<PAGE>

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-KSB

(Mark One)

[ X ] Annual Report to Section 13 or 15(d) of the Securities Exchange Act of
      1934

For the fiscal year ended September 30, 1997

[   ] Transition report pursuant to Section 13 or 15(d) of the Securities
      Exchange Act of 1934


Commission File No. 0-22432

                              DIPLOMAT CORPORATION
                              --------------------
            (Exact name of registrant as specified in its charter)

           Delaware                                       13-3727399
           --------                                       ----------
(State or other jurisdiction of             (I.R.S. Employer Identification No.)
   incorporation or organization)

25 Kay Fries Drive, Stony Point,New York                     
----------------------------------------                     10980
(Address of principal executive offices)                   (Zipcode)


Registrant's telephone number, including area code-.       (914) 786-5552

Securities registered pursuant to Section 12(b) of the Act:

Title of each Class                          Name of exchange on which
-------------------                          -------------------------

Applicable                                   registered     Nasdaq Stock Market
                                             ----------

Securities registered pursuant to Section 12(g) of the Act:
        Common Stock,$.0001 par value and Common Stock Purchase Warrants
        -----------------------------------------------------------------
                                (Title of Class)

        Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter prior that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No

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Regulation S-K (s.229.405 of this chapter) is not contained herein, and will not
be contained, to the best of the registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB (X)


        The issuer's net sales for the most recent fiscal year were $35,147,333.

        The aggregate market value of the voting stock held by non-affiliates
based upon the closing bid price on December 15, 1997 was approximately
$25,390,000.

        As of January 12, 1998 there were 10,685,683 shares of Common Stock, par
value $.00001 per share, outstanding.

        Certain exhibits listed in Part IV have been incorporated by reference.
The index to exhibits appears on Page


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PART I

Item 1. Business

               Except for historical information contained herein, the
statements in this Item are forward-looking statements that are made pursuant to
the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. Forward-looking statements involve known and unknown risks and
uncertainties which may cause the Company's actual results in future periods to
differ materially from forecasted results. Those risks included, among others,
the receipt and timing of future customer orders, price pressures and other
competitive factors leading to a decrease in anticipated revenues and gross
profit margins.

               This 10-KSB assumes the completion of the acquisition of
Lew Magram, Ltd. which as of the date hereof has not closed. There can be no
assurance that the acquisition will close.

General

               The term "the Company" shall include Diplomat Corporation and its
wholly-owned subsidiaries, Biobcttoms, Inc. ("Biobottoms") Brownstone Holdings,
Inc. ("Brownstone") and Lew Magram Ltd. ("Lew Magram") unless otherwise
indicated. The term "Diplomat" shall refer to the operations of the Diplomat
Corporation exclusive of its subsidiaries.

               On February 9, 1996, Diplomat Corporation completed the
acquisition of Biobottoms, a California corporation located in Petaluma,
California. Biobottoms is a children's, mail order catalog company selling
apparel and accessories in the United States for newborns through preteens.
Management of the Company believes that this business combination will
strengthen the Company's existing business by joining the manufacturing strength
and expertise of the Company with the retailing expertise of Biobottoms.

               On October 30, 1997, Diplomat acquired out of bankruptcy all of
the assets of Jean Grayson's Brownstone Studios, Inc., a mail order catalog
company. As a result of this acquisition, the scope of the Company's business
has expanded into the mature women's apparel and accessories markets primarily
through direct mail catalog.

               On January 13, 1998, the Company completed the acquisition of Lew
Magram, a New Jersey based women's apparel mail order catalog business. For
accounting purposes, the acquisition was effected as of July 1, 1997, the day
that the Company took effective control of Lew Magram.

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               The Company designs, develops, markets and distributes infantwear
and care products, nursery accessories and products for infant and toddler
comfort and care, women's apparel and accessories, and apparel and accessories
for newborns through preteens. Diplomat sells primarily cloth diapers, diaper
covers, furniture covers, layette, infant and child travel products, such as
infant car seat covers, and other accessories marketed principally under the
trademarks Ecology KidsTM and BiobottomsTM. Brownstone, through direct mail
catalogs, sells mature women's apparel and accessories under the various
trademarks of Brownstone. Lew Magram, through direct mail catalogs, sells
apparel and accessories for the professional women's market. The Company's
products are marketed in the United States and internationally. While
international sales of Diplomat's products have not been material, its products
are sold in several Pacific Rim countries, (Japan, Singapore, Taiwan and
Malaysia). Biobottoms' products are sold domestically and internationally.
Biobottoms distributes a catalog in Japan and has an 800 number which is
answered in Japanese at the Petaluma office. Sales in Japan have accounted for
20% of Biobottoms' sales since the Company acquired it. International sales of
women's apparel have not been significant.

               In November 1996, the Company restructured Diplomat's Stony
Point, New York operations by eliminating several of its unprofitable retail
lines and downsizing its distribution facility. The Company intends to focus
Diplomat's operations on its traditional core business under its Ecology KidsTM
brand name, which has historically generated the largest part of the Company's
revenue.

Marketing and Sales

               The primary customers of Diplomat are major mass merchandisers,
including Toys `R' Us, Inc. ("Toys `R' Us") and Wal-Mart Stores, Inc.
("Wal-Mart") . The foregoing two customers represented a total of approximately
42% of the Diplomat division's total revenues during the fiscal year ended
September 30, 1997. Diplomat's products are presently carried by Wal-Mart, Toys
`R' Us, Target Stores and Kids `R' Us, all nationally known merchants.
Diplomat's products are also sold to drug store chains, catalog showrooms, mail
order catalogs and food and drug chains which include Publix, Winn-Dixie and
Walgreens.

                                       4

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               Biobottoms is a direct mail catalog company selling apparel and
accessories primarily for newborns through preteens. The majority of the
products offered for sale by Biobottoms are made of natural fibers and are
designed by Biobottoms with an emphasis on comfort and ease of care. Biobottoms
mailed over 9 million catalogs to its existing and prospective customers and
delivered over $18 million of merchandise in 1996. The catalog is redesigned
four times a year and is mailed as many as 13 times a year to a combination of
customers and prospective customers. The catalog is divided into product
categories, generally by the age of the child and the size of the products being
offered. Biobottoms operated a retail store selling overstocks and out-of-season
items. The store was closed in December 1997.

               Nearly 70% of Biobottoms' products are designed to its
specifications and marketed under Biobottoms' brand name. Established national
brands, such as CONVERSE and SARA'S PRINTS round out the product offering.
unlike other segments of the apparel industry, the demand for children's
clothing is driven by the physical growth of the child, rather than changing
fashions. As a result, staples and basics account for much of the merchandise
mix, with low return rates and low markdowns.

               Biobottoms' brand products allow the Company to distinguish
itself from other catalogs and retailers. The lower cost of these goods also
gives management more pricing flexibility. Biobottoms has increased its average
order size in each of the past few years by increasing the number of items per
order while decreasing the average item price. Biobottoms has also significantly
expanded the age range of its merchandise, testifying to the appeal of the
Biobottoms brand.

               The increase in the number of working women has provided a very
receptive environment for catalogers over the past two decades. The Company
understands that more than 70% of women aged 25 to 54 were working full time in
1993, versus 43% in 1965. The increasing number of dual income families and
single women in the workforce is expected to continue to fuel the growth of
direct marketing through the 1990's.

               Even though the Company has shifted its emphasis to the mail
order business, it continues to market Diplomat's products. The Company's plan
is to evaluate Diplomat's business and determine which areas should be
continued. Diplomat was a party to an exclusive distribution agreement ("the
Lamaze Agreement") with Ambrose & Montgomery, doing business as "Lamaze from
AMI". Pursuant to the Lamaze Agreement, Diplomat was granted the right to
utilize the Lamaze registered trademark in conjunction with the



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manufacture, advertisement, promotion, distribution and sale of various products
for infants. The Lamaze Agreement expired in July 1996.  Accordingly, the
Company no longer uses the Lamaze registered trademark.

               Although the Company has traditionally focused on direct
marketing of infant- related care and comfort products and accessories and
apparel accessories for newborns through preteens, management believes that
economic conditions in the direct marketing apparel industry are favorable. The
Company has expanded its strategy to become an industry leader in the direct
mail catalog apparel industry through its recent acquisitions of Lew Magram and
the assets of Jean Grayson's Brownstone Studio, Inc.

               Lew Magram is engaged in the direct mail catalog upscale women's
apparel and accessories business. Lew Magram mails its catalogs to prospective
target customers based on customer files and rented prospect lists.

               Brownstone is engaged in the business of selling mature women's
apparel and accessories through a mail order catalog and through a single outlet
store located in Secaucus, New Jersey.

New and Planned Products

               The Company's success depends in part upon the development of
strong brand identification for its current and proposed products. The primary
direction of the Company's marketing plan is to promote certain of its existing
products and develop new products under the various trademarks that it owns.
Achieving and maintaining market acceptance for its products will require
significant efforts and expenditures. There can be no assurance that the Company
will be successful in effecting this plan.

               Product development and selection are based upon reliability of
vendors, visual appeal, perceived customer value, and uniqueness of design.
Biobottoms utilizes customers feedback on products' performance and their
reported preferences for new product designs, fabrications and category
expansion. Biobottoms' sales are generated from both house file customers
(persons who have either previously purchased from Biobottoms or requested a
catalog) and rented mailing lists (names of current customers from other catalog
companies). Analysis of this segmentation allows Biobottoms to mail frequently
and selectively to its most responsive customers.

Manufacturing and Sourcing


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               Historically, Diplomat obtained substantially all of its raw
materials required for the manufacture of its products and shipped such
materials to contract manufacturers who assembled the products in accordance
with the Company's specifications and under its supervision, either from
facilities at the Company's Rockland County, New York warehouse and distribution
facilities, or other locations in New York State.

               Biobottoms provides for manufacturing and sourcing of products 
in  a number of ways. Private label vendors supply some high volume basics,
such  as shirts, play pants and knit shorts, where price

competitiveness is critical.

               Lew Magram and Brownstone private label products are produced by
many third part manufacturers based on design and material specifications
provided by Lew Magram and Brownstone. Branded merchandise is purchased by Lew
Magram and Brownstone merchants from third party vendors.

               Other manufacturers, that may be more costly, compared to private
label vendors, may be used for products requiring shorter lead times or testing
fashion trends. This provides greater flexibility for inventory management.
Manufacturing groups provide control of the manufacturing process by closely
supervising all phases of production with local consultants and contractors.
Manufacturing groups are a convenient source for testing new private label
product concepts. Branded merchandise from a variety of manufacturers is the
further source of products for Biobottoms.

  
Major Customers

               For the fiscal year ended September 30, 1996, two of the
Company's customers, Toys `R' Us and Wal-Mart individually accounted for
approximately 17% and 36% respectively, of the Diplomat net sales. For the
fiscal year ended September 30, 1997, such customers individually accounted for
31% and 11%, respectively, of the Diplomat division's sales. Sales to such
customers accounted for approximately 22% of the Company's sales for the nine
month period ended September 30, 1996. The Company has no written contracts with
such customers and there can be no assurance that such customers will continue
to purchase products from the Company. The loss of either of these customers
would have a materially adverse effect on the Company's business.

               In addition, the Company sold its products to approximately 500
retail accounts consisting primarily of mass merchandisers and toy retailers,
and, to a lesser extent, drug store chains, catalog showrooms, mail order
operations and food store chains. in addition to Toys 'R' Us and Wal-Mart, the
Company's customers include Burlington Coat Factory, Kids `R' Us, Winn- Dixie
Supermarkets, American Drug Stores, Eckerd Drugs, Walgreens, Caldor, Target
Stores and Publix Supermarkets. A reduction in the number of retail accounts
from prior periods reflects 


                                       7

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a change in customer mix, with an increased emphasis on mass merchandisers and
chain stores. The decrease also reflects general economic conditions which
include a decrease generally in the number of retailers.

               Neither Lew Magram and Brownstone have a single customer which
accounts for a significant portion of their sales.

               Seasonality of product is generally not a factor affecting the
Company's sales. Sales fluctuations are, however, affected by special seasonal
promotional activities of the merchandise retailer. The sales of the mail

order companies are affected by seasonality with the winter holiday season being
the strongest.

Quality Assurance

The Company's products are chosen based upon the following criteria:

                    .o   Quality
                    .o   Price/Value
                    .o   Fabric
                     o   Fit
                     o   Testing
                     o   Exclusivity
                     o   Color/Print
                     o   Styling
                     o.  Manufacturing Responsibility
                     o   Merchandising

               At least two additional features must be present that add
appropriate performance or styling benefits, including: 

                     Specialized fabrications
                     Premium construction details
                     Appropriate decorative items, such as buttons
                     Logos, Patches and Graphics to enhance brand identification

Governmental Regulation

               As a seller of infant products, the Company is subject to laws
and regulations administered by various states and the Federal Trade Commission.
As a seller of bedding products, the Company is also required to maintain
licenses in the various states where it conducts business. These licenses
subject the Company to compliance with a variety of laws and regulations
regarding the labeling and cleanliness of its products. In addition, the Company
has all of its bedding products produced to the upholstered product
specifications required by the flammability laws of 


                                       8

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the State of California, which the Company believes to be the most stringent in
the United States. The Company believes that it complies with the laws and
regulations in all material respects.

Product Liability

               The Company currently has an aggregate of $2,000,000 of product
liability insurance for its current products with an umbrella policy of up to an
aggregate of $3,000,000. The Company does not intend to increase such coverage
upon commercialization of any other product under development. There can be no

assurance that the Company's existing coverage will be sufficient to cover any
liability resulting from any product liability claims or that the Company would
have funds available to pay any claims over the limit of its insurance. Either
an under insured or an uninsured claim could have a materially adverse effect on
the Company.

Trademarks, Patents and Proprietary Rights

               The Company's success depends, in part, upon the development of
strong brand identification for its current and proposed products. Diplomat has
trademark protection for the name Ecology Kids(TM) and, since the recent asset
acquisition, Brownstone(TM) and other trademarks, and has historically relied
heavily on its right to utilize the Lamaze name in accordance with its now
expired distribution agreement with AMI. Although there can be no assurance
thereof, the Company does not believe that the inability to use the Lamaze name
will have an adverse effect on the Company.

             The Company has trademark protection to utilize the name "Fresh Air
Wear" in connection with the sale of Biobottoms' products and may apply for
other trademarks as it deems appropriate. There can be no assurance that future
trademark protection will be obtained, or that if obtained, will not be
infringed upon by others. In addition, if any of the Company's trademarks are
infringed upon, there can be no assurance that the Company can successfully
challenge any alleged infringement. In the event that it becomes necessary to
establish recognition of alternative trademarks, the cost of such development
could be substantial, and, as a result, materially adversely affect the
Company's business and prospects.

                    In November 1992 the Company acquired the four-year
exclusive license to a United States patented thermochromatic process that can
be utilized with a diaper cover to indicate wetness and soiling through heat
generated color changes. This License was entered into for the purpose of
promoting an extension of the Company's diaper cover business and for use in
developing a disposable diaper pad product combination, providing the
convenience of disposable diapers, while generating significantly less solid
waste. Plans to develop the disposable diaper pad product are not being actively
pursued at this time. The License required that the Company pay 


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fixed annual minimum royalty payments of $50,000 in 1993, $87,500 in 1994, and
$100,000 in 1995 and 1996. All minimum royalty payments required to be paid have
been paid through 1995 and the balance of the 1996 payments were paid in 1997.
The Company did not exercise its right to extend the License.

Competition

             There are a wide range of catalogs selling infant and children's
apparel in competition with Biobottoms. These vary from general catalog
merchandisers, such as JC Penney, to smaller specialty children's, apparel
catalogs. Biobottoms believes it competes primarily with the latter, which group

includes: Hanna Anderson, Playclothes, Childrens Wear Digest, Storybook
Heirlooms and Wooden Soldier. Companies in the catalog business compete on
price, product quality, features, benefits, brand name and customer service.
Biobottoms seeks to market a product line that is distinctive from its
competitors. Biobottoms also competes with non-mail order children's clothing
retailers, including specialty stores, department stores, major chains and
discount retailers. Gap Kids, Gymboree and other national retailers are also
competitors outside the direct mail industry. Although certain of these direct
competitors have greater financial and marketing resources, Biobottoms believes
that it has been able to be competitive because of its ability to offer quality
products, reasonable prices and outstanding customer service.

