<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-QSB
(Mark one)
( X ) QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1996
( ) TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE
ACT
For the transition period from _______ to________
Commission file number 0-19227
COSMETIC GROUP U.S.A., INC.
(Exact name of small business issuer as specified in its charter)
<TABLE>
<S> <C>
CALIFORNIA 95-4040591
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
</TABLE>
11312 Penrose Street, Sun Valley, CA 91352
(Address of principal executive offices)
(818) 767-2889
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes X No
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date: 5,063,756 shares of common
stock outstanding at October 31, 1996.
Transitional Small Business Disclosure Format (check one) Yes No X
<PAGE> 2
INDEX
COSMETIC GROUP U.S.A., INC.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed consolidated balance sheet - September 30, 1996
Condensed consolidated statements of operations - Three months
and nine months ended September 30, 1996 and 1995
Condensed consolidated statements of cash flows - Nine months ended
September 30, 1996 and 1995
Notes to condensed consolidated financial statements - September 30,
1996
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
PART II. OTHER INFORMATION
Item 4. Submission of matters to a vote of security holders
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
<PAGE> 3
PART I. FINANCIAL INFORMATION
Item 1.
COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEET (UNAUDITED)
SEPTEMBER 30, 1996
<TABLE>
<S> <C>
ASSETS - Note 3
CURRENT ASSETS
Cash $ 4,000
Accounts receivable, less allowance of $50,000 1,909,000
Inventory - Note 2 2,716,000
Prepaid expenses and other 872,000
Due from officer/director/shareholder 70,000
----------
TOTAL CURRENT ASSETS 5,571,000
PROPERTY, PLANT AND EQUIPMENT, net of accumulated
depreciation and amortization of $1,644,000 2,246,000
OTHER ASSETS 188,000
-----------
$ 8,005,000
-----------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Due under finance agreement $ 708,000
Accounts payable 1,804,000
Accrued liabilities 524,000
Current portion of notes payable 314,000
----------
TOTAL CURRENT LIABILITIES 3,350,000
NOTES PAYABLE, less current portion 133,000
10% SUBORDINATED CONVERTIBLE NOTES - Note 3 300,000
DEFERRED INCOME TAXES 20,000
SHAREHOLDERS' EQUITY - Notes 3 and 4
Preferred stock, $.01 par value, authorized
1,000,000 shares, none issued -
Common stock, no par value, authorized 25,000,000
shares, issued and outstanding 5,063,756 shares 6,388,000
Retained deficit (2,186,000)
-----------
4,202,000
-----------
$ 8,005,000
===========
</TABLE>
See accompanying notes.
<PAGE> 4
COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales $3,940,000 $2,911,000 $10,680,000 $5,812,000
Cost of sales 2,326,000 1,983,000 6,249,000 4,395,000
---------- ---------- ---------- ----------
Gross profit 1,614,000 928,000 4,431,000 1,417,000
Selling, general and
administrative expenses 1,272,000 1,241,000 3,721,000 2,679,000
Settlement of litigation -
Note 5 240,000 240,000
Interest expense 76,000 121,000 281,000 268,000
---------- ---------- ---------- ----------
1,588,000 1,362,000 4,242,000 2,947,000
---------- ---------- ---------- ----------
Income (loss) before
income taxes 26,000 (434,000) 189,000 (1,530,000)
Income taxes - - - -
---------- ---------- ---------- ----------
Net income (loss) $ 26,000 $ (434,000) $ 189,000 ($1,530,000)
========== ========== ========== ==========
Net income (loss) per share $ .01 ($ .10) $ .04 ($ .38)
===== ===== ===== =====
Weighted average number of
common shares outstanding 5,063,756 4,343,536 5,059,034 3,977,932
========== ========== ========== ==========
</TABLE>
See accompanying notes.
<PAGE> 5
COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1996 1995
---------- ----------
<S> <C> <C>
OPERATING ACTIVITIES
Net cash provided by (used in)
operating activities $ 60,000 $(1,605,000)
INVESTING ACTIVITIES
Purchase of property, plant and equipment (465,000) (184,000)
--------- ---------
Net cash used in investing activities (465,000) (184,000)
FINANCING ACTIVITIES
Issuance of common stock 1,384,000
Registration costs (110,000) -
Loan from officer/director/shareholder - 63,000
Net proceeds from short term receivable line 103,000 444,000
Other borrowings 844,000 360,000
Repayment of borrowings (450,000) (1,273,000)
--------- ---------
Net cash provided by financing
activities 387,000 978,000
--------- ---------
Net increase (decrease) in cash (18,000) (811,000)
Cash at beginning of period 22,000 1,026,000
--------- ---------
Cash at end of period $ 4,000 $ 215,000
========= ==========
</TABLE>
See accompanying notes.
