company, Ltd. and the Company.(6)

10.17    First Amendment to Stock Purchase Agreement dated October 15, 1996, by
         and among Harlyn Products, Inc., Harlyn International Company, Ltd. and
         the Company.(6)

10.18    Second Amendment to Stock Purchase Agreement dated November 7, 1996, by
         and among Harlyn Products, Inc., Harlyn International Company, Ltd. and
         the Company.(6)

10.19    Agreement of Purchase and Sale of the Capital Stock of Self Heating
         Container, Inc., dated September 17, 1996 by and between Self Heating
         Container Corporation of California and the Company(10)

10.20    Agreement of Purchase and Sale of the Capital Stock of Insta-Heat,
         Inc., dated September 17, 1996, by and between Insta-Heat, Inc. and the
         Company(10)

10.21    Agreement of Purchase and Sale of the Capital Stock of Georgetown
         Collection, Inc., dated November 20, 1996, By and between Consumer
         Venture Partners I, L.P., Vermont Capital Venture Fund, North Atlantic
         Venture Fund, Merchant Partners and the Company.(8)

10.22    Form of Private Securities Subscription Agreement.(6)

10.23    Form of Registration Rights Agreement.(6)

21.1     Subsidiaries of Registrant.(11)

23.0     Consent of Deloitte & Touche LLP, independent auditors. (11)

27.0     Financial Data Schedule (11)
</TABLE>

----------------------

(1)      Filed as part of Exhibit 3.1 to The L. L. Knickerbocker Company, Inc.
         Form SB-2 Registration Statement No. 33-85230-LA as filed with the
         Securities and Exchange Commission on or about October 13, 1994.

(2)      Filed as an exhibit to the L. L. Knickerbocker Company, Inc. Annual
         Report on Form 10-KSB filed with the Securities and Exchange Commission
         on or about March 29, 1995.


                                       
<PAGE>   60

(3)      Filed as an Exhibit to The L. L. Knickerbocker Company, Inc. Form SB-2
         Registration Statement No. 33-85230-LA as filed with the Securities and
         Exchange Commission on or about October 13, 1994.

(4)      Filed as Exhibit to The L. L. Knickerbocker Company, Inc. report on
         Form 8-K filed with the Securities and Exchange Commission on or about
         March 21, 1995.

(5)      Filed as an exhibit to The L. L. Knickerbocker Company, Inc. Annual
         Report on Form 10-KSB filed with the Securities and Exchange Commission
         on or about April 15, 1996.

(6)      Filed as an Exhibit to The L. L. Knickerbocker Company, Inc. Form
         10-QSB/A as filed with the Securities & Exchange Commission on or about
         November 27, 1996.

(7)      Filed as Exhibit to The L. L. Knickerbocker Company, Inc. report on
         Form 8-K filed with the Securities and Exchange Commission on or about
         July 3, 1996.

(8)      Filed as Exhibit to The L. L. Knickerbocker Company, Inc. report on
         Form 8-K filed with the Securities and Exchange Commission on or about
         December 5, 1996.

(9)      Filed as an exhibit to The L. L. Knickerbocker Company, Inc. Annual
         Report on Form 10-KSB filed with the Securities and Exchange Commission
         on or about April 15, 1997.

(10)     Filed as an exhibit to The L. L. Knickerbocker Company, Inc. Amended
         Annual Report on Form 10-KSB/A filed with the Securities and Exchange
         Commission on or about August 15, 1997.

(11)     Filed as an exhibit to The L.L. Knickerbocker Company, Inc. Form 10-KSB
         filed with the Securities and Exchange Commission on or about March 31,
         1998.