             Lew Magram competes in the highly competitive retail women's
apparel market specifically the retail direct market catalog women's apparel
market. Direct competitors include Spiegel, Chadwick's of Boston and J. Crew,
each of which have substantially greater resources and market share than Lew
Magram.

             The infant and toddler products industries, as well as the women's
apparel and accessory markets, are extremely competitive in the United States
and Diplomat faces substantial competition in each of its product lines. The
Company competes in a variety of segments within these product categories,
including disposable diapers, infant and juvenile furnishings, and mature
women's apparel and accessories. Competitive factors include quality, price,
style, name recognition and service. Although the Company believes that it can
compete favorably in these areas, there can be no assurance thereof.

             The mature women's apparel and accessories markets are extremely
competitive. Brownstone competes in three size categories, petite, missy and
large sizes. Brownstone competes with several catalogs serving these markets
including Talbott's, Nicole Somers, Damon's & Draper's Papillon, as well as, to
various degrees, specialty store catalogs such as Nordstrom's Sak's and Nieman
Marcus.

Employees


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               As of October 27, 1997, Diplomat had 33 full time employees in
its Stony Point facility. Of such employees, three act in executive capacities,
three are full time sales and marketing personnel, one is a customer service
representative and 26 are administrative and warehouse personnel. None of the
employees are covered by a collective bargaining agreement. The company
considers its relations with the employees to be good.

             Biobottoms employs permanent, full time and part time employees,
part time casual (not eligible for benefits), and temporary workers due to
seasonal increases in its sales volume. This allows for optimal employment
levels during peak and slack times. Also, it allows a portion of the work force
the option of flexible working hours. At October 27, 1997, Biobottoms employed
148 employees 63 of which are full time. None of the Biobottoms employees are

represented by any labor union.

             Diplomat, through a management arrangement with Lew Magram, has
been managing the business of Brownstone.

             Lew Magram has approximately 325 employees, including 225 full time
and 100 part time employees.

Item 2. Properties

Properties and Facilities

             In December 1992, Loshell Realty Corporation ("Loshell"), owner of
the real estate and buildings housing the Company's warehouse and distribution
facilities located at 25 Kay Fries Drive, Stony Point, New York (the
"Facilities'), transferred to the Company a fee interest in the Facilities,
subject to purchase money mortgage indebtedness. The Facilities consist of five
buildings aggregating approximately 40,000 square feet, located on approximately
seven acres. The Facilities had an adjusted basis of $1,984,857 when transferred
to the Company. Approximately 1,000 square feet of the Facilities are utilized
by the Company's contract manufacturers located at the premises. Sheldon R.
Rose, the Ccmpany's former President and Chief Executive officer and his wife
are the sole shareholders of Loshell. In connection therewith, the Company
assumed purchase money mortgage indebtedness of Loshell aggregating
approximately $1,799,000 ($1,101,000 with respect to a first mortgage note due
August 2010, bearing interest at an initial rate of $11.75% adjusted every three
years, commencing July 1993 (currently 6.375%) and $698,000 with respect to a
subordinated mortgage note originally due July 1995, but extended to January
1998, bearing interest at an initial rate of 11.5% per annum. Mr. Rose and his
wife have personally guaranteed payment of the first mortgage, and Mr. Rose and
Loshell are co-makers of the subordinated mortgage note. The Company pays
approximately $26,000 per month for both mortgage payments and real estate
taxes.


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               Biobottoms leases approximately 17,60O square feet of office
space and 18,700 square feet of warehouse space in Petaluma, California. In
addition, Biobottoms leases 1,700 square feet of retail space in Petaluma,
California. Total fixed monthly payments (exclusive of any applicable common
area maintenance charges) currently under these leases is $28,632 and the lease
agreements provide for fixed annual increases. The office lease and warehouse
leases expire on July 1, 1998. No determination has been made as to whether
either or both of these leases will be renewed. These properties are adequate
for current planned operations. Other suitable facilities are available at
competitive prices and terms. The retail lease for Petaluma renews bi-annually.

               Brownstone has moved from its Secaucus facility and is operating
from the facilities of Lew Magram in Teaneck, New Jersey. Lew Magram leases
approximately 73,000 square feet of warehouse and office space in Teaneck, New
Jersey. Total fixed monthly charges are approximately $49,000 subject to annual

escalation clauses. The lease expires in August 1999, subject to two five-year
renewal options. Lew Magram also leases approximately 13,000 square feet in New
York City at $19,000 per month. .

Item 3. Legal Proceedings

                   In September 1996, the Company was named as a defendant in an
action brought in the Supreme Court of the State of New York, County of Rockland
(Richard Tracy and Anne Tracy v. Insulx Product Corporation, Consolidated Rail
Corporation, Diplomat Corporation and Bruce M. Smith Contracting Corporation).
Mr. Tracy alleges that the defendants negligent maintenance of a railroad
crossing adjacent to the Company's property caused him to collide with a train.
Mr. Tracy is seeking $10,000,000 in damages for his injuries, and Mrs. Tracy is
seeking an additional $1,000,000 in damages for loss of Mr. Tracy's services.
The Company and its insurance carrier intend to vigorously defend against these
claims. The ultimate outcome of this litigation cannot presently be determined.
Accordingly, no provision for the liability has been made in the accompanying
financial statements. Additionally, the Company maintains $1,000,000 of
insurance coverage which could be applied to any liability posed by this matter.

             In February 1997, Francine Nichols, a former consultant to the
Company, commenced an action against the Company in the Supreme Court of the
State of New York, New York County, to recover approximately $240,000 allegedly
due under a consulting agreement between Ms. Nichols and the Company. The
Company disputes each claim and intends to vigorously defend against them.
However, should the claimant prevail, the result may have a material adverse
affect on the Company.

             In July 1997, Federal Express commenced an action against
Biobottoms claiming approximately $180,000 in unpaid delivery invoices.
Biobottoms has disputed this claim and has filed a counter claim on
several


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bases, one of which is nonperformance. Although Biobottoms intends to vigorously
defend against the claim, should the claimant prevail, the result may have a
material adverse affect an Biobottoms and the Company.

             In November 1997, Lew Magram was served with a proposed assessment
from the State of New York related to a sales tax audit aggregating
approximately $2.4 million, including penalties and interest. Lew Magram
disputes the assessment and intends to vigorously defend against it. Although
the Company is entitled to indemnification by certain selling Lew Magram Ltd
shareholders, an unfavorable result could have a material adverse effect on the
Company.
             Other than the above claims, the Company has no notice of any
pending or threatened material litigation.

Item 4. Submission of Matters To A Vote Of Security Holders

             During the fiscal year covered by this report, the Company did not
submit any matters to a vote of security holders.











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                                  PART II

Item 5. Market for the Company's Common Stock and Warrants

      As of the date hereof, the Company has outstanding its Common Stock $.0001
par value ("Common Stock") and Warrants to purchase its Common Stock
("Warrants"). The principal market for the Common Stock and Warrants is the
NASDAQ Small Cap Market ("NASDAQ") under the symbols of DIPL and DIPLW,
respectively. The following table sets forth the closing high and low bid prices
for the Common Stock and Warrants for each calendar quarter.The prices represent
inter-dealer quotations without adjustment for retail markups, markdowns or
commissions and may not represent actual transactions. NASDAQ quotations do not
assume that the market for the Company's securities will be sustained,

                                      Common Stock          Warrants
                                      ------------          --------

                                          Bid
                                          ---

For Fiscal Year Ending
September 30, 1996                   High       Low         High     Low
------------------                  -----      ----        -----     ---

First Quarter                       3 3/8      1 5/8        1/16     1/4
Second Quarter                      2 1/2      1 1/8        1/2      1/4
Third Quarter                       2 1/8      1 1/16       -        3/16
Fourth Quarter                      2          1 5/16       1/4      1/16

September 30, 1997
------------------

First Quarter                       2          7/8          3/16     3/16
Second Quarter                      2 3/8      7/8          7/16      1/4
Third Quarter                       3 1/2      1 5/8        15/16     1/4
Fourth Quarter                      3 5/8      2 5/8        1         7/16


        The Common Stock and Warrants commenced trading on NASDAQ on November
4,1993.

        The Company believes that there are approximately 2,200 beneficial
owners of each of its securities.


                                       DIVIDEND POLICY

               The Company has not paid any dividends on its Common Stock and
does not anticipate paying cash dividends in the foreseeable future, The Company
intends to retain any earnings to finance the growth of the Company. There can
be no 


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assurance that the Company will ever pay cash dividends pursuant to the
Company's credit agreement with its commercial lender and the terms of
indebtedness incurred in connection with the acquisition of Biobottoms.









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

RESULTS OF OPERATIONS

Twelve Months Ended September 30, 1997 Compared to Twelve Months Ended September
30, 1996

NET SALES

          Consolidated net sales for the Twelve Month Period ended September 30,
1997 ("1997 Period") increased approximately $3,908,000 or 19% from the Twelve
Month Period ended September 30, 1996 ("1996 Period"). The sales of Diplomat
for the 1997 Period were $6,893,000 as compared to $8,904,000 for the 1996
Period and the sales of Biobottoms were $17,592,000 in the 1997 Period as
compared to $17,378,000 in the 1996 Period.

           Consolidated cost of sales were 48% of net sales in the  1997 Period
and 71% in the 1996 Period. The cost of sales were $11,659,000 in the 1997
Period. Cost of sales of Diplomat for the 1997 Period were $3,585,000 as
compared to $8,738,000 in the 1996 Period. The reduction of 59% was the result
of the restructuring of the Company during the 1997 Period and from lower sales.
Cost of sales of Biobottoms decreased 1% even

though sales increased less than 1% from the 1996 Period to the 1997 Period.

OPERATING EXPENSES

          Consolidated operating expenses, which include selling, general,
administrative, warehouse and distribution expenses increased approximately
$1,868,000 from the 1996 Period to the 1997 Period. Operating expenses of
Diplomat for the 1997 Period were $1,872,000 as compared to $4,809,000 in the
1996 Period. The reduction of 61% resulted from decreased expenses from
restructuring, in addition to elimination of licensing fees and lower
professional, advertising and consulting fees in the 1997 Period together with
the settlement of lawsuits and adjustment of accrued expenses. Operating
expenses of Biobottoms decreased 4% from the 1996 Period. Consolidated operating
expenses were 48% of net sales in the 1997 Period and 66% in the 1996 Period.

          Interest expense decreased 52% from 1996 to 1997 as a result of the
conversion of debt to preferred stock by a principal stockholder.

          The net income for the 1997 Period was $756,047 as compared to a net
loss of $8,404,000 for the 1996 Period.


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          At September 30, 1997, the Company has recorded deferred tax assets of
$1,362,000. The full utilization of such deferred tax assets is dependent upon
the Company realizing taxable income in future years. The total amount of future
taxable income for utilizing such deferred tax assets will be approximately
$3,400,000. Based on the current year's operations, such realization would take
approximately three years.

Nine Months Ended September 30, 1996 Compared to Nine Months Ended September 30,
1995

NET SALES

          Consolidated Net Sales for the None Month Period ended September 30,
1996 ("1996 Period") decreased approximately $958,000 from the Nine Month Period
ended September 30, 1995 ("1995 Period") primarily as a result of lower sales of
Diplomat for the period. The lower sales in 1996 were impacted significantly by
an adverse retail environment that continued fro the last quarter of 1995. The
sales of Diplomat decreased 24% and the sales of Biobottoms increased 16% from
1995 to 1996.

          Consolidated cost of sales were 69% of net sales in 1996 and 52% in
1995. Cost of sales of Diplomat increased 32% primarily from a writedown of
inventory from its restructuring.

          Cost of sales of Biobottoms increased 16% as a result of an increase
in sales.


          For the 1996 period, Toys "R" Us and Wal-Mart represented 11% and 40%
respectively of the Diplomat sales as compared to 32% and 22% in 1995.

OPERATING EXPENSES

          Consolidated operating expenses, which include selling, general,
administrative, warehouse and distribution expenses, increase $1,400,000 from
1995 to 1996. The increase resulted primarily from increased catalog expenses of
Biobottoms. The operating expenses of Diplomat increased by a minor amount from
1995 to 1996. Consolidated operating expenses were 55% of net sales in 1996 and
45% in 1995.

         The Company restructured its Stony Point, New York operations by
eliminating several of its unprofitable retail lines and downsizing its
distribution facility. The Company intends to focus its Stony Point operations
on its traditional core business. The restructuring expenses total approximately
$1,739,000 for the period ended September 30, 1996.

          Interest expenses decreased $141,000 in 1996 as a result of Biobottoms
decreased borrowing at lower rates.


                                       17

<PAGE>

          The net loss for the 1996 Period was $7,225,000 as compared to a net
loss of $721,000 for the 1995 Period. Significantly lower sales of Diplomat
during 1996, without corresponding reductions in operating expenses and
additional interest expenses from the acquisition were the principal components
for the loss in 1996, in addition to the restructuring expenses. Biobottoms had
a net loss of $1,150,000 from the date of acquisition.

          The following summary combines the consolidated results of operations
of the Company and Biobottoms as if the acquisition had occurred at the
beginning of fiscal 1995, after giving effect to the amortization of goodwill
and increased interest expense on the acquisition debt.

                                         Nine Months              Pro-Forma
                                           Ended              Nine Months Ended
                                     September 30, 1996       September 30, 1995
                                    
Net Sales                                $19,222,801              $20,180,355
Cost of Sales                             13,334,588               10,569,150
                                          ----------               ----------
Gross Profit                               5,888,213                9,611,205
                                         -----------               ----------
Selling, General & Administrative         10,589,561                9,179,201
Restructuring Expense                      1,738,975                    0
                                           ---------                    -
Operating Income(Loss)                    (6,440,323)                 432,004
Interest Expense                             784,577                  933,895
                                             -------                 --------
                                    

Loss before Income Taxes                  (7,224,900)                (501,891)
Income Taxes (Benefit)                          0                    (173,072)
                                                -                    ---------
Net Loss                                 $(7,224,900)               $(328,819)
                                    
Liquidity and Capital Resources     
                                
        The Company completed an initial public offering on November 13, 1993
and received net proceeds of approximately $4,454,000. Proceeds of the offering
were used for purchases of inventory, marketing and promotion, product
development, reduction of accounts payable and repayment of loans from a
principal stockholder and executive officer. The Company has relied upon the
proceeds of its initial public offering, borrowings from an institutional
lender, a principal stockholder and director of the Company, and proceeds from
the exercise of convertible securities in 1995, 1996 and 1997 in order to fund
its operation.

         The Company's principal working capital credit facility is provided by
Congress Financial Corporation ("Congress Financial").


                                       18

<PAGE>

        In April 1994, the Company entered into an agreement with Congress
Financial providing the Company with a maximum $3,000,000 secured line of credit
to be used for loans and trade letters of credit. The loans are secured by
substantially all of the Company's personal property, including without
limitation, accounts receivable, inventory and trademarks. The interest rate on
loans is two (2%) above the prime rate announced by Core States Bank. The credit
agreement contains restrictions relating to the payment of dividends.
Additionally, prior to amendment, the Company was required to maintain a minimum
of $3,500,000 in stockholders equity and a minimum of $4,500,000 of working
capital (excluding the Congress loan and certain subordinated debt). At
September 30, 1996, the Company was not in compliance with these financial
covenants, however Congress continued to extend the Company credit under the
terms of the original agreement. On February 25, 1997, the violations were
waived by Congress, and the Company and Congress agreed on revised financial
covenants. Under the revised agreement, the stockholders equity and working
capital minimums (excluding the Congress loan and certain subordinated debt)
were reduced to (750,000) and 500,000, respectively, and was increased during
the fiscal year ending September 30, 1997 to (250,000) and 1,500,000,
respectively. The Company has been in compliance with the revised financial
covenants at each measurement date.

