<PAGE>   1




                       SECURITIES AND EXCHANGE COMMISSION
                            Washington, D. C.  20549
                                  FORM 10-KSB


[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 for the fiscal year ended December 31, 1996.

[  ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934 for the transition period from
      ___________ to _ _________

Commission File No. 0-19227

                          COSMETIC GROUP U.S.A., INC.
---------------------------------------------------------------
          (Name of small business issuer as specified in its charter)

<TABLE>
     <S>                                              <C>
               California                                95-4040591
     -------------------------------                     ----------
     (State or other jurisdiction of                  (I.R.S. Employer
      incorporation or organization)                  Identification No.)
</TABLE>

11312 Penrose Street, Sun Valley, California           91352 
 (Address of principal executive offices)            (Zip Code)

Issuer's telephone number, including area code:  (818) 767-2889

Securities registered pursuant to Section 12(b) of the Act:  Units (each Unit
consisting of two shares of Common Stock and one redeemable Common Stock
Purchase Warrant), Common Stock, No Par Value, and Warrants to purchase Common
Stock

Securities registered pursuant to Section 12(g) of the Act:  Units (each Unit
consisting of two shares of Common Stock and one redeemable Common Stock
Purchase Warrant), Common Stock, No Par Value, and Warrants to purchase Common
Stock

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

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB.  [ X ]

Revenues for the fiscal year ended December 31, 1996 totaled $15,180,000.
<PAGE>   2
As of March 12, 1997, the aggregate market value of the voting stock held by
non-affiliates of the registrant (based upon the average of the closing bid and
asked prices on such date) was approximately $4,970,000.

As of March 12, 1997, the registrant had outstanding 5,175,438 shares of Common
Stock.

Documents incorporated by reference:  Certain responses to Part III are
incorporated herein by reference to information contained in the registrant's
definitive proxy statement for its 1996 annual meeting of stockholders as filed
with the Securities and Exchange Commission on or before April 30, 1997.

                                                  Exhibit index page number:    
                         Total sequentially numbered pages in this document:    
<PAGE>   3
                                     PART I
ITEM 1.  BUSINESS

GENERAL

The Company operates in two segments, contract manufacturing and the
manufacture and sale of professional hair care products under the name
"Zegarelli."  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.  Products are manufactured both from formulas developed by the
Company and proprietary formulas owned by the Company's customers.  The
Company's contract manufacturing operations consist of the manufacture of
products in three principal categories: color cosmetics and fragrances, creams
and lotions and hair care products. As part of the Company's efforts to expand
its product offerings, the Company upgraded its in-house capacity to
manufacture powder-based cosmetics and creams and lotions during 1993 and
completed the installation of a high capacity system for the manufacture of
hair care products and creams and lotions in February 1994.

Contract manufacturers, such as the Company, formulate and manufacture
cosmetics and other personal care products for companies that market products
for sale at the retail level under their own brand names.  Customers for
contract manufacturers range from marketers of personal care products that lack
manufacturing capabilities to marketers that manufacture a significant portion
of their personal care products.  Companies with manufacturing capabilities
utilize services of contract manufacturers as a result of internal decisions
not to devote manufacturing resources to certain product lines, due to the size
of the product run or the nature of the manufacturing process, or in response
to scheduling needs or a lack of sufficient manufacturing capacity.  Although
these customers eventually may bring in-house the production of products
manufactured for them by contract manufacturers, it is the Company's experience
that many manufacturers and distributors of cosmetics and other personal care
products utilize the services of contract manufacturers on a regular basis and
that the relationship established in filling specific product orders can lead
to orders for additional products in the future.

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 under the Zegarelli name.
The line includes shampoos, conditioners and styling and finishing products.
The Company has entered into a license agreement with a corporation owned by
Mr. Zegarelli which grants to the Company an exclusive, non-transferable
license to use the Zegarelli name in connection with the manufacture and sale
of hair care and other personal care products.  The Company also has entered
into a distribution agreement with Sally Beauty Company, Inc. ("Sally"), a
subsidiary of Alberto-Culver Co., which grants to Sally the exclusive right to
distribute the Zegarelli product line in the United States through beauty
supply stores, to salons and professional hairdressers.  The Company also uses
independent distributors to sell the Zegarelli product line directly to larger
salons and salon chains, and, in connection therewith,





                                       1
<PAGE>   4
the Company generally expects to repurchase products from Sally for sale to its
independent distributors and to use warehouse and shipping services provided by
Sally.  Sales of the Zegarelli product line to Sally commenced in the second
quarter of 1995, and sales to independent distributors commenced in the third
quarter of 1995.

The Company's efforts during 1995 and 1996 with respect to its Zegarelli
product line primarily focused on introducing the product line to the
professional hair care industry through participation in trade shows and other
promotional and marketing activities and on seeking to establish relationships
with independent distributors.  The Company also expended a significant effort
in 1995 and 1996 in developing the sales programs, sales aids and other
promotional materials that the Company believes are necessary to establish
relationships with independent distributors and promote salon use and retail
sales.  The Company believes that it now has in place the promotional materials
and programs that are required to support its marketing efforts.