<PAGE> 6
COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1996
1. Basis of Preparation
The accompanying unaudited condensed consolidated financial statements include
the accounts of the Company and its subsidiary. The statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information pursuant to Regulation S-B. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the three months and nine months ended September 30, 1996 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1996. For further information refer to the consolidated financial
statements and footnotes thereto included in Form 10-KSB for the year ended
December 31, 1995 filed by the Company.
2. Inventory
Inventory at September 30, 1996 consists of:
<TABLE>
<S> <C>
Raw materials and components $1,863,000
Work-in-process 290,000
Finished goods 563,000
---------
$2,716,000
-----------
</TABLE>
3. Debt
In May 1996, the Company terminated its Account Purchase and Finance Agreement
which provides the Company with accounts receivable financing and entered into
a new accounts receivable financing arrangement. The new Accounts Receivable
Security Agreement provided for advances of up to 75% of eligible accounts
receivable with a maximum advance of $1,000,000. Obligations of the Company
bear interest at 16% per annum, which rate may increase if the prime rate
exceeds 8.25%. The initial proceeds of the new financing were used to repay the
balance due under the former financing.
The Company's obligations to its lenders are secured by a security interest in
substantially all of the assets of the Company and its subsidiary.
<PAGE> 7
(continued)
COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1996 (CONTINUED)
3. Debt (continued)
In June 1996, the Company borrowed $150,000 from a partnership of which a
director of the Company is the general partner. The loan was repaid in full in
August 1996 with interest at the rate of 10% a year. As additional incentive
for making the loan, the Company issued the individual 7,500 shares of the
Company's common stock; the fair market value of the shares has been charged to
interest expense.
In September 1996, the Company commenced a private placement of $500,000
principal amount of 10% Subordinated Convertible Notes. Interest on the notes
is payable semi-annually and the principal is due in September 1999. The notes
are convertible into shares of common stock at the rate of $2 per share
(subject to anti-dilution provisions). In September, the Company sold $300,000
principal amount of the notes to a partnership of which a director of the
Company is the general partner.
4. Shareholders's Equity
During the nine months ended September 30, 1996, the Company charged common
stock $110,000 for costs incurred in connection with the registration of common
stock sold in private placements.
5. Litigation
The Company was a defendant in a lawsuit filed in March 1996 in the United
States District Court for the District of Minnesota. The complaint alleged that
a portion of a product delivered by the Company for the plaintiff was defective
and sought incidental and consequential damages in an unspecified amount and
reimbursement of certain fees and expenses.
In September 1996, the Company and the plaintiff agreed to settle the
litigation in consideration of the payment by the Company of $100,000 cash,
payable over a 60-day period, and the issuance of 100,000 shares of the
Company's common stock to the plaintiff. The Company recorded an expense of
$240,000 in the third quarter of 1996 in connection with the settlement of the
litigation, of which $100,000 is attributable to the cash payment, $122,500 is
attributable to the value of the shares of common stock issuable to the
plaintiff and the balance is attributable to certain fees and expenses incurred
in connection with the settlement of the litigation.
<PAGE> 8
Item 2.
COSMETIC GROUP U.S.A., INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion contains "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Act of 1934, as amended. There are certain important
factors that could cause future results to differ materially from those
anticipated by management in the forward-looking statements included in the
following discussion. Among these important factors are (a) the Company's
dependence on a small number of customers, (b) recent operating losses and cash
flow deficiencies, (c) risks associated with the introduction of the Company's
Zegarelli product line, including the need to increase sales levels and expand
the Company's distribution network, (d) the Company's dependence on key
executives, (e) the variability of quarterly results, (f) the competitive
environment in the Company's markets, (g) the Company's reliance on a single
manufacturing facility, (h) product liability risks, (i) government regulation,
(j) control by management, and (k) volatility in the price of the Company's
common stock, including the possible effect on the market price of the
availability for sale and actual sales of currently outstanding shares of
common stock and shares of common stock issuable upon the exercise of
outstanding options and warrants.
GENERAL
The Company operates in two segments, contract manufacturing and the
manufacture and sale of professional hair care products under the "Zegarelli"
name. Through its contract manufacturing operations, the Company custom
develops, formulates and manufactures a wide range of color cosmetics and other
personal care products for customers that market products for sale under their
own brand names. In addition to its operations as a contract manufacturer, in
1994, the Company developed with Arnold Zegarelli, a professional hair
designer, a line of professional hair care products which are manufactured by
the Company and marketed to beauty salons and hair care professionals. Sales of
the Zegarelli product line commenced in the second quarter of 1995.