         Under the terms of the credit agreement, the Company could borrow up to
85% (reduced to 80% in the third quarter of 1997) of the amount of eligible
accounts receivable (as defined in the agreement), not to exceed the maximum
credit. In February 1995 the Agreement was amended to adjust the formula used to
determine the amount available for revolving loans by including therein an
amount based upon eligible inventory not to exceed $750,000.

         In connection with that amendment, Robert Rubin, a director and

principal stockholder of the Company, furnished the lender with a personal
limited guarantee up to a maximum liability of $375,000, pertaining to loans
made based upon eligible inventory. In connection with the initial Congress
transaction, the Company borrowed from Robert Rubin $590,000 on a secured term
loan basis, subordinated to Congress Financial, in order to repay in full its
then existing outstanding principal indebtedness to Citibank, N.A. Such Citibank
facility in the initial principal amount of $650,000, was established in June,
1993, secured by certain assets of the Company and a shareholder guaranty from
Mr. Rubin. The loan from Mr. Rubin was repayable with interest at the prime rate
plus 1 1/2%, with required principal payment amortization identical to the terms
applicable to the Citibank loan terms. Accordingly, the Company made principal
payments of $120,000 in 1994, $120,000 in 1995, $175.000 in 1996 and would have
been required to make payments of $174,800 in 1997. The balance of this debt was
converted into Preferred Stock in September 1996.

         In connection with the Biobottoms acquisition, the Company incurred
debt of $4,303,100 consisting of Deferred Payment Notes, payable to (i) the
former Biobottoms stockholders in the amount of $1,500,000, (ii) Mr. Rubin in
the amount of $2,353,000,and (iii) American United Global in the amount of
$450,000. The American


                                       19

<PAGE>

United Global loan was paid in May, 1996. The note to the former Biobottoms
Stockholders was paid in July 1997.

         Effective September 30, 1996, Mr. Rubin, a director and principal
stockholder of the Company, agreed to convert an aggregate of $2,900,000 in
outstanding debt into an aggregate of 290,000 Shares of Series B Preferred
Stock, which pay an annual dividend of 9% based on per share liquidation value.

         The Company issued to Mr. Rubin an aggregate of 550,000 shares of
Common Stock in consideration of Mr. Rubin's waiver of certain compensation owed
to him and for restructuring certain debt owed to him, waiving certain defaults
and making additional loans to the Company in the aggregate amount of $600,000.
As of September 30, 1996, the $600,000 loan was converted into 60,000 shares of
Series C Preferred Stock, which pay an annual dividend of 9% based on per share
liquidation value.

         In connection with the February 9, 1996 closing on the Biobottoms
acquisition (the "Closing"), Biobottoms established an inventory based credit
facility with Congress Financial Corporation, the Company's principal lender,
secured by a first priority security interest in substantially all of the assets
of Biobottoms and a guaranty of such obligations by the Company (the "Biobottoms
Congress Loan Facility"). The maximum credit available under the facility is
$2,000,000 and on the date of Closing $648,531 was available and borrowed.

         The Biobottoms/Congress Loan Facility is guaranteed by the Company and
a default thereunder constitutes a default under the Company's Loan and Security
Agreement with Congress. The interest rate charged on the loan is the prime rate

as announced by Core States Bank, N.A. (the 'Prime Rate') plus 2%. At September
30, 1996, Biobcttoms was not in compliance with certain covenants of the loan
agreement, however Congress continued to extend Biobottoms credit under the
terms of the original agreement. On February 25, 1997 the violations were waived
by Congress, and Congress and the Company agreed on revised financial covenants
for the remainder of the Company's fiscal year ending September 30, 1997. The
Company expects to be in compliance with the revised financial covenants at each
measurement date.

         In February 1997, Mr. Rubin made an additional loan to the Company in
the amount of $200,000. This loan, and the Series B and C Preferred Stock are
referred to hereafter as the "Rubin obligations."

         In September, 1997, Mr. Rubin made an additional loan to the Company in
the amount of $1,200,000.


                                       20

<PAGE>

         The Deferred Payment Notes and the Rubin obligations are, and the
American United loans were, subject to an Intercreditor Agreement with Congress
Financial (the "Intercreditcr Agreement") which has the effect of restricting or
limiting enforcement remedies under the promissory notes evidencing the Deferred
Payment and the Rubin Obligations prior to repayment of the senior debt payable
to Congress Financial and restricting the repayment of principal payable thereon
based upon certain minimum excess loan availability requirements.

        The Intercreditor Agreement also provides that irrespective of the
relative priority status between the holders of the Deferred Payment Notes and
the Rubin Obligations, repayment of the Deferred Payment is permitted to be paid
provided that there has been no default of senior debt payable by the Company or
Biobottoms to Congress, minimum excess availability requirements under the
Company's loan facility with Congress are satisfied and such payments are made
with proceeds from a subsequent sale of its capital stock. Subject to the
Intercreditor Agreement, the Deferred Payment and the Rubin obligations were
payable from the proceeds from any sale of capital stock by the Company in the
proportions of 40% on account of the Deferred Payment and 60% on account of the
Rubin Obligations, except that before any such distributions are made, the
Company will be required to reduce the outstanding principal amount of the
Deferred Payment by $150,000. These provisions were amended on February 25,
1997, such that the proceeds of a private placement of the Company's Common
stock shall be applied first to repay in full the principal of, and all accrued
interest on, the Deferred Payment Notes.

        The Intercreditor Agreement contains provisions to the effect that prior
to March 1, 1998, no principal amount of the Rubin obligations may be repaid,
except from proceeds from the sale of capital stock by the Company, subject in
all respect to the Intercreditor Agreement. Commencing March 1, 1998 and subject
to the provisions of the Intercreditor Agreement, including without limitation
the requirement that the Company have certain minimum levels of excess loan
availability at the time of the making of any such principal payment, the Rubin
obligations are subject to principal payments monthly of the amount equal to 25%

of the Company's net profit for the second preceding month, plus depreciation
and amortization expenses for said month, with the unpaid principal amount of
the Rubin Obligations and unpaid interest accrued thereon payable in full on
February 9, 1999.

         In connection with the Biobottoms /Congress Loan Facility, Mr. Rubin
also issued to Congress his written commitment to provide additional term loans
to the Company, not to exceed in the aggregate the principal amount of $300,000,
such loans to be made solely at the discretion of Congress. Proceeds from any
such loans may only be used by the Company to provide working capital for
Biobottoms.

        Proceeds from the Congress loan and the Rubin/American United Loans were
used on February 9, 1996 or remained otherwise available as of that date as
follows:


                                       21

<PAGE>

               Payment at Closing of Biobottoms'
               Institutional Secured Lender                 $1,448,025

               Cash portion of Biobottoms Purchase
               Price                                         1,000,000

               Loan Costs and Legal Fees                        96,690

               Available Working Capital                     1,103,816

         At the time that the Biobottoms acquisition was completed, additional
equity financing was contemplated to fund the scheduled payments of the
acquisition debt and working capital requirements for the Diplomat and
Biobottoms businesses. Such financing was not secured within the time
constraints contemplated by the management of the Company. As a result, the
acquisition debt was not paid when due. In addition, the Company is experiencing
severe working capital shortages and requires additional capital resources to
fund its existing operations. Under Diplomat's and Biobottoms' lending
facilities with Congress Financial, the Company has borrowed the maximum amounts
available as of the date hereof and there is no unused loan availability. The
company is pursuing a number of financing alternatives, although there can be no
assurance that such efforts will result in necessary financing or that the terms
of such financing will be on terms favorable to existing stockholders. The
failure to secure additional working capital and funds to pay the Biobottoms
acquisition debt will materially adversely affect the business and financial
condition of the Company. Insufficient working capital may require the Company
to reduce operations significantly.

         In July 1995, the Company, in connection with a financial consulting
agreement, issued to Boulder Enterprises, Inc., Class B, Class C and Class D
Warrants, each exercisable for 500,000 shares of common stock, at $1.37, $1.00
and $3.00 per share, respectively. All of the Class B Warrants were exercised
during 1995 providing the Company with net proceeds of $628,000. The Class D

warrants expired in July, 1996. The Class C Warrants were exercised in April
1997 providing the Company with proceeds of $500,000.

         In August 1996, the Company, in connection with a Non-Qualified Stock
Option Plan, issued 500,000 options which were exercised at a price of $.95 per
share in November 1996, the Company, in connection with an Incentive Stock
option Plan, issued 1,060,000 options at an exercise price of $1.00 per share.

         In May 1997, the Company, in connection with a Private Placement,
offered 1,250,000 shares of Common Stock at a price of $2.00 per share.


                                       22

<PAGE>

         There can be no assurance that the Company will operate profitably in
the future or that cash from operations will become the principal source of
funds for operations.

         During the twelve months ended September 30, 1997, there was a decrease
in cash flow from operating activities of approximately $2,342,000 primarily
from an increase in inventory required for the sale of seasonal products. This
increase was funded by the revolving line of credit from Congress, loans from
Robert Rubin and the proceeds from the issuance of stock.











                                       23

<PAGE>


PART III

Item 9.     Directors and Executive Officers, Promotors and Control Persons
            Compliance with Section 16(a) of the Exchange Act
            
Directors and Executive Officers and Key Employees

The Directors, Executive Officers and Key Employees of the Company are as
follows:

     Name                          Age               Position
     ----                          ---               --------


     Robert M. Rubin               57       Chairman of the Board and Director

     Jonathan Rosenberg            37       President, Chief Executive officer
                                            and Director

     Stuart A. Leiderman           53       Executive Vice President - Sales
                                            and Marketing and Director

     Warren H. Golden              55       Executive Vice President,
                                            Chief Operating Officer and
                                            Director 

     Irwin Oringer                 61       Chief Accounting officer and
                                            Controller

     Howard Katz                   56       Director

     Wesley C. Fredericks, Jr.     49       Director


        Jonathan Rosenberg was appointed to the Board of Directors in July 1995
and has been President and Chief Executive officer since November 1996. Since
1993, Mr. Rosenberg served as an independent consultant to the Company,
providing advice in the operations and finance areas and in long-term strategic
planning. From 1987 until 1993, he was President and Chief operating officer of
Servtex International, Inc., a New York based company engaged in international
sourcing of imports and manufacturing activities on an agency basis for textile
related products.

        Stuart A. Leiderman has served as Executive Vice President of Sales and
Marketing since July 1989, and has been a Director of the Company since June
1992. From 1965 to 1969, Mr. Leiderman was a Divisional Vice President for
Hasbro, Inc., 


                                       24

<PAGE>

Playskool Baby Division, a company engaged primarily in the development, sales
and marketing of toys.

        Robert M. Rubin has served as a Director of the Company since June 1992
and has been Chairman since November 1996. Since December 5, 1995, Mr. Rubin has
been a Director of Help at Home, Inc., a public company engaged in the business
of providing homemaker and general housekeeping services to elderly and disabled
persons at home. Since June 1994, Mr. Rubin has been a Director of Kaye Kotts
Associates, Inc., a public company that provides representation for delinquent
tax payers before tax authorities. In October 1996, Mr. Rubin became a director
of Med-Emerg International Inc., an operator of nursing homes and related

healthcare services. Currently, Mr. Rubin is also a director of Arzan
International, an Israeli food distributor.

         Mr. Rubin has served as the Chairman of the Board of Directors of
Western Power Equipment Corporation ("WPEC"), a construction equipment
distributor since November 20, 1992 . Between November 20, 1992 and March 7,
1993, Mr. Rubin served as Chief Executive Officer of WPEC. Between October 1990
and January 1, 1994 Mr. Rubin served as the Chairman of the Board and Chief
Executive officer of American United Global Inc., a telecommunications and
software company ("AUGI") and since January 1, 1994, solely as Chairman of the
Board of AUGI. Mr. Rubin was the founder, President, Chief Executive officer and
a Director of Superior Care, Inc. ("SCI) from its inception in 1976 until May
1986 and continued as a Director of SCI (now known as Olsten Corporation
("Olsten") until the latter part of 1987. Olsten, a New York Stock Exchange
listed company is engaged in providing home care and institutional staffing
services and health care management services. Mr. Rubin was formerly a Director
and Vice Chairman, and is a minority stockholder of American Complex Care,
Incorporated ("ACCI"), a public company which provided on-site health care
services, including intradermal infusion therapies. In April 1995, the principal
operating subsidiaries of ACCI petitioned in the Circuit Court of Broward
County, Florida for an assignment for the benefit of creditors. Mr. Rubin is
also a Director, Chairman and minority stockholder of Universal Self Care, Inc.,
a public company engaged in the sale of products used by diabetics, and Response
USA, Inc., a public company engaged in the sale and distribution of personal
emergency response systems. Mr. Rubin is also Chairman, Chief Executive officer
and a Director and a principal stockholder of ERD Waste Corp.("ERD"),a public
company specializing in the management and disposal of municipal solid waste,
industrial and commercial nonhazardous solid waste and hazardous waste. ERD and
its subsidiaries filed a petition under Chapter 11 of the federal bankruptcy
laws, which is pending.

         Warren H. Golden was appointed to the Company's Board of Directors and 
as Executive Vice President and Chief Operating Officer of the Company in
January, 1998 . Mr. Golden has been with Lew Magram Ltd. since 1991, From 1989
to 1991, he was with S.C. Corporation with S.C. Corporation , most recently as
President. From 1983 to 1989, he was Vice President of Operations, CFO and
Treasurer of Honeybee, Inc. In 1986, he 


                                       25

<PAGE>

became a Director of Honeybee. Prior to Honeybee, Mr. Golden was Senior Vice
President, Operations and Control, for Plymouth Shops, a New York apparel
retailer. Mr. Golden is a graduate of Long Island University.

         Irwin Oringer, a Certified Public Accountant, has been Chief Accounting
officer and Controller of the Company since September 1992. From October 1991,
until he joined the Company in September 1992, Mr. Oringer was Corporate
Controller of Trans-National Trade Development Corporation, a company engaged in
the business of importing diversified consumer products. From 1968 to 1991 he
held a variety of financial management positions with subsidiaries of Kenrich,
Inc., a holding company for businesses engaged in the wire and cable business.
In February 1991, Kenrich and its subsidiaries filed a petition

under Chapter 11 of the Federal bankruptcy laws and was subsequently liquidated.

         Howard Katz has been a Director of the Company since October 1996. Mr.
Katz has been Executive Vice President of American United Global, Incorporated
since April 15, 1996. From December 1995 through April 15, 1996 Mr. Katz was a
consultant for, and from January, 1994 through December, 1995 he held various
executive positions, including Chief Financial officer with, National Fiber
Network (a fiber optics telecommunications company). From January 1991 through
December 1993 Mr. Katz was the President of Katlaw Construction Corporation, a
company that provides general contractor services to foreign embassies and
foreign missions located in the United States.

         Wesley C. Fredericks, Jr. has been a director of the Company since July
1997. Since 1994, he has been a member of the law firm of Gersten, Savage,
Kaplowitz & Fredericks, LLP. From 1990-1994, Mr. Fredericks was a principal in
and president of Manufacturers Products Co., an automotive supply company.

         On December 23, 1997, the Board approved an increase in the size of the
Board from five to seven directors. Directors of the Company are elected for one
year terms or until their successors are elected, and Officers serve at the
pleasure of the Board of Directors.

Item 10. Executive Compensation

The following table sets forth a summary of the compensation paid to or accrued
by the Company during the fiscal period ended September 30, 1997 to the
Company's Chief Executive Officer and to each of the other most highly
compensated executive officers of the Company determined as of the end of the
last fiscal year.

Name                                Annual                   
and                                 Compensation (1)       Restricted
Principal Position      Year        Salary                 Stock Award
------------------      ----        ------                 -----------


Sheldon R. Rose         9/30/96     $159,375                    0
CEO                     1995        $191,047



                                       26
<PAGE>

 (Resigned 11/96)

Jonathan Rosenberg      9/30/97     $190,769                    0
CE0                     9/30/96     $130,804
(Elected 11/96)

Stuart Leiderman        9/30/97     $150,000                    0
Executive Vice          9/30/96     $112,500
President               1995        $139,334



(1)   The Company did not issue any bonuses, other annual compensation, stock
appreciation rights or long term incentive plan payouts to any of the named
individuals in the Summary Compensation Table.

         In January 1996, Jonathan Rosenberg, a director of the Company, became
a full time employee of the Company, serving with the title of chief operating
officer. His compensation on an annualized basis for 1996 was $175,000. In
addition to benefits generally available to senior level employees of the
Company, he receives an automobile allowance of $750 per month. In connection
with his employment, he was granted 75,000 incentive stock options, having an
exercise price of $1.50 per share, exercisable over a five (5) year period,
15,000 shares per year.





                OPTIONS/SAR GRANTS IN LAST FISCAL YEAR
                --------------------------------------

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------
                                                     Realizable
                                                     Value at
                                                     Assumed
           Individual Grants                         Annual Rates        
                                                     of                  
                                                     Stock Price         Alternative (f)
                                                     Appreciation for    and (g): Grant
                                                     Option Term         Date Value

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

--------------------------------------------------------------------------------------------------
Name           Number of    Percent of      Exercise    Expiration   5%     10%($)    Grant Date
(a)           Securities     Total          of          Date         (f)     (g)      Present
              Underlying    Options/SARs    Base Price      (e)                       Value $
              option/SARs   Granted to      ($/Sh)                                       (h)
              Granted (#)   Employees in     (d)
                (b)         Fiscal Year
                                (c)
--------------------------------------------------------------------------------------------------
<S>           <C>           <C>            <C>          <C> 
Jonathan      250,000       100%           $1.00        2007
Rosenberg
--------------------------------------------------------------------------------------------------
</TABLE>

                                       27

<PAGE>


<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------
<S>           <C>           <C>            <C>          <C> 
Stuart        100,000       100%           $1.00        2007
Leiderman
--------------------------------------------------------------------------------------------------
</TABLE>


        In September 1996, the Company entered into an arrangement with Gersten,
Savage, Kaplowitz & Fredericks, LLP ("GSK&F") which provided that GSK&F will
provide certain legal and consulting services to the Company over an extended
period of time. As compensation for its services, certain individual members of
the firm received an aggregate of 350,000 shares of Common Stock and options to
purchase an aggregate of 150,000 shares of Common Stock at $2.50 per share.

Employment and Related Agreements

        Sheldon R. Rose was employed under a three-year employment agreement
commencing on or about November 4, 1993, pursuant to which he was paid a base
salary of $175,000 per annum and was entitled to an annual cash bonus, based
upon the Company's reported pre-tax income from operations. In April 1994 the
Board of Directors approved a $37,500 increase to Mr. Rose's employment
agreement. No bonuses have been paid to Mr.Rose in the preceding three years. In
November 1996, the Company entered into a termination agreement with Mr. Rose.
The termination agreement provided for the cancellation of Mr. Rose's agreement
with the Company and his resignation as a Director of the Company.

      The agreement provided that the Company will pay Mr. Rose an aggregate of
$70,833 over a four month period as severance pay. As part of the agreement, the
Company and certain of its affiliates would either purchase or cause to be
purchased an aggregate of 1,019,000 shares of the Company's Common Stock for an
aggregate of $475,000.

        Stuart A Leiderman was employed under a three-year employment agreement
commencing on or about November 4, 1993, pursuant to which he is paid a base
salary of S150,000 per annum and is entitled to an annual bonus as determined by
the Board of Directors. No bonuses have been paid to Mr. Leiderman in the three
preceding fiscal years. The Company also provides and maintains an automobile
for Mr. Leiderman. Although the employment agreement has expired, Mr. Leiderman
is currently employed under the same terms.

        In January 1994, the Company entered into a three year financial
consulting agreement with Robert M. Rubin, a director and principal stockholder
of the Company, pursuant to which he is paid $125,000 per annum. In September
1996, this agreement was extended until December 31, 1998.

        In March 1994, the Company entered into a consulting agreement with
Francine H. Nichols to render consulting services pertaining to the development
and promotion


                                       28


<PAGE>

of new products to be manufactured, marketed or distributed by the Company,
which included the development of educational and developmental toy products not
presently developed by the Company. In order to assist the Company in the
implementation of its marketing and product promotion strategies, she prepared
written educational editorial material relating to infant and child care to be
included with or printed on packaging of Company products, and for pamphlets and
similar materials to be distributed by the Company with its products. The
agreement expired December 31, 1996 and was not extended. It provided that the
Company will pay Ms. Nichols a consulting fee in the amount of I% of net sales
(as defined in the agreement) of products sold, marketed or distributed by the
Company with the trademark "Lamaze From AMI" or any variation thereof, The
maximum consulting fee in any year may not exceed $200,000.

      In September 1996, the Company entered into an arrangement with Gersten,
Savage, Kaplowitz & Fredericks, LLP ("GSK&F") which provided that GSK&F will
provide certain legal and consulting services to the Company over an extended
period of time.

        As compensation for its services, certain individual members of GSK&F
received an aggregate of 350,000 shares of Common Stock and options to purchase
an aggregate of 150,000 shares of Common Stock at $2.50 per share.

        In June, 1997, the Company entered into an arrangement with Shanna L.
Wolf and Marc E. Lehmann which provided for financial and investor relations
services to the Company. As compensation for the services, the consultants will
receive a total of $2,500 per month and options to purchase 25,000 shares each
of Common Stock at $1.75 per share.

        In August, 1997, the Company entered into an agreement with Robert
Selame which provided for consulting services with regard to new product ideas.
As compensation for the services, the consultant will receive a 3% royalty on
sales of the new products and options to purchase 150,000 shares of Common Stock
at $1 7/8 per share.

        In January, 1998, each of Irving Magram, Warren Golden and Stephanie
Sobel entered into employment agreements with the Company or Lew Magram. The
employment agreement between the Company and Warren Golden provides that Mr.
Golden will be employed as the Company's Executive Vice President and Chief
Executive Officer and Lew Magram's Executive Vice President for three years,
subject to annual renewals, at an annual salary of $200,000. The employment 
agreement between Irving Magram and Lew Magram

                                       29

<PAGE>

           

provides that Mr. Magram will be employed as President of Magram for three
years, subject to annual renewals, at an annual salary of $200,000. The
employment agreement between Stephanie Sobel and Lew Magram provides that Ms.
Sobel will be employed as Senior Vice President of Marketing for three years,
subject to annual renewal, at an annual salary of $172,500.

Stock Option Plan

         The Company's 1992 Stock Option Plan ("1992 Stock Option Plan")
provides for the issuance of up to 200,000 shares of Common Stock upon exercise
of incentive stock options and is intended to qualify under Section 422 of the
Internal Revenue Service Code of 1986, amended ("Code").

         The Stock Option Plan may be administered by the Board of Directors or
by a stock option committee of the Board of Directors (the "Committee").
incentive stock options are granted under the Stock option Plan to employees
generally on the basis of the recipient's responsibilities and the achievement
of performance objectives. Subject to the limitations set forth in the Stock
Option Plan, the Board or the Committee has the authority to determine when the
options may be exercised and vest. Under the Plan, the per share exercise price
may not be less than the greater of 100% of the fair market value of the shares
on the date of grant. With respect to any participant who owns stock possessing
more than 10% of the voting rights of the Company's outstanding capital stock,
the per share exercise price must be at least 110% of the fair market value on
the date of grant and the term may not be longer than five years. As of this
date, the Company has outstanding an aggregate of 130,000 Stock options,
exercisable at $1.50 per share, all of which are held by affiliates or employees
of the Company at the time of grant.

August 1996 Stock Option Plan

         The Company also established a non-qualified stock option plan
providing for the issuance of up to 1,500,000 shares of Common Stock to its
directors, officers, key employees and consultants (the "August 1996 Plan"). To
date, the Company has granted directors, officers and key employees an aggregate
of 150,000 incentive and non-qualified stock options, at an exercise price of
$2.00 per share and 500,000 non-qualified stock options issued and exercised by
a consultant. Future grants could have an adverse affect on the market price of
the Company's securities.

November 1996 Stock Option Plan

         Under the Company's November 1996 Incentive Stock Option Plan (the
"November 1996 Plan), options to purchase a maximum of 1,500,000 shares of


                                       30

<PAGE>

Common Stock of the Company (subject to adjustments in the event of stock
splits, stock dividends, recapitalizations and other capital adjustments) may be
granted to employees, officers and directors of the Company and other

persons who provide services to the Company. As of the date of this Prospectus,
1,060,000 of such options have been granted at an exercise price of $1.00, and
150,000 have been granted at an exercise price of $2.375. The options to be
granted under the Plan are designated as incentive stock options or
non-incentive stock options by the Board of Directors which also has discretion
as to the persons to be granted options, the number of shares subject to the
options and the terms of the option agreements. Only employees, including
officers and part time employees of the Company, and non-employee directors,
consultants and advisors and other persons who perform significant service for
or on behalf of the Company, may be granted incentive stock options. officers
and directors who currently own more than 5% of the issued and outstanding stock
are not eligible to participate in the Plan.

           The Plan provides that options granted thereunder shall be
exercisable during a period of no more than ten years from the date of grant,
depending upon the specific option agreement, and that, with respect to
incentive stock options, the option exercise price shall be at least equal to
100% of the fair market value of the Common Stock at the time of the grant.

Employee Pension Plan

           In 1985, the Company instituted a pension plan (the "Pension Plan"),
which is a defined benefit pension plan maintained for all employees. Benefits
are payable based on 60% of average compensation for the three highest paid
consecutive years of service, reduced for less than 29 years of service
retirement. The Pension Plan is funded as required by the Employee Retirement
Income Security Act of 1974 ("ERISA") and does not require employee
contributions. Full vesting occurs immediately upon joining the Plan. As of this
date, Sheldon R. Rose and Stuart A. Leiderman have accrued 22 and 5 years,
respectively, of service under the Pension Plan. As of February 1993, the plan
was curtailed and no additional pension benefits will accrue.



                                       31

<PAGE>


Item 11. Security Ownership of Certain Beneficial Owners and Management

                                                              Percentage
   Name and                       Number of Shares(2)(3)      Beneficially
   Address(l)                      Beneficially Owned         Owned
   ----------                     ---------------------       -------
Stuart A. Leiderman(4)                          308,000         2.87%

Robert M. Rubin(5)                            7,588,967        49.74%


Jonathan Rosenberg(6)                           165,000         1.52%

Wesley C. Fredericks, Jr.(7)                    258,333         2.39%

Howard Katz(8)                                   66,500           *

All officers and
directors as a group
(5 persons)                                   8,386,800         53.66%




* less than one percent.



(1) Unless otherwise indicated, the address of all officers and directors listed
above is in the care of the Company.

(2) Beneficial ownership is determined in accordance with the rules of the
securities and Exchange Commission and generally includes voting or investment
power with respect to securities and includes Shares of Common Stock issuable
upon conversion of outstanding preferred stock, or subject to Options, or
warrants currently exercisable or convertible, or exercisable or convertible
within 60 days. The percentage of stock outstanding for each stockholder is
calculated by dividing (i) the number of shares of Common Stock deemed to be
beneficially held by such stockholder as of January 12, 1998 by (ii) the sum of
(A) the number of shares of Common Stock outstanding as of January I2, 1998
plus (B) the number of shares issuable upon exercise of options or warrants held
by such stockholder which were exercisable as of January 12, 1998 or which will
become exercisable within 60 days after January 12, 1998.


                                       32

<PAGE>

(3) The table does not include the beneficial ownership of the Company's Common
Stock to be issued upon the closing of the acquisition of Lew Magram Ltd. In
December 1997, the Company entered into an Agreement and Plan of Merger with Lew
Magram Ltd., Robert Rubin, Jay Kaplowitz, Irving Magram, Warren Golden and
Stephanie Sobel, all of the shareholders of Lew Magram Ltd. (the "Merger"). 
Prior to the closing, Messrs. Magram and Golden and Ms. Sobel owned all of  the
outstanding common stock of Lew Magram Ltd. and Messrs. Rubin and Kaplowitz
owned all of the outstanding Senior Convertible Preferred Stock of Lew Magram
Ltd., which Messrs. Rubin and Kaplowitz acquired in May 1997, which is
convertible into one-half of the outstanding common stock of Lew Magram Ltd.
after giving effect to the conversion. At the closing of the Merger, the Company
issued 95,000 shares

of Series D Preferred Stock to each of the Lew Magram Ltd. shareholders of which
Mr. Rubin received 42,750 shares. Mr. Magram received 40,375 shares, Messrs.
Golden and Kaplowitz received 4,750 shares each and Ms. Sobel received 2,375
shares, subject to the right of Mr. Magram to put Lew Magram Ltd common stock to
Messrs. Rubin and Kaplowitz equivalent to approximately 7,017 shares of Series D
Preferred Stock. In addition, Mr. Magram, Mr. Golden and Ms. Sobel will receive
125,000 shares, 83,333 and 41,667 shares of the Company's common stock,
respectively. Each share of the Company's Series D Preferred Stock shall be
convertible into 33 1/3 shares of the Company's Common Stock.

(4) Represents (i) 268,000 shares of Common Stock currently owned, and (ii)
40,000 shares of Common Stock issuable upon exercise of currently exercisable
options granted under the November 1996 Plan. Mr. Leiderman also has an
additional 60,000 options under the November 1996 Option Plan which are not
currently exercisable and will not become exercisable in the next sixty days.

(5) Represents (i) 3,016,750 shares of Common Stock currently owned,(ii)
1,000,000 shares of Common Stock issuable upon conversion of 100,000 shares of
the Company's Series A Preferred Stock, (iii) 290,000 shares of Series B
Preferred Stock which provide for certain conversion rights and entitle him to
2,900,000 votes, (iv) 60,000 shares of Series C Preferred Stock which provide
for certain conversion rights and entitle him to 600,000 votes, (v) 20,000
shares of Common Stock issuable upon exercise of currently exercisable options
issued pursuant to the 1992 Stock Option Plan, and (vi) 52,217 shares of Common
Stock approved for issuance but not yet issued.

(6) Represents (i) 65,000 shares of Common Stock issuable upon exercise of
currently exercisable options granted pursuant to the 1992 Stock Option Plan ,
and (ii) 100,000 shares of Common stock issuable upon the exercise of currently
exercisable 


                                       33

<PAGE>

options granted pursuant to the November 1996 Plan. Mr. Rosenberg
also has an additional 30,000 options under the 1992 Stock Option Plan and
150,000 options under the November 1996 Option Plan which are not currently
exercisable and will not become exercisable in the next sixty days.

(7) Represents (i) 157,500 shares of Common Stock currently owned, (ii) 67,500
shares which may be issued upon exercise of currently exercisable options issued
pursuant to the August 1996 Stock Option Plan, and (iii) 33,333 shares of Common
Stock issuable upon currently exercisable options issued pursuant to the
November 1996 Plan. Mr. Fredericks also has an additional 66,664 options under
the November 1996 Plan which are not currently exercisable and will not become
exercisable within the next sixty days.

(8) Includes 66,500 shares of Common Stock issuable upon exercise of currently
exercisable options granted pursuant to the November 1996 Stock Option Plan. Mr.
Katz also has an additional 58,500 options which are not currently exercisable
and will not become exercisable within the next sixty days.


Item 12. Certain Relationships and Related Transaction

         In April 1994, the Company entered into an agreement with Congress
Financial Corporation providing the Company with a $3.0 million secured line of
credit to be used for loans and trade letters of credit (the "Agreement"). The
loans are secured by substantially all of the Company's personal property,
including without limitation, accounts receivable, inventory and trademarks. The
interest rate on loans is two percent above the prime rate announced by Core
States Bank. Under the terms of the Agreement, the Company may borrow up to 80%
of the amount of eligible accounts receivable (as defined in the Agreement), not
to exceed the -maximum credit. In February 1995, the Agreement was amended to
adjust the formula used to determine the amount available for revolving loans by
including therein an amount based upon eligible inventory not to exceed
$750,OO0. At the present time, the Company is fully utilizing its line of
credit. On February 9, 1996, the date of closing of the purchase of Biobottoms
by Diplomat, Congress entered into a loan and security agreement with Biobottoms
providing for a line of credit of $2.0 million limited to 45% of eligible
inventory (as defined in the Agreement).