The Company continues to devote substantial resources to the introduction and
marketing of its Zegarelli product line. The current sales level of the
Zegarelli line are not sufficient to cover related costs and expenses. The
Company's ability to increase sales of the Zegarelli line to the extent
necessary to meet ongoing costs and expenses is dependent upon an expansion of
the Company's distribution network and increased market acceptance of the
product line. There can be no assurance that the Company will be able to
successfully establish and maintain the necessary distribution network for the
Zegarelli product line or otherwise successfully compete in the professional
hair care products market.
<PAGE> 9
RESULTS OF OPERATIONS
Net sales for the quarter ended September 30, 1996 increased $1,029,000 (35%)
and net sales for the nine months ended September 30, 1996 increased $4,868,000
(84%) from the comparable periods of 1995, as the Company's revenues continue
to recover from the depressed levels in the first half of 1995. The increase
for the three month period is attributable to increased sales of Zegarelli hair
care products to $1,310,000 for the three months ended September 30, 1996,
compared to $118,000 for the same quarter last year. Sales to Avon Products
("Avon"), the Company's largest customer for its contract packaging business
declined to $435,000 for the three months ended September 30, 1996 compared to
$1,324,000 for the same quarter last year; increased sales to other contract
manufacturing customers in the September 1996 quarter offset this reduction.
The increase in net sales for the nine month period is attributable to
increased sales of Zegarelli hair care products ($2,642,000 for the nine months
ended September 30, 1996 compared to $816,000 for the same period last year)
and to increased sales to contract packaging customers, including major
infomercial marketing companies. Sales to Avon were approximately the same
($2,400,000) for the nine months ended September 30, 1996 and 1995. Sales of
Zegarelli hair care products and current levels of sales in the contract
packaging business are expected to continue for the balance of the year.
Cost of sales increased $343,000 in the three months ended September 30, 1996
and $1,854,000 in the nine months ended September 30, 1996, as compared with
the same periods last year. As a percentage of net sales, cost of sales was 59%
for the three months and for the nine months ended September 30, 1996, compared
to 68% for the three months ended September 30, 1995 and 76% for the nine
months ended September 30, 1995. The decrease in the cost of sales percentage
is primarily attributable to efficiencies associated with significantly higher
sales levels and changes in the sales mix.
Selling, general and administrative expenses were $1,272,000 for the three
months ended September 30, 1996 and $3,721,000 for the nine months ended
September 30, 1996, compared to $1,241,000 and $2,679,000, respectively, for
the same periods in 1995. These amounts represent an increase of $31,000 (3%)
for the three month period and $1,042,000 (39%) for the nine month period. As a
percentage of net sales, these expenses were 32% and 35% for the three months
and nine months ended September 30, 1996, compared to 43% and 46% for the same
periods last year. The dollar increase for the nine month period is primarily
attributable to expenses in connection with the development and marketing of
the Zegarelli hair care line, including the addition of executive and support
personnel required for its current and anticipated operations. The decrease in
the percentage to net sales is the result of significantly higher sales in the
1996 periods, with a portion of expenses being of a fixed nature.
<PAGE> 10
In the three months ended September 30, 1996 the Company recorded a charge of
$240,000 related to the settlement of litigation which was filed in March 1996.
There was no comparable charge in 1995.
Interest expense was $76,000 for the three months ended September 30, 1996 and
$281,000 for the nine months ended September 30, 1996. For the comparable
periods in 1995 such expenses were $121,000 and $268,000, respectively. The
decrease for the three month period is attributable to the lower interest rate
under the accounts receivable credit facility which replaced the previous
accounts receivable line in May 1996.
For the three months and nine months ended September 30, 1996, the Company
recorded net income of $26,000 and $189,000, respectively. Operating results
for these periods include a charge to income, as discussed above, of $240,000
for the settlement of litigation; without this charge, net income would have
been $266,000 for the three months ended September 30, 1996 and $429,000 for
the nine months ended September 30, 1996. For the comparable periods in 1995,
the Company had a net loss of $434,000 and $1,530,000. The improvement in
operating results is the result of higher sales and the resulting gross profit
and reduced interest costs (for the quarter ended September 30, 1996), offset
by increased selling, general and administrative expenses and the charge
related to settlement of litigation. Net income per share was $.01 for the
three months ended September 30, 1996 and $.04 for the nine months ended
September 30, 1996. Net loss per share was ($.10) for the three months ended
September 30, 1995 and ($.38) for the nine months ended September 30, 1995. The
average number of shares used in computing per share amounts increased as a
result of private placements of common stock and the conversion of convertible
debt in the latter part of 1995.
LIQUIDITY AND CAPITAL RESOURCES
Working capital amounted to $2,221,000 at September 30, 1996, an increase of
$330,000 from December 31, 1995. For the nine months ended September 30, 1996,
operations resulted in cash flow of $60,000, $465,000 was invested in new
equipment, borrowings, net of repayments, were $497,000 and registration costs
amounted to $110,000.