         In April 1994 and in connection with the Congress agreement, the
Company borrowed from Mr. Rubin $590,000 on a secured term loan basis,
subordinated to Congress, in order to repay in full its then existing
outstanding principal indebtedness to Citibank, N.A. Such Citibank facility in
the initial principal amount of $650,000 was established in June, 1993, secured
by certain assets of the Company and a shareholder guaranty by Mr. Rubin. The
loan from Mr. Rubin was repayable with interest at the prime rate plus 1%, with
required principal payment amortization identical to the terms applicable to the
Citibank loan terms. Accordingly, the Company 


                                       34

<PAGE>

was required to make principal payments on the loan from Mr. Rubin of $120,000
in 1994, $120,000 in 1995, $120,000 in 1996 and the balance in 1997. At
September 30, 1996 the outstanding balance of $310,000 was converted into
preferred stock.

         Initial borrowings from Congress in the amount of $1,065,192 were used
to repay indebtedness to the American Insured Receivables Fund, the Company's
former asset based lender. In February 1995, the Agreement was amended to adjust
the formula used to determine the amount available for revolving loans by
including therein an amount based upon eligible inventory not to exceed
$750,000. In connection with this amendment, Robert Rubin, a director and
principal stockholder of the Company, furnished the lender with a personal
limited guaranty up to an aggregate maximum liability of $375,000, pertaining to
loans made based upon eligible inventory.

         In January 1994, the Company entered into a three year financial
consulting agreement with Robert M. Rubin, a director and principal stockholder
of the Company, providing for the payment to him of $125,000 per annum. Mr.
Rubin consults with the Company on financial management and long term planning

matters, including consideration of acquisitions. The term of the agreement was
extended to December 31, 1998 in consideration of Mr. Rubin's subordinated loan
to the Company made in connection with the credit agreement described above.

           In July 1995, pursuant to the Company's 1992 Stock Option Plan, the
Company granted each of Jonathan Rosenberg and Robert M. Rubin, options to
purchase 20,000 shares of the Company's Common Stock, and Irwin Oringer options
to purchase 15,000 shares of the Company's Common Stock, all at an exercise
price of $1.50 per share, exercisable over a five year term expiring July 14,
2000. The common shares underlying such options were included in a registration
statement that became effective in March 1995. As of the date hereof, none of
these options have been exercised.

         In 1996, pursuant to the Company's 1992 Stock Option Plan, the Company
granted Jonathan Rosenberg options to purchase 75,000 shares of the Company's
Common Stock at an exercise price of $1.50. To date, none have been exercised.

        In February 1996, Mr. Rubin loaned the Company $2,353,500 to be used as
part of the acquisition price of Biobottoms. In connection with such loan, the
Company issued Mr. Rubin 100,000 shares of its Series A Preferred Stock,
convertible into 1,000,000 shares of common stock at the option of Mr. Rubin.
The holder of such shares of preferred stock will have the right, subject to a
subordination and intercreditor agreement by and among Congress, Robert Rubin,
American United Global, Inc. and Joan Cooper and Anita Dimondstein as Agents,
during any period during which there shall be an Event of Default under the
Rubin/American United Loans, as such term is defined therein, to designate a
majority of the members of the Board of Directors of the Company. This right of
designation continues during the duration of any such Event of 


                                       35

<PAGE>

Default. The Company has agreed, at its sole cost and expense, to include the
common shares issuable upon conversion of the shares in any registration filed
with the Securities and Exchange Commission by the Company within six months of
the date of the issue. In the absence of such filing, the Company has agreed, at
its sole cost and expense and upon the request of Mr. Rubin, to file and use its
best efforts to effect a registration of such shares within three (3) months of
his written request.

         In May 1997 the Company issued to Mr. Rubin of an aggregate of 550,000
shares of Common Stock in consideration of Mr. Rubin's waiver of certain
compensation owed to him and for restructuring certain debt owed to him, waiving
certain defaults and providing an additional loan to the Company in the
aggregate amount of $600,000.

        As of September 30, 1996, the $600,000 loan was converted into 60,000
Shares of Series C Preferred Stock. The Series C Preferred Stock, which has a
liquidation value of $10.00 per Share, is convertible into Common Stock at 75%
of the current market price based on the average closing price for the Common
Stock for the 10 days preceding the conversion. Each share of Series C Preferred
Stock entitles the holder to 10 votes per share. The Series C Preferred Stock

pays an annual dividend of 9%, based on the per Share liquidation value. In the
event that the dividend, which is payable monthly, is not paid for three
consecutive months , Mr. Rubin shall be entitled to an additional 100,000 Shares
of Common Stock for each month that the dividend is not paid.

         As of September 30, 1996, Robert Rubin, a director and principal
stockholder of the Company, converted an aggregate of approximately $2,900,000
in outstanding debt into an aggregate of 290,000 Shares of Series B Preferred
Stock. The Series B Preferred Stock, which has a liquidation value of $10 per
share, is convertible into Common Stock at 75% of the current market price based
on the average closing price for the Common Stock for the 10 days preceding the
conversion. In addition, each share of Series B Preferred entitles the holder
thereof to 10 votes per share. The Series B Preferred Stock pays an annual
dividend of 9%, based on the per Share liquidation value. In the event that the
dividend, which is payable monthly, is not paid for three consecutive months,
Mr. Rubin shall be entitled to an additional 100,000 Shares of Common Stock for
each month that the dividend is not paid.

         In March 1997, the Company approved the issuance of 52,217 shares of
Common Stock to Mr. Rubin in lieu of the dividend payments due under the Series
B and Series C Preferred Stock, as well as for an adjustment in salary, for the
period from January 1, 1997 through March 31, 1997.

         On September 9, 1996, the Company entered into an arrangement with
Gersten, Savage, Kaplowitz & Fredericks , LLP ("GSK&F") which provided that
GSK&F will provide certain legal and consulting services to the Company over an
extended 


                                       36

<PAGE>

period of time. As compensation for its services, certain individual members of
GSK&F received an aggregate of 350,000 shares of Common Stock and options to
purchase an aggregate of 150,000 shares of Common Stock at $2.50 per share. Of
such securities, 157,500 shares of Common Stock and 67,500 options were issued
to Wesley C. Fredericks who has since then become a director of the Company.

In November 1996, the Company issued an aggregate of 1,060,000 options to 35
employees of the Company, including two executive officers and one outside
director, pursuant to the November 1996 Plan. The Options are exercisable at
$1.00 per share, vest over a period of five years, and expire ten years from the
date of grant, if not sooner due to termination or death of the employee.

         In May 1997, the Company issued an aggregate of 150,000 options
pursuant to the November 1996 Plan, 50,000 of which were issued to Howard Katz,
a director of the Company, and 100,000 of which were issued to Mr. Fredericks in
connection with his agreeing to become a member of the company's board of
directors,

         In May 1997, the Company authorized the issuance of 200,000 of Common
Stock to Mr. Rubin in consideration of Mr. Rubin extending loans to the company
as well as extending a personal guarantee to Congress on behalf of the Company.


         Between May and July 1997, the Company issued an aggregate of 158,408
shares of Common Stock and options to acquire 200,000 shares of Common Stock to
six consultants. Of the 200,000 options, 50,000 are exercisable at $1.75 per
share and 150,000 are exercisable at $1.875 per share.

               From May 1997 through September 1997, the Company sold 1,250,000
shares of its Common Stock in a private placement of its securities in which it
raised $2,500,000. In addition to these shares, the Company issued to European
Community Capital a placement agent's warrant exercisable to purchase up to
200,000 shares of Common Stock at $3.3125 per share. The Company issued an
option to a principle of the placement agent to purchase up to 100,000 shares of
on Stock at $2.00 per share.

               In September, 1997, Mr. Rubin made an additional loan to the
Company in the amount of $1,200,000.

               In October 1997, in part to raise capital for the Company's
acquisition out of bankruptcy of the assets of Brownstone, the Company completed
a private offering of its securities which raised $3,480,000 from accredited
investors. The private placement consisted of units, each unit consisting of ten
shares of Series E Preferred Stock and 7,500 shares of Common Stock at a
purchase price of $10,000 per unit. As a result the Company will be issuing an
aggregate of 3,480 shares of Series E Preferred Stock and 2,610,000 shares of
Common Stock in the next few weeks.



                                       37

<PAGE>

        In December 1997, the Company entered into an Agreement and Plan of
Merger with Lew Magram Ltd., Robert Rubin, Jay Kaplowitz, Irving Magram, Warren
Golden and Stephanie Sobel, all of the shareholders of Lew Magram Ltd.
("Merger"). On January 13, 1998, Lew Magram Ltd. was merged with Magram
Acquisition Corp. resulting in Lew Magram becoming a wholly owned subsidiary of
the Company. Prior to the closing Messrs. Magram and Golden and Ms. Sobel owned
all of the outstanding common stock of Lew Magram Ltd. and Messrs. Rubin and
Kaplowitz owned all of the outstanding Senior Convertible Preferred Stock of Lew
Magram Ltd., which Messrs. Rubin and Kaplowitz acquired in May 1997, which was
convertible into one-half of the outstanding common stock of Lew Magram Ltd.
after giving effect to the conversion. At the closing of the Merger, the Company
issued 95,000 shares of the Series D Preferred Stock to each of the Lew Magram
Ltd. shareholders of which Mr. Rubin received 42,750 shares, Mr. Magram received
40,375 shares, Messrs. Golden and Kaplowitz received 4,750 shares each and Ms.
Sobel received 2,375. In addition, Mr. Magram, Mr. Golden and Ms. Sobel received
125,000 shares, 83,333 and 41,667 shares of the Company's common stock,
respectively. Each share of the Company's Series D Preferred Stock is
convertible into 33 1/3 shares of the Company's Common Stock. Each of the
stockholders have agreed to indemnify the Company for any material breach of the

representations made by Lew Magram Ltd. in the Merger Agreement limited to
$9,500,000 and which claims for indemnification must be brought within one year
of the closing date of the Merger. Messrs. Rubin and Kaplowitz assigned to the
Company their rights to any claim either of them may have for breach of any
warranty made by Lew Magram Ltd. in the May 1997 Senior Convertible Preferred  
Stock purchase agreement in return for a release of their indemnification
obligations under the Merger Agreement.



                                       38

<PAGE>


Item 13.            Exhibits, Lists and Reports an Form 8-K


(a).  Exhibits (numbered in accordance with Item 601 of Regulation S-B).

Exhibit
  No.        Description
  ---        -----------

3a       Certificate of Incorporation, as amended*

3b       By-laws, amended*

3c       Amendment to Certificate of Incorporation*

4a       Form of Common Stock Certificate*

4b       Form of Warrant Agency Agreement between the Registrant and North
         American Transfer Company*

4c       Revised form of Unit Purchase Option*

4d       Common Stock Purchase Warrant*

4e       Certificate of Designation of Class B and Class C Preferred Stock*****

4f       Certificate of Designation of Series D Preferred Stock********

5        Opinion of Gersten, Savage, Kaplowitz, Fredericks & Curtin, LLP

10a      Employment Agreement with Stuart A. Leiderman*

10b      Stock Option Plan*

10c      November 1996 Stock Option Plan*****

10d      Exclusive Distributorship Agreement by and between Ambrose Montgomery,
         Inc. and Diplomat Juvenile Corporation*

10e      License Agreement by and between Diplomat Juvenile Corporation, Wesley
         Howell and Steve Prested*

10f      Loshell Realty mortgages with Union State Bank and Stony Point
         Technical Park, Inc. and related Mortgage Notes, including Sheldon Rose
         guarantee of Union State Bank*

10g      Agreement dated as of March 1, 1994 by and between Francine H. Nichols
         and Diplomat Corporation**



                                       39


<PAGE>

10h      First Amendment to Exclusive Distributorship Agreement by and between
         Ambrose & Montgomery, Inc. and Diplomat Corporation**

10i      Collateral Assignment of Trademarks and Trademark Licenses (Security
         Agreement) by and between Congress Financial Corporation and Diplomat
         Corporation **

10j      Second Amendment to Exclusive Distributorship Agreement between Ambrose
         Montgomery, Inc. and Diplomat Corporation***

10k      Amended and Restated Subordinated and Intercreditor Agreement dated as
         of February 9, 1996 by and among Congress Financial Corporation, Robert
         Rubin, American United Global, Inc., Joan Cooper and Anita Dimondstein,
         as agents, Diplomat Corporation and Biobottoms, Inc.****

10l      Amendments No. 1, No. 2 and No. 3 to Loan and Security Agreement by and
         between Congress Financial Corporation and Diplomat Corporation.****

10m      Loan and Security Agreement made as of February 9, 1996 by and among
         Robert M. Rubin, American United Global, Inc., Diplomat Corporation and
         Biobottoms, Inc. ****

10n      Secured Subordinated Term Note dated February 9, 1996 in the principal
         amount of $2,353,100 of Diplomat Corporation payable to American United
         Global, Inc. ****

10o      Secured Subordinated Term Note dated February 9, 1996 in the principal
         amount of $450,000 of Diplomat Corporation payable to American United
         Global, Inc. ****

10p      Biobottcms, Inc. Guarantee of $2,353,100 Secured Subordinated Term
         Note.****

10q      Biobottoms, Inc. Guarantee of $450,O0O Secured Subordinated Term
         Note.****

10r      Loan and Security Agreement dated February 9, 1996 by and between
         Congress Financial Corporation and Biobottoms, Inc.****

10s      Diplomat Corporation Guarantee dated February 9, 1996 to Congress
         Financial Corporation of Biobottoms, Inc. Indebtedness.****

10t      Collateral Assignment of Trademarks and Trademark Licenses dated
         February 9,1996 between Biobottoms, Inc. and Congress Financial
         Corporation.****


                                       40

<PAGE>

10u      Security Agreement (Rights in Agreement and Plan of Merger) dated

         February 9, 1996 between Biobottoms, Inc. Diplomat Corporation and
         Congress Financial Corporation.****

10v      Agreement and Plan of Merger by and among Diplomat Corporation,
         Diplomat Acquisition Corporation, Biobottoms, Inc. and Principal
         Stockholders, together with Amendment No. I thereto.****

10w      Consulting Service Agreement dated February 9, 1996 by and among
         Diplomat Corporation, Diplomat Acquisition Corporation, Biobottoms,
         Inc., and Anita Dimondstein.****

10x      Consulting Service Agreement dated February 9, 1996 by and among
         Diplomat Corporation, Diplomat Acquisition Corporation, , Inc., and
         Joan Cooper.****

10y      Asset Purchase Agreement dated as of September 24, 1997 by and among
         Diplomat Corporation and Jean Grayson's Brownstone Studio, Inc. and
         Wilroy Inc. *******

10z      Bill of Sale provided by Jean Grayson's Brownstone Studio, Inc. and
         Wilroy, Inc. *******

10aa     Assignment and Assumption Agreement dated October 30, 1997 between
         Brownstone Holdings, Inc., Jean Grayson's Brownstone Studio, Inc. and
         Wilroy, Inc. *******

10bb     Loan and Security Agreement by and among Congress Financial Corporation
         and Jean Grayson's Brownstone Studio, Inc. dated February 28, 1997, as
         amended September 17, 1997. *******

10cc     Junior Participation Agreement between Congress Financial Corporation,
         Robert M. Rubin and Jay M. Kaplowitz dated September 27, 1997. *******

10dd     Agreement and Plan of Merger by and among Diplomat Corporation, Magram
         Acquisition Corp and Lew Magram Ltd********

10ee     Employment Agreement with Irving Magram********

10ff     Employment Agreement with Warren Golden********

10gg     Employment Agreement with Stephanie Sobel********
 
21       Subsidiaries of the Registrant********

*        Incorporated by reference to Diplomat Corporation Registration
         Statement No. 33-66910 NY

**       Incorporated by reference to Diplomat Corporation Annual Report an Form
         IO- KSB for the year ended January 1, 1994.

***      Incorporated by reference to Diplomat Corporation Registration
         No33-95986


                                       41

<PAGE>

****     Incorporated by reference to Diplomat Corporation Annual Report on Form
         10-KSB for the year ended December 31, 1995.

*****    Incorporated by reference to Diplomat Corporation Annual Report on Form
         10-KSB for the year ended September 30, 1996.

******   Incorporated by reference to Diplomat Corporation report on Form 8-K
         dated November 15, 1997.

*******  Incorporated by reference to Diplomat Corporation Registration Form
         SB-2 dated November 17, 1997.

******** Filed with this Form 10-KSB.
                                       42


<PAGE>
                                   SIGNATURES

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

                                    DIPLOMAT CORPORATION

                                    By:/s/ Jonathan Rosenberg
                                       -----------------------
                                       Jonathan Rosenberg
                                       President, Chief Executive Officer

Dated: January 12, 1998

        Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons, which include the
Chief Executive Officer, the Chief Financial Officer and a majority of the Board
of Directors, on behalf of the Registrant and in the capacities and on the dates
indicated:

        Name                        Title                           Date
        ----                        -----                           ----

/s/ Jonathan Rosenberg         President, Chief Executive     January 12, 1998
----------------------         Officer and Director
Jonathan Rosenberg             (Principal Exec Officer)
                               
/s/ Robert M. Rubin            Chairman of the Board and      January 12, 1998
-------------------            a Director
Robert M. Rubin                       
                               
                               
/s/ Stuart Leiderman           Executive Vice President of    January 12, 1998
--------------------           Sales and Marketing and a
Stuart Leiderman                      Director
                          
                               Director                       January 12, 1998
----------------               
Howard Katz                    
                               
                               Director                       January 12, 1998
----------------------------   
Wesley C. Fredericks, Jr.    

/s/ Irwin Oringer              Principal Accounting Officer   January 12, 1998
-----------------                   and Controller
Irwin Oringer                       

                                       43

<PAGE>

                      DIPLOMAT CORPORATION AND SUBSIDIARIES

                        CONSOLIDATED FINANCIAL STATEMENTS

                                      INDEX
 
                                                                      Page
                                                                     Number
                                                                  -------------

         INDEPENDENT AUDITORS' REPORT                                 F - 2

         CONSOLIDATED BALANCE SHEET                                   F - 3

         CONSOLIDATED STATEMENTS OF OPERATIONS                        F - 4

         CONSOLIDATED STATEMENTS OF CHANGES IN
           STOCKHOLDERS' EQUITY                                       F - 5

         CONSOLIDATED STATEMENTS OF CASH FLOWS                        F - 6

         NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                   F - 7



                                      F - 1


<PAGE>
                          INDEPENDENT AUDITOR'S REPORT
                          ----------------------------


To the Board of Directors and Stockholders
Diplomat Corporation
Stony Point, New York

                  We have audited the accompanying consolidated balance sheet of
Diplomat Corporation and Subsidiaries as of September 30, 1997 and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the year ended September 30, 1997 and the nine months ended September 30,
1996.These financial statements are the responsibility of the Company's
management.Our responsibility is to express an opinion on these financial
statements based on our audits.

                  We conducted our audits in accordance with generally accepted
auditing standards.Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements.An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation.We believe that our audits provide a reasonable basis for our
opinion.

                  In our opinion, the financial statements referred to above
present fairly, in all material respects, the financial position of Diplomat
Corporation and Subsidiaries as of September 30, 1997 and the results of its
operations and its cash flows for the year ended September 30, 1997 and the nine
months ended September 30, 1996 in conformity with generally accepted accounting
principles.

                                                /s/ Feldman Radin & Co., P.C.
                                                    Feldman Radin & Co., P.C.
                                                    Certified Public Accountants

New York, New York
January 13, 1998

                                     F - 2


<PAGE>
<TABLE>
<CAPTION>

                      DIPLOMAT CORPORATION AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEET

                               SEPTEMBER 30, 1997

                                     ASSETS

CURRENT ASSETS:
                                                                   Pro-Forma         Actual
                                                                   ---------         ------
                                                                  (unaudited)
<S>                                                            <C>                <C>
     Cash and cash equivalents                                  $     59,750       $    35,669  
     Accounts receivable, net of allowance of $147,001             2,212,856         1,419,720
     Inventories                                                  10,005,057         5,236,811
     Prepaid catalogs                                              2,452,858           918,028
     Prepaid expenses                                              1,396,881           350,783
     Other current assets                                            938,802           938,802
                                                                ------------        ----------
          TOTAL CURRENT ASSETS                                    17,066,204         8,989,813

PROPERTY AND EQUIPMENT, net                                        3,465,493         2,152,520

OTHER ASSETS:
     Goodwill                                                     10,879,788         3,448,444
     Customer List                                                 4,875,000                --
     Other                                                           728,437         1,136,053
                                                                ------------       -----------
                                                                $ 37,014,921       $15,726,830
                                                                ============       ===========

                      LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
     Accounts payable and accrued expense                        $11,713,554       $ 5,592,089
     Loans payable - Stockholder                                   1,435,000         1,435,000
     Loans payable - Congress Financial Corp.                      4,130,136         1,866,426
     Open prepaid orders                                             335,948                --
     Outstanding merchandise credits                               2,981,521                --
     Current maturities of long term debt                            893,936           682,863
                                                                ------------       -----------
          TOTAL CURRENT LIABILITIES                               21,490,095         9,576,378

LONG TERM DEBT, less current maturities                            1,235,754         1,076,610

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY:

     Preferred stock, $.10 par value, 1,000,000 shares           
         authorized 505,000 shares issued and outstanding         12,883,048         4,191,380
     Common stock, $.0001 par value, 50,000,000 shares            
         authorized, 8,001,933 shares issued and outstanding             801               801

     Paid-in capital                                               9,266,908         9,266,908 
     Accumulated deficit                                          (7,861,684        (8,385,247)
                                                                ------------       ----------- 
          TOTAL STOCKHOLDERS' EQUITY                              14,289,073         5,073,842
                                                                ------------       -----------

                                                                $ 37,014,921       $15,726,830
                                                                ============       ===========
</TABLE>


                       See notes to financial statements.

                                      F - 3

<PAGE>


                      DIPLOMAT CORPORATION AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION> 
                                                                          Actual
                                                               -------------------------------- 
                                                  Pro-Forma                           Nine                
                                                 Year ended     Year ended         months ended   
                                                September 30,   September 30,     September 30,
                                                     1997           1997             1996
                                                -------------   -------------     -------------
                                                (unaudited)                    
<S>                                             <C>            <C>               <C>
NET SALES                                       $  35,147,333   $ 24,484,508$  19,222,801  
                                                                               
COST OF GOODS SOLD                                 16,665,203     11,659,386       13,334,588  
                                                -------------    ------------    ------------  
                                                                               
     GROSS PROFIT                                  18,482,130     12,825,122        5,888,213  
                                                -------------    ------------     -----------
                                                                               
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES      16,720,829     11,675,754       10,589,561  
                                                                               
RESTRUCTURING AND REORGANIZATION COSTS                --                  --        1,738,975  
                                                -------------    ------------    ------------
                                                                               
OPERATING INCOME (LOSS)                             1,761,301      1,149,368       (6,440,323) 
                                                                               
OTHER EXPENSE                                        (644,233)      (663,754)        (784,577)
                                                -------------    ------------     ------------
                                                                               
INCOME (LOSS) BEFORE INCOME TAXES                   1,117,068        485,614       (7,224,900) 
                                                                               
INCOME TAXES (BENEFIT)                               (210,433)      (270,433)             --       
                                                -------------    ------------     -----------
                                                                               
NET INCOME (LOSS)                                   1,327,501        756,047       (7,224,900) 
                                                                               
PREFERRED STOCK DIVIDENDS                           (362,892)       (317,892)             --       
                                                ------------    ------------       ----------
                                                                               
NET INCOME (LOSS) TO COMMON SHAREHOLDERS        $    964,609     $   438,155      $(7,224,900)  
                                                ============    ============      ===========
                                                                               
NET INCOME (LOSS) PER COMMON SHARE              $       0.16    $        .07      $     (1.59)  
                                                ============    ============      ===========
                                                                               
AVERAGE NUMBER OF SHARES USED IN COMPUTATION       5,892,454       5,892,454        4,549,525    
                                                ============    ============      ===========
</TABLE>

                      See notes to financial statements.

                                      F - 4

<PAGE>

                        DIPLOMAT CORPORATION AND SUBSIDIARIES

                   CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

                          YEAR ENDED SEPTEMBER 30, 1997 AND

                        NINE MONTHS ENDED SEPTEMBER 30, 1996

<TABLE>
<CAPTION>
                                                   Common Stock        Preferred Stock                                       
                                                ------------------  ----------------------    Paid-in    Accumulated
                                                  Shares    Amount   Shares       Amount      Capital       Deficit       Total
                                                ----------  ------  --------  ------------  -----------  ------------  ------------
<S>                                             <C>         <C>     <C>       <C>           <C>          <C>           <C>    

Balance at December 30, 1995                     4,493,525  $  458     -      $    -        $ 5,201,441  $ (1,675,393) $  3,526,507
                                                                                                                                  
 Exercise of options, issuance of 500,000                                                                                         
   shares of common stock par .0001 @ .95          500,000      50                              474,950                     475,000
 Issuance of common stock                                                                       400,000                     400,000
 Issuance of preferred stock                                         410,000     4,100,000                                4,100,000
 Net loss                                                                                                  (7,224,900)   (7,224,900)
                                                ----------  ------  --------  ------------  -----------  ------------  ------------

Balance at September 30, 1996                    4,993,525     508   410,000     4,100,000    6,076,391    (8,900,293)    1,276,607

 Private placements                              1,250,000     125                            2,174,875                   2,175,000
 Exercise of warrants                              500,000      50                              499,950                     500,000
 Issuance of shares                              1,258,408     118                              515,692                     515,810
 Preferred stock issued for interest                                                91,380                                   91,380
 Net income                                                                                                   756,047       756,047
 Preferred stock dividends                                                                                   (241,000)     (241,000)
                                                ----------  ------  --------  ------------  -----------  ------------  ------------

Balance at September 30, 1997                    8,001,933  $  801   410,000  $  4,191,380  $ 9,266,908  $ (8,385,247) $  5,073,842
                                                ==========  ======  ========  ============  ===========  ============  ============
</TABLE>








                       See notes to financial statements.

                                      F - 5

<PAGE>

                      DIPLOMAT CORPORATION AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>

                                                                        For the       For the nine
                                                                      year ended      months ended
                                                                     September 30,    September 30,
                                                                          1997            1996
                                                                     -------------    -------------
<S>                                                                  <C>              <C>
CASH FLOWS FROM OPERATING ACTIVITIES:

     Net income (loss)                                               $     756,047    $  (7,224,900)
     Adjustment to reconcile net income (loss) to net cash                               
         provided by (used in) operating activities:                                     
            Amortization                                                   176,333             --
            Depreciation                                                   249,732          211,237
            Issuance of stock for expenses                                  91,380          400,000
                                                                                         
CHANGES IN ASSETS AND LIABILITIES:                                                       
                                                                                         
     (Increase) decrease in accounts receivable                            243,791         (282,507)
     (Increase) decrease in inventories                                 (1,489,071)       2,551,187
     (Increase) decrease in prepaid expenses                               656,195        1,041,372
     (Increase) decrease in prepaid catalogs                              (918,028)        (641,132)
     (Increase) decrease in other current assets                          (205,824)         702,866
     (Increase) decrease in other assets                                  (522,393)         500,202
     Increase (decrease) in accounts payable and accrued expenses       (1,380,753)       2,054,897
                                                                     -------------    -------------
                                                                                         
         NET CASH USED BY OPERATING ACTIVITIES                          (2,342,591)        (686,778)
                                                                     -------------    -------------
                                                                                         
CASH FLOWS FROM INVESTING ACTIVITIES:                                                    
                                                                                         
     Cash paid for Biobottoms, Inc. (net of cash acquired)                    --         (2,899,211)
     Purchase of trademark                                                 (75,000)            --
     Purchase of property and equipment                                   (179,904)        (211,096)
                                                                     -------------    -------------
         NET CASH FLOWS PROVIDED BY (USED) BY INVESTING ACTIVITIES        (254,904)      (3,110,307)
                                                                     -------------    -------------
                                                                                         
CASH FLOWS FROM FINANCING ACTIVITIES:                                                    
                                                                                         
     Repayment of Biobottoms aquisition loan                            (1,500,000)            --
     Proceeds of loans payable, affiliate                                     --            450,000

     Revolving credit loans                                               (304,226)         583,650
     Preferred stock dividends paid                                       (243,892)            --
     Issuance preferred and common stock                                 3,190,809          475,000
     Borrowings from stockholder                                         1,435,000        2,620,000
     Repayment of long term debt and loan payables                         (13,785)        (393,678)
                                                                     -------------    -------------
         NET CASH PROVIDED BY FINANCING ACTIVITIES                       2,563,906        3,734,972
                                                                     -------------    -------------
                                                                                         
NET DECREASE IN CASH                                                       (33,589)         (62,113)
                                                                                         
CASH AND CASH EQUIVALENTS, at beginning of period                           69,258          131,371
                                                                     -------------    -------------
                                                                                         
CASH AND CASH EQUIVALENTS, at end of period                          $      35,669    $      69,258
                                                                     =============    =============
                                                                                         
                                                                                         
SUPPLEMENTAL CASH FLOW INFORMATION:                                                      
     Cash paid during the year for:                                                      
                                                                                         
         Interest                                                    $     666,390    $     706,000
                                                                     =============    =============
         Income taxes                                                $        --      $        --
                                                                     =============    =============
                                                                                       

</TABLE>



                       See notes to financial statements.

                                      F - 6

<PAGE>


                      DIPLOMAT CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                        THE YEAR ENDED SEPTEMBER 30, 1997

                    AND NINE MONTHS ENDED SEPTEMBER 30, 1996

1.       SIGNIFICANT ACCOUNTING POLICIES:

                  A. The financial statements include the accounts of the
         Company and its wholly-owned subsidiaries. All significant intercompany
         balances and transactions have been eliminated.

                  B. Inventories are stated at the lower of cost or market. Cost
         is determined by the first-in, first-out (FIFO) method.

                  C. Property and equipment are stated at cost. Depreciation is
         provided using primarily the straight-line method and accelerated
         methods (for machinery and equipment) over the expected useful lives of
         the assets, which range from 31.5 years for the building and real
         property, to between five and 10 years for machinery, furniture and
         equipment.

                  D. The Company follows SFAS 109 for income taxes. Pursuant to
         SFAS 109 deferred tax assets and liabilities are determined based on
         differences between the financial reporting and tax basis of assets and
         liabilities and are measured by applying enacted tax rates and laws to
         taxable years in which such differences are expected to reverse.

                  E. For purposes of the statement of cash flows, the Company
         considers all highly liquid debt instruments purchased with an original
         maturity of three months or less to be cash equivalents.

                  F. The preparation of financial statements in conformity with
         generally accepted accounting principles requires management to make
         estimates and assumptions that affect the reported amounts of assets
         and liabilities and disclosure of contingent assets and liabilities at
         the date of the financial statements and the reported amounts of
         revenues and expenses during the reported period. Actual results could
         differ from those estimates.

                  G. In March 1995, the Financial Accounting Standards Board
         ("FASB") issued Statement of Financial Accounting Standards ("SFAS")
         No. 121, "Accounting For the Impairment of Long Lived Assets and For
         Long Lived Assets to be Disposed Of ". SFAS No. 121 requires the
         Company to review long-lived assets and certain identifiable assets and
         any goodwill related to those assets for impairment whenever
         circumstances and situations

                                      F - 7



<PAGE>



         change such that there is an indication that the carrying amounts may
         not be recoverable. The adoption of SFAS No. 121 did not result in any
         material adjustments in the financial statements.