In order to supplement its working capital and the available borrowings under
its accounts receivable facility (which has a maximum availability of
$1,000,000), in September 1996, the Company commenced the private placement of
$500,000 principal amount of its 10% Subordinated Convertible Notes (the
"Convertible Notes"). The Company has sold $300,000 principal amount of
Convertible Notes to a partnership of which a director of the Company is the
general partner. No assurances can be given that the placement of the
remaining Convertible Notes will be successfully completed. The net proceeds
from the placement will be used to fund the cash portion of the litigation
settlement referred to above and for working capital and other general
corporate purposes. The issuance of $300,000 principal amount of Convertible
Notes will result in an increase of $30,000 in the Company's annual interest
expense; if the placement of the remaining $200,000 principal amount of
Convertible Notes is successfully completed, the Company's annual interest
expense will increase by $50,000 in the aggregate. For further information
<PAGE> 11
regarding the terms of the Convertible Notes, see Note 3 of Notes to Unaudited
Condensed Consolidated Financial Statements.
The Company believes that funds generated from operations, borrowings under its
credit facilities and the proceeds from the private placement of the
Convertible Notes (regardless of whether the sale of the remaining $200,000
principal amount of Convertible Notes is completed) will be sufficient to
finance its working capital and capital expenditure requirements for the next
twelve months. However, there can be no assurance that such funds will be
sufficient or that the Company's operations will not result in cash flow
deficiencies. In addition, in order to take advantage of business
opportunities, the Company may consider raising additional funds from time to
time through the private placement of debt or equity securities.
<PAGE> 12
PART II. OTHER INFORMATION
Item 4. Submission of matters to a vote of security holders
The annual meeting of shareholders was held on July 16, 1996. At the meeting,
the shareholders elected a Board of Directors consisting of Alfred E. Booth,
Jr., Judith E. Zegarelli, Frank X. McGarvey, Jack Brehm, William B. Barnett and
Eric Nickerson pursuant to management's nomination as set forth in the proxy
statement dated June 7, 1996. Of the 4,132,275 shares of common stock
represented in person or by proxy at the annual meeting, 4,054,075 shares were
voted in favor of the election of Mr. Booth (with 0 votes withheld), 4,054,075
shares were voted in favor of the election of Ms. Zegarelli (with 0 votes
withheld), 4,053,975 shares were voted in favor of the election of Mr. McGarvey
(with 0 votes withheld), 4,054,075 shares were voted in favor of the election
of Mr. Brehm (with 0 votes withheld), 4,054,075 shares were voted in favor of
the election of Mr. Barnett (with 0 votes withheld), and 4,054,075 shares were
voted in favor of the election of Mr. Nickerson (with 0 votes withheld).
At the annual meeting, the shareholders also approved: (i) the proposal to
amend the Company's 1990 Stock Incentive Plan to increase the number of shares
subject to the plan from 800,000 to 1,000,000, such proposal receiving
3,793,414 votes for approval and 215,922 votes against approval, with 26,852
votes abstaining and 23,857 broker non-votes, and (ii) the proposal to ratify
the selection of Ernst & Young LLP as independent accountants for fiscal 1996,
such proposal receiving 4,117,275 votes for approval and 12,000 votes against
approval, with 3,000 votes abstaining.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits - None
(b) Reports on Form 8-K
Report on Form 8-K was filed under date of July 16, 1996 with respect to
Item 5.
Report on Form 8-K was filed under date of September 30, 1996
with respect to Item 5 and 7.
<PAGE> 13
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereto
duly authorized.
COSMETIC GROUP U.S.A., INC.
/s/ JENNIFER J. EGGERS
Date: November 13, 1996 -----------------------------
Jennifer J. Eggers
Chief Financial Officer and
Chief Accounting Officer
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 4,000
<SECURITIES> 0
<RECEIVABLES> 1,959,000
<ALLOWANCES> 50,000
<INVENTORY> 2,716,000
<CURRENT-ASSETS> 5,571,000
<PP&E> 3,890,000
<DEPRECIATION> 1,644,000
<TOTAL-ASSETS> 8,005,000
<CURRENT-LIABILITIES> 3,350,000
<BONDS> 0
0
0
<COMMON> 6,388,000
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 8,005,000
<SALES> 10,680,000
<TOTAL-REVENUES> 10,680,000
<CGS> 6,249,000
<TOTAL-COSTS> 3,721,000
<OTHER-EXPENSES> 240,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 281,000
<INCOME-PRETAX> 189,000
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 189,000
<EPS-PRIMARY> 0.04
<EPS-DILUTED> 0.04
</TABLE>