                  H. Effective December 30, 1995, the Company adopted SFAS No.
         107, "Disclosures About Fair Value of Financial Instruments", which
         requires disclosure of fair value information about financial
         instruments whether or not recognized in the balance sheet. The
         carrying amounts reported in the balance sheet for cash, trade
         receivables, accounts payable and accrued expenses approximate fair
         value based on the short term maturity of these instruments.

                  I. The Company accounts for stock transactions with employees
         in accordance with APB No. 25, "Accounting for Stock Issued to
         Employees". In accordance with SFAS No. 123, " Accounting for Stock
         based Compensation", the Company has adopted the pro-forma disclosure
         requirements contained therein.

                  J. Direct response advertising costs, consisting primarily of
         catalog preparation, printing and postage expenditures, are amortized
         over the period during which the benefits are expected.

                  K. Revenue is recognized at the time merchandise is shipped to
         customers. Proceeds received for merchandise not yet shipped are
         reflected as "customers' unshipped orders," a current liability.

2.       BUSINESS:

                  The Company is engaged in two lines of business and
         accordingly its operations are classified into two business segments:
         mail order catalog retail operations, and the manufacturing marketing
         and distribution of infants accessories principally to mass merchants.

                  As of 1995, the Company reported its results of operations on
         a fifty-two/fifty-three week year ending on the Saturday closest to
         December 31. However, on November 12, 1996, the Company has changed its
         reporting date to September 30.


                                      F - 8


<PAGE>



3.       ACQUISITION OF LEW MAGRAM, LTD.:

                   On December 23, 1997, the Company (through its wholly-owned
         subsidiary, Magram Acquisition Corp.) entered into a definitive
         agreement to acquire Lew Magram, Ltd.(Magram), a New York corporation
         with a place of business in Teaneck, New Jersey, which is in the
         business of mail order catalogue sales of womens' clothing. The
         accompanying financial statements include unaudited pro-forma balance
         sheets and income statements as if the acquisition was effected as of
         July 1, 1997, the date that the Company assumed effective control of
         Magram. The acquisition was accounted for as a purchase and the
         consideration consisted of the issuance of the Company's $.10 par
         value, Series D, convertible preferred stock. The Series D preferred
         stock is convertible into 3,166,667 shares of the Company's common
         stock, (which assumes a market value of $4.00 per share). An additional
         250,000 shares of common stock were also given as consideration. The
         fair market value of the consideration was approximately $8.7 million
         and acquisition costs were approximately $646,000. The Company recorded
         the carryover basis for a certain selling stockholder of Magram who is
         also a principal stockholder of the Company.

                  The net fair market of identifiable assets acquired was
         approximately $1.9 million, and included customer lists valued at $5
         million. The customer lists are being amortized over a period of 10
         years. Goodwill amounted to approximately $7.4 million and is being
         amortized over 25 years.

                  The following unaudited pro-forma summary combines the
         consolidated results of operations of the Company and Magram as if the
         acquisition had occurred at the beginning of 1996, after giving effect
         to certain adjustments, including amortization.

                                                                  Nine months
                                               Year ended            ended
                                              September 30,       September 30,
                                             ---------------     ---------------
                                                  1997                 1996
                                               (unaudited)          (unaudited)

              Net sales                      $  72,710,390       $  56,785,858

              Net loss                          (3,708,442)        (11,897,951)

              Net loss per common share            (.63)               (2.62)


                   The pro-forma results do not necessarily represent results
         which would have occurred if the acquisition had taken place on the

         basis assumed above, nor are they indicative of the results of future
         combined operations.

4.       ACQUISITION OF BIOBOTTOMS, INC. AND RELATED FINANCING:

                                      F - 9


<PAGE>



                  A. Acquisition of Biobottoms, Inc.: On February 9, 1996, the
         Company completed the acquisition of Biobottoms, Inc. ("Biobottoms"), a
         California-based mail-order catalog company, specializing in apparel
         and accessories for newborn through preteen children, pursuant to an
         Agreement and Plan of Merger made as of December 22, 1995 by and among
         Diplomat Corporation, Diplomat Acquisition Corp., a wholly-owned
         subsidiary of the Company, organized under the laws of the State of
         Delaware ("DAC"), Biobottoms and Joan Cooper and Anita Dimondstein,
         individuals and principal stockholders of Biobottoms (the "Merger
         Agreement"). Biobottoms has become a wholly-owned subsidiary of the
         Company and will continue its principal place of business in Petaluma,
         California.

                  The Company paid $2,500,000 for Biobottoms, $1,000,000 in cash
         and $1,500,000 in the form of two promissory notes to Biobottoms'
         shareholders, each in the amount of $750,000 ("Acquisition notes"). The
         notes bear interest at 1% over the prime rate as defined in the
         agreements. One such note is due six months from the acquisition date
         and the second note is due in two equal installments of $375,000, nine
         months and eighteen months after the date of acquisition, respectively.
         The Company did not make the payments which were required in August and
         November 1996. On December 9, 1996, the Company received notification
         of the default from the former Biobottoms shareholders, which required
         that the Company cure the default on the notes within 270 days, or be
         subject to enforcement action. On February 25, 1997, the former
         Biobottoms shareholders agreed not to initiate enforcement action under
         this or susequent defaults until not earlier than December 31, 1997. In
         connection with obtaining this agreement, Diplomat agreed to pay the
         Biobottoms shareholders ten installemnts of $5,000 to be applied
         against the acquisition notes, commencing on February 21, 1997 and to
         undertake to conduct a private placement of its securities to raise
         funds for the remaining balance due on the acquisition notes. In July
         1997, the Company received proceeds from a private placement and
         pursuant to an agreement with the Biobottoms shareholders paid
         $1,500,000 in full satisfaction of all amounts due under the
         acquisition notes, and also amended its consulting agreement with Joan
         Cooper and Anita Dimondstein to provide for additional compensation of
         29,204 shares each of the Company's common stock. Additionally, the
         Company incurred costs related to the acquisition in the amount of
         approximately $720,000. Of this amount, $600,000 represents the
         estimated fair value of 100,000 shares of the Company's convertible
         Series A preferred stock issued to a significant stockholder (who is

         also a member of the Board of Directors), as a fee for his assistance
         in consummating the acquisition. The Series A preferred shares are
         convertible into 1,000,000 common shares of the Company. The Series A
         preferred stock is not entitled to any specific dividends or
         liquidation rights.

                  The acquisition of Biobottoms has been accounted for as a
         purchase and accordingly, its results of operations are included with
         the Company's beginning February 9, 1996.

                  The following unaudited pro-forma summary combines the
         consolidated results of operations of the Company and Biobottoms as if
         the acquisition had occurred at the beginning of 1995, after giving
         effect to certain adjustments, including amortization of

                                     F - 10


<PAGE>



         goodwill, increased interest expense on the acquisition debt, and the
         adjustments required as a result of changes to certain employment
         agreements as a direct result of the acquisition.

                                                       Year ended
                                                       December 30,
                                                          1995
                                                      ---------------
                                                        (unaudited)
                      
                      Net sales                       $   27,137,857
                      Net loss                            (1,719,030)
                      Net loss per common share                (0.38)
                   
                   The pro-forma results do not necessarily represent results
         which would have occurred if the acquisition had taken place on the
         basis assumed above, nor are they indicative of the results of future
         combined operations.

                  B. Financing: Simultaneously with the closing of the
         Biobottoms acquisition, the Company and Biobottoms entered into a loan
         and subordinated security agreement with a director and principal
         stockholder of the Company and an affiliate of such individual pursuant
         to which the Company borrowed from such director and principal
         stockholder and affiliate $2,353,100 and $450,000, respectively. The
         loan from the director and principal stockholder was utilized to fund
         the acquisition of Biobottoms in part. The loan from the affiliate has
         been utilized for working capital purposes. Subject to an intercreditor
         agreement between the Company's asset based lender and other lenders,
         the $450,000 loan was paid in full on May 4, 1997. 


                  In connection with such aforementioned loan by a director and
         principal stockholder of the Company in the amount of $2,353,100, the
         Company issued 100,000 shares of its Series A Preferred Stock, which
         are convertible into 1,000,000 shares of common stock at the option of
         the director and principal stockholder. The holder of such shares of
         preferred stock will have the right, subject to a subordination and
         intercreditor agreement by and among Congress Financial Corporation and
         others, during any period during which there shall be an Event of
         Default under such loans, as such term is defined therein, to designate
         a majority of the members of the Board of Directors of the Company.
         Such right of designation will continue during the duration of any such
         Event of Default. The Company has agreed at its sole cost and expense
         to include the common shares issuable upon conversion of the shares in
         any registration statement filed with the Securities and Exchange
         Commission by the Company within six months of the date hereof.

                                     F - 11


<PAGE>



5.       RESTRUCTURING OF OPERATIONS:

                  During the quarter ended September 30, 1996, management
         instituted various actions designed to significantly cut costs in the
         Company's manufacturing operation located in Stony Point, New York, and
         to refocus the operation on its most profitable product lines and
         channels of distribution. Towards this end, the following significant
         decisions were made: (i) the former Chief Executive Officer's contract,
         which expired in October 1996, was not renewed, and all ties with this
         officer were severed; (ii) certain royalty agreements, specifically
         those related to products which the Company is discontinuing, were not
         renewed by the Company; (iii) a decision was made to target primarily
         mass merchant customers; and (iv) significant permanent cutbacks in
         personnel and other operating costs were made.

                  As a result of the actions taken, the Company incurred
         restructuring charges of approximately $1,738,975. The restructuring
         charges include approximately $568,000 primarily for write-offs and
         other costs associated with the discontinuance of various products and
         $771,000 for severance pay and professional and consulting fees payable
         in connection with the restructuring plan.

6.       CONVERSION OF STOCKHOLDER DEBT AND ISSUANCE OF SERIES B
         PREFERRED STOCK:

                  Effective September 30, 1996, a significant stockholder and
         member of the Company's Board of Directors converted $3,500,285 of
         indebtedness into 290,000 shares of Series B preferred stock of the
         Company and 60,000 shares of the Company's Series C preferred stock.
         Both the Series B and C shares of preferred stock have a liquidation

         preference of $10 per share ("Liquidation Value") and a normal dividend
         of 9% of Liquidation Value, payable monthly. Should the Company not pay
         the dividends on either the Series B or C preferred stock for three
         consecutive months, the holder will be entitled to receive 100,000
         shares of the Company's common stock for each month that the dividend
         has not been paid as a penalty. The preferred stock, based on
         Liquidation Value is convertible into common stock of the Company at
         75% of the average market value of the common stock for the ten trading
         days immediately preceding the day of conversion. The preferred stock
         also has voting rights equal to 3,500,000 shares of common stock on all
         matters on which common stock votes, including election of directors.
         As part of the consideration for the conversion the holder was issued
         500,000 shares of the Company's common stock. The issuance of the
         common stock was valued at approximately $0.80 per share, the estimated
         fair value of such shares at the time of issuance.

                  In September 1997, this significant shareholder loaned the
         Company an additional $1.2 million, with interest at 9%.

7.       INVENTORIES:

                                     F - 12


<PAGE>



                  Inventories consist of the following at September 30, 1997:
                     

                     Raw materials and packaging     $               375,510
                     Work-in-process                                 365,333
                     Finished goods                                4,495,968
                                                      ----------------------
                                                     $             5,236,811
                                                      ======================
           
8.       PROPERTY AND EQUIPMENT:

                  Property and equipment consist of the following at September 
                  30, 1997:
               
                     Land                            $               420,000
                     Building                                      1,517,600
                     Equipment                                     2,808,526
                                                      ----------------------
                                                                   4,746,126

                     Less accumulated depreciation                 2,593,606
                                                      ----------------------
                                                     $             2,152,520
                                                      ======================



9.       OTHER ASSETS:

                  Other assets consist of the following at September 30, 1997:

                     Deferred acquisition costs      $               407,616
                     Noncurrent deferred tax asset                   581,535
                     Other                                           146,902
                                                      ----------------------
                                                     $             1,136,053
                                                      ======================



                                     F - 13


<PAGE>



10.      REVOLVING CREDIT AGREEMENTS:

         (a) In April 1994, the Company entered into an agreement with Congress
         Financial Corporation ("Congress") providing the Company with a
         $3,000,000 collateralized line of credit to be utilized for loans and
         trade letters of credit. The loan is collateralized by substantially
         all of the Company's personal property, including accounts receivable,
         inventory, and trademarks. The interest rate on loans is 2% above the
         prime rate announced by Philadelphia National Bank. The prime rate was
         8.5% and 8.25% at September 30, 1997 and 1996, respectively. The
         outstanding balance was $820,186 at September 30, 1997.

                  Pursuant to the amended terms dated October 1995, the Company
         may borrow up to an amount equal to the sum of:

                  (i)   80% of eligible accounts receivable (as defined)
                  (ii)  100% of cash collateral
                  (iii) the lesser of 35% of eligible inventory (as defined) or
                  $1,250,000, less 
                  (iv) any availability reserves.

                  The revolving credit agreement contains restrictions relating
         to the payment of dividends, and the maintenance of working capital and
         stockholders' equity. Up to $375,000 of such loan is guaranteed by a
         director and significant stockholder.

         (b) On February 9, 1996, the Company's wholly owned subsidiary
         (Biobottoms), entered into a new financing arrangement with Congress
         which includes a $2,000,000 revolving credit line, restricted to the
         lesser of 45% of the value of eligible inventory or 80% of the value of
         an orderly liquidation of such inventory. Borrowings on the line of
         credit bear interest at the prime rate plus 2% and it expires on
         February 9, 1999. Fees are paid on the unused line of credit at the
         rate of 1/2%. The line of credit is collateralized by substantially all

         of the Company's assets. The balance on this loan was $1,046,240 at
         September 30, 1997.

                  The above credit agreements with Congress Financial Corp. are
         currently being re-written as part of Congress's review and approval
         of the Magram acquisition.

                                     F  - 14


<PAGE>



11.      LONG-TERM DEBT:

              Long-term debt consists of the following at September 30, 1997:

         Note payable - bank, payable in monthly
         installments of $10,018 which includes interest at
         8.375%, due August 2010. The note is collateralized
         by land and buildings and is guaranteed by a
         stockholder.
                                                               $        952,806

         Note payable - bank, payable in monthly
         installments of $7,201 which includes interest at
         12%. The note is collateralized by land and
         buildings and is cosigned by a stockholder.(b)                 564,540

         Equipment Loans - payable in monthly installments               80,634

         Other                                                          161,493

         Acquisition notes payable(a)                                         -

                                                               ----------------
                                                                      1,759,473


         Current maturities                                             682,863
                                                               ----------------
         Long - term debt                                      $      1,076,610
                                                               ================

              The maturities of long term debt is as follows:

                    1998                           $  893,936
                    1999                              215,976
                    2000                               50,233
                    2001                               55,733
                    Thereafter                        543,595
                                           ------------------
                                                   $1,759,473                
                                           ==================
 
         (a) The Company paid $2,500,000 for Biobottoms, $1,000,000 in cash and
         $1,500,000 in the form of two promissory notes to Biobottoms'
         shareholders, each in the amount of $750,000 ("Acquisition Notes"). The
         notes bear interest at 1% over the prime rate as defined in the
         agreements as long as no default occurs. One such note was due six
         months from the acquisition date and the second note was due in two
         equal installments of $375,000, nine months and eighteen months after
         the date of acquisition, respectively. The Company did not make the
         payments which were required in August and November 1996. On December
         9, 1996, the Company received notification of the default from the
         former Biobottoms shareholders, which required that the Company cure
         the default under the notes within 270 days, or be subject to
         enforcement action. On February 25, 1997, the Biobottoms former
         shareholders agreed not to initiate enforcement action as a result of
         this or subsequent

                                      F - 15

<PAGE>


         defaults until not earlier than December 31, 1997. In connection with
         obtaining this agreement, Diplomat agreed to pay the Biobottoms
         shareholders ten installments of $5,000 to be applied against the
         acquisition notes, commencing on February 21, 1997 and to undertake to
         conduct a private placement of its securities to raise funds for the
         remaining balance due on the acquisition notes. In July 1997, the
         Company received proceeds from a Private Placement and pursuant to an
         agreement with the Biobottoms shareholders paid $1,500,000 in full
         satisfaction of all amounts due under the acquisition notes, and also
         amended its consulting agreements with Joan Cooper and Anita
         Dimondstein to provide for additional compensation of 29,204 shares
         each of the Company's common stock. Additionally, the Company incurred
         notes related to the acquisition in the amount of approximately
         $720,000. Of this amount, $600,000 represents the estimated fair value
         of 100,000 shares of the Company's convertible Series A Preferred Stock
         issued to a significant stockholder (who is also a member of the Board
         of Directors), as a fee for his assistance in consummating the

         acquisition. The Series A Preferred shares are convertible to 1,000,000
         common shares of the Company. The Series A Preferred Stock is not
         entitled to any specific dividends or liquidation rights.

         (b) Full payment of this mortgage was due on January 26, 1997. The
         lender agreed to extend the mortgage for an additional twelve months in
         exchange for an extension fee of $15,000 and the agreement to bring
         certain past due amounts current.

12.      STOCKHOLDERS' EQUITY:

              A. On December 31, 1992, the Board of Directors adopted a stock
         option plan which allows for the grant of option to employees and
         non-employees to purchase up to 200,000 shares of the Company's common
         stock. The exercise price per share cannot be less than the fair market
         value of the Company's common stock on the date of grant. During each
         of 1996 and 1995, the Company issued 75,000 options exercisable at
         $1.50 per share. There were no options exercised or canceled during
         either of the years presented.

              B. There are currently 581,175 warrants outstanding to purchase
         shares of the Company's common stock at $3.50 per share. The warrants,
         which were issued in connection with the Company's initial public
         offering of its common stock, are exercisable until November 4, 1998.
         To date, these warrants have not been exercised.

             C. During 1995, warrants to purchase 1,500,000 shares of common
         stock were granted; 500,000 of these warrants, exercisable at $1.37
         per share, were exercised during 1995 resulting in net proceeds to the
         Company of $628,000. The remaining 1,000,000 warrants were exercisable
         as follows, (i) 500,000 at $3.00 per share expiring on July 18, 1996
         and (ii) 500,000 at $1.00 per share expiring on July 18, 1997, which
         were exercised during 1997. The warrants expiring July 18, 1996 were
         not exercised.

              D. In September 1996, the Company issued 500,000 common shares at
         $0.95 per share to previously unrelated investors from the exercise of
         options. Net proceeds to the Company were $475,000.

                                     F - 16


<PAGE>



              E. In May 1997, the Company issued to Mr. Rubin of an aggregate of
         550,000 shares of Common Stock in consideration of Mr. Rubin's waiver
         of certain compensation owed to him and for restructuring certain debt
         owed to him, waiving certain defaults and providing an additional loan
         to the Company in the aggregate amount of $600,000 during 1996.

              F. In March 1997, the Company approved the issuance of 52,217
         shares of Common Stock to Mr. Rubin in lieu of the dividend payments
         due under the Series B and Service C Preferred Stock, as well as for an

         adjustment in salary, for the period from January 1, 1997 through March
         31, 1997.

              G. In September 9, 1996, the Company entered into an arrangement
         with Gersten, Savage, Kaplowitz & Fredericks, LLP ("GSK&F") which
         provided that GSK&F will provide certain legal and consulting services
         to the Company over an extended period of time. As compensation for its
         services, certain individual members of GSK&F received an aggregate of
         350,000 shares of Common Stock and options to purchase an aggregate of
         150,000 shares of Common Stock at $2.50 per share. Of such securities,
         157,500 shares of Common Stock and 67,500 options were issued to Wesley
         C. Fredericks who has since then become a director of the Company.

              H. In November 1996, the Company issued an aggregate of 1,060,000
         options to 35 employees of the Company, including two executive
         officers and one outside director, pursuant to the November 1996 Plan.
         The Options are exercisable at $1.00 per share, vest over a period of
         five years, and expire ten years from the date of grant, if not sooner
         due to termination or death of the employee.

              I. In May 1997, the Company issued an aggregate of 150,000 options
         pursuant to the November 1996 Plan, 50,000 of which were issued to
         Howard Katz, a director of the Company, and 100,000 of which were
         issued to Mr. Fredericks in connection with his agreement to become a
         member of the Company's board of directors.  Such options are
         exercisable at $2.38 per share.

              J. In May 1997, the Company authorized the issuance of 200,000
         shares of Common Stock to Mr. Rubin in consideration of Mr. Rubin
         extending loans to the company as well as extending a personal
         guarantee to Congress on behalf of the Company.

              K. Between May and July 1997, the Company issued an aggregate of
         158,408 shares of Common Stock and options to acquire 200,000 shares of
         Common Stock to six consultants. Of the 200,000 options, 50,000 are
         exercisable at $1.75 per share and 150,000 are exercisable at $1.875
         per share.

              L. From May 1997 through September 1997, the Company sold
         1,250,000 shares of its Common Stock in a private placement of its
         securities in which it raised $2,500,000. In addition to these shares,
         the Company issued to European Community Capital a placement agent's
         warrant exercisable to purchase up to 200,000 shares of Common Stock at
         $3.3125 per share. The Company issued an option to a principal of the
         placement agent to purchase up to 100,000 shares of Common Stock at
         $2.00 per share.

                                     F - 17


<PAGE>



              M. In September 1997, Mr. Rubin made an additional loan to the

         Company in the amount of $1,200,000.

              N. In October 1997, in part to raise capital for the Company's
         acquisition out of bankruptcy of the assets of Brownstone, the Company
         completed a private offering of its securities which raised $3,480,000
         from accredited investors. The private placement consisted of units,
         each unit consisting of ten shares of Series E Preferred Stock and
         7,500 shares of Common Stock at a purchase price of $10,000 per unit.
         As a result the Company will be issuing an aggregate of 3,480 shares of
         Series E Preferred Stock and 2,610,000 shares of Common Stock.

13.      CONCENTRATION OF CREDIT RISKS:

              Financial instruments that potentially subject the Company to
         concentrations of credit risk consist principally of trade accounts
         receivable. Concentrations of credit risk with respect to trade
         receivables include concentrations of trade accounts in the juvenile
         products industry.

14.      NET SALES:

              For the year ended September 30, 1997 and the nine months ended
         September 30, 1996 two customers of Diplomat accounted for 6% and 4%
         and 6% and 15% of net sales, respectively.

15.      COMMITMENTS AND CONTINGENCY:



                                     F - 18


<PAGE>





              Litigation

              In September 1996, the Company was named as a defendant in an
         action brought in the Supreme Court of New York. The plaintiff alleges
         that the defendants' (including the Company) negligent maintenance of a
         railroad crossing adjacent to the Company's property caused him to
         collide with a train. The plaintiff is seeking $10,000,000 in damages
         for his injuries, and his spouse is seeking an additional $1,000,000 in
         damages for loss of the plaintiff's services. The Company and its
         insurance carrier intend to vigorously defend this action. The ultimate
         outcome of the litigation cannot be presently determined. The Company
         does maintain $1,000,000 of insurance coverage which could be applied
         to any liability posed by this matter.

              In February 1997, Francine Nichols, a former consultant to the
         Company, commenced an action against the Company in the Supreme Court
         of the State of New York, New York County, to recover approximately
         $240,000 allegedly due under a consulting agreement between Ms Nichols
         and the Company. The Company disputes

                                     F - 19


<PAGE>




         each claim and intends to vigorously defend against them and believes 
         that it will prevail.

              In July 1997, Federal Express commenced an action against
         Biobottoms claiming approximately $180,000 in unpaid delivery invoices.
         Biobottoms has disputed this claim and has filed a counter claim on
         several bases, one of which is nonperformance. Biobottoms intends to
         vigorously defend against the claim, and believes that it will prevail.

16.      INCOME TAXES:

              The following analyzes the deferred tax assets at September 30,
         1997:

          Deferred tax asset:

          Net operating loss carry forward              $        3,167,000
          Depreciation                                             102,000
          Inventory                                              1,016,000
          Other items                                              164,000
                                                        ------------------
                                                                 4,449,000

          Less: Valuation allowance                             (3,087,000)
                                                        ------------------
            Deferred tax asset                          $        1,362,000
                                                        ==================

              A valuation allowance is provided to reduce the deferred tax
         assets to a level which, more likely than not, will be realized. The
         net deferred tax asset reflects management's estimates of the amount
         which will be realized from future profitability which can be predicted
         with reasonable certainty. The valuation allowance was $2,835,000 at
         September 30, 1997, which represents a decrease of $212,000 over the
         amount reported at September 30, 1996.

              As of September 30, 1997, the Company has net operating loss carry
         forwards for Federal income tax purposes of approximately $7,900,000
         which are available to offset future Federal taxable income through
         2009.

                                     F - 20


<PAGE>



         The provision for income taxes differs from the amount computed by
         applying the 34% federal statutory income tax rate to the net loss
         before provision for income taxes as follows:


<TABLE>
<CAPTION>

                                                                                     Nine
                                                            Year ended           months ended     
                                                           September 30,         September 30,     
                                                               1997                  1996       
                                                        -------------------   ------------------
  <S>                                                   <C>                   <C>                   

  Income tax (benefit) computed at statutory rate       $           257,000   $       (2,456,000)   

  Tax benefit of  net operating loss carry forward                 (257,000)

  State tax benefit, net of federal tax benefit                       1,567             (313,000)

  Adjustment to valuation allowance                                (212,000)           2,769,000   
                                                        -------------------   ------------------
  Income tax (benefit) as reported                      $          (210,433)  $          -       
                                                        ===================   ===================
</TABLE>

17.      BUSINESS SEGMENT INFORMATION:

              Summarized financial information by business segment for nine
         months ending September 30, 1997 is as follows:

                                                           Year ended
                                                          September 30,
                                                              1997
                                                     -----------------------
                Net sales:
                
                     Specialty catalog retail        $            17,591,784
                    operations

                     Mass merchant manufacturing                   6,892,724
                      and distribution
                                                     -----------------------
                                                                  24,484,508
                                                     -----------------------
               Operating income:

                     Specialty catalog retail                       (287,066)
                    operations

                     Mass merchant manufacturing                   1,436,434
                     and distribution
                                                     -----------------------
                                                                   1,149,368
                                                     -----------------------


                                     F - 21



<PAGE>


               Total assets:

                     Specialty catalog retail                     10,311,497
                    operations

                     Mass merchant manufacturing                   5,415,333
                     and distribution
                                                     -----------------------
                                                                  15,726,830
                                                     -----------------------

               Depreciation and amortization:

                     Specialty catalog retail                        320,941
                    operations

                     Mass merchant manufacturing                     105,124
                     and distribution
                                                     -----------------------
                                                                     426,065
                                                     -----------------------

               Capital expenditures:

                     Specialty catalog retail                        159,766
                    operations

                     Mass merchant manufacturing                      20,138
                     and distribution
                                                     -----------------------
                                                     $               179,904
                                                     -----------------------



18.      YEAR ENDED SEPTEMBER 30, 1996 (UNAUDITED):

                  The following summarizes the Company's results of operations
         for year ended September 30, 1996:

                                                            Year ended
                                                        September 30, 1996
                                                     -----------------------
               Net sales                             $            20,576,697

               Cost of sales                                      14,579,343
                                                     -----------------------
               Gross profit                                        5,997,354


                                     F - 22


<PAGE>




               Operating expenses                                 13,543,927

                                                     -----------------------
               Operating loss                                     (7,546,573)

               Other income                                            3,980

               Interest expense                                     (908,664)
                                                     -----------------------
               Loss before income taxes                           (8,451,257)

               Income taxes                                           47,000
                                                     -----------------------
               Net loss                              $            (8,404,257)
                                                     -----------------------
               Net loss per share                    $                 (1.97)
                                                     -----------------------
               Number of shares used in                            4,267,640
               computation

19.      STOCK OPTION PLANS

              The Company's 1992 Stock Option Plan ("1992 Stock Option Plan")
         provides for the issuance of up to 200,000 shares of Common Stock upon
         exercise of incentive stock options and is intended to qualify under
         Section 422 of the Internal Revenue Service Code of 1986, amended
         ("Code").

              The Stock Option Plan may be administered by the Board of
         Directors or by a stock option committee of the Board of Directors (the
         "Committee"). Incentive stock options are granted under the Stock
         Option Plan to employees generally on the basis of the recipient's
         responsibilities and the achievement of performance objectives. Subject
         to the limitations set forth in the Stock Option Plan, the Board or the
         Committee has the authority to determine when the options may be
         exercised and vest. Under the Plan, the per share exercise price may
         not be less than the greater of 100% of the fair market value of the
         shares on the date of grant. With respect to any participant who owns
         stock possessing more than 10% of the voting rights of the Company's
         outstanding capital stock, the per share exercise price must be at
         least 110% of the fair market value on the date of grant and the term
         may not be longer than five years. As of this date, the Company has
         outstanding an aggregate of 130,000 Stock options, exercisable at $1.50
         per share, all of which are held by affiliates or employees of the
         Company at the time of grant.


         August 1996 Stock Option Plan -- The Company also established a
         non-qualified stock option plan providing for the issuance of up to
         1,500,000 shares of Common Stock to its directors, officers, key
         employees and consultants (the "August 1996 Plan"). To date, the
         Company has granted directors, officers and key employees an aggregate
         of 150,000 incentive and non-

                                     F - 23
<PAGE>

         qualified stock options, at an exercise price of $2.00 per share and
         500,000 non-qualified stock options issued and exercised by a
         consultant. Future grants could have an adverse affect on the market
         price of the Company's securities.

         November 1996 Stock Option Plan -- Under the Company's November 1996
         Incentive Stock Option Plan (the "November 1996 Plan"), options to
         purchase a maximum of 1,500,000 shares of Common Stock of the Company
         (subject to adjustments in the event of stock splits, stock dividends,
         recapitalizations and other capital adjustments) may be granted to
         employees, officers and directors of the Company and other persons who
         provide services to the Company. As of the date of this Prospectus,
         1,060,000 of such options have been granted at an exercise price $1.00,
         and 150,000 have been granted at an exercise price of $2.375. The
         options to be granted under the Plan are designated as incentive stock
         options or non-incentive stock options by the Board of Directors which
         also has discretion as to the persons to be granted options, the number
         of shares subject to the options and terms of the option agreements.
         Only employees, including officers and part time employees of the
         Company, and non-employee directors, consultants and advisors and other
         persons who perform significant service for or on behalf of the
         Company, may be granted incentive stock options, officers and directors
         who currently own more than 5% of the issued and outstanding stock are
         not eligible to participate in the Plan.

              The Plan provides that options granted thereunder shall be
         exercisable during a period of no more than ten years from the date of
         grant, depending upon the specific option agreement, and that, with
         respect to incentive stock options, the option exercise price shall be
         at least equal to 100% of the fair market value of the Common Stock at
         the time of the grant.

              In fiscal 1997, the Company adopted the disclosure provisions of
         SFAS No. 123, "Accounting for Stock-Based Compensation". For disclosure
         purposes, the fair value of options is estimated on the date of grant
         using the Black-Scholes option option pricing model with the following
         weighted average assumptions used for stock options granted during the
         years ended September 30, 1997 and 1996: annual dividends of $0;
         expected volatility of 94.99%; risk-free interest rate of 7% and
         expected life of five years. The weighted average fair value of stock
         options granted during the years ended September 30, 1997 and 1996 was
         $1.17 and $1.48, respectively. If the Company had recognized
         compensation cost for stock options in accordance with SFAS No. 123,
         the Company's proforma net loss and net loss per share would have been

         $328,099 and $.06 per share for the fiscal year ended September 30,
         1997 and $8,298,400 and $1.82 per share for the nine months ended
         September 30, 1996.

20.      SUBSEQUENT EVENT

              In October 1997, the Company acquired out of bankruptcy all of the
         assets of Brownstone Studios, Inc., a mail-order catalog company.

                                     F - 24