The current sales levels of the Zegarelli line are not sufficient to cover the
related costs and expenses.  The Company's ability to increase sales of the
Zegarelli line to the level necessary to meet ongoing costs and expenses is
dependent upon the growth and expansion of the Company's distributor network
with 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 its Zegarelli product line or otherwise
successfully compete in the professional hair care products market.  For
information on the effects of the Zegarelli product line on the Company's
results of operations for 1995 and 1996, see "Management's Discussion and
Analysis or Plan of Operation - Results of Operations."

The Company's Zegarelli product line is discussed in this Item 1 under the
caption "Zegarelli Product Line."  The remaining portions of this Item 1
generally describe only the operations of the Company's contract manufacturing
business unless the context indicates otherwise.  For financial information
about the Company's segments, including the amount of net sales and operating
profit or loss for 1995 and 1996, see "Note 9 of Notes to Financial
Statements."

The Company is the product of a reorganization of two previously unaffiliated
companies, Cosmetic Group USA, Inc. ("CUSA") and K7 Capital Corporation ("K7").
CUSA was organized in 1986.  K7 was organized in February 1990 with a view to
acquiring a privately held company and, at the time of the reorganization, was
an inactive public company.  As a result of the reorganization, K7 succeeded to
the business of CUSA and changed its name to "Cosmetic Group U.S.A., Inc.," and
the shareholders of CUSA immediately prior to the reorganization became the
owners of approximately 82.5% of the outstanding shares of common stock of the
surviving corporation.





                                       2
<PAGE>   5
PRODUCTS

Through its contract manufacturing operations, the Company offers customers the
ability to manufacture a wide range of color cosmetics and other personal care
products. Products are manufactured from both proprietary formulas owned by the
Company's customers and formulas developed by the Company.  The Company's
contract manufacturing operations consist of the manufacture of products in
three primary categories: color cosmetics and fragrances, creams and lotions
and hair care products.

From inception through 1991, the products manufactured by the Company primarily
consisted of color cosmetics and fragrances. The Company expanded its product
offerings to include creams and lotions in 1992 and completed the installation
in February 1994 of a manufacturing system which significantly increases its
capacity to produce hair care products and creams and lotions.  The Company
utilizes this equipment to manufacture a substantial portion of the products
included in its Zegarelli line.  For information regarding the products
included in the Zegarelli line, see "Zegarelli Product Line".

The following table shows the Company's sales by segment and by each major
product category within the contract manufacturing segment as a percentage of
net sales for each of the three years ended December 31, 1996:

<TABLE>
<CAPTION>
                                                 Percentage of Sales
                                                 -------------------
                                                Year ended December 31,
                                               ------------------------

         Contract manufacturing           1994          1995           1996 
         ----------------------          ------        ------         ------
         <S>                             <C>           <C>            <C>
           Color cosmetics and
            fragrances                     70%           69%            60%

           Creams and lotions              25            18             11
                                            5
           Hair care products              --                            3



         Zegarelli products*               --            13             26
         ------------------               ---           ---           ----
                                          100%          100%           100%
                                          ===           ===            === 
</TABLE>
_______________

 * Sales of the Zegarelli product line commenced in 1995.





                                       3
<PAGE>   6
In addition to filling individual product orders, the Company is able to
develop for its customers a full line of color cosmetics. The Company's sales
personnel and laboratory staff have worked with certain customers to develop
and formulate many of the cosmetics marketed by those customers through their
infomercial programs and other distribution channels.  Ownership of the
formulas for these products generally has been retained by the Company.

SALES AND MARKETING

The Company's marketing plans and programs are intended to expand the Company's
customer base and provide for more aggressive marketing of the Company's
products and services. These marketing efforts include the continuing
development of target lists of potential customers, advertising in trade
publications, participation in trade shows and the development of brochures and
other printed materials for distribution to potential customers.

The Company believes that providing exceptional customer service is a key
element of its marketing program. The Company's marketing efforts emphasize its
ability to fill orders in a prompt and reliable fashion. The Company also
emphasizes its laboratory services and, in particular, its ability to formulate
and manufacture a full range of color cosmetics. The Company believes that the
services of its laboratory staff are an important factor in the acquisition of
new customers and in obtaining additional orders from existing customers.  See
"Laboratory Services".

At March 10, 1997, the Company's sales staff (for both its contract
manufacturing and Zegarelli operations) consisted of 15 sales personnel
(including five executive officers), four customer service representatives and
five independent sales representatives who are compensated on a commission
basis.  The Company's Chief Executive Officer also participates in sales to key
customers.  From time to time, the Company has been referred customers by
consultants, independent sales representatives and other third parties who are
not under any contractual obligation with the Company.  It is the Company's
practice to pay negotiated commissions to such third parties if the referrals
result in sales by the Company.

The Company generally manufactures products only in response to specific
customer orders. Since orders from a small number of customers (which may vary
from period to period) typically account for a substantial portion of the
Company's net sales in any period, the Company's net sales and net income may
fluctuate significantly from quarter to quarter, depending upon the timing of
customer orders and shipment dates.  Therefore, year-to-year comparisons of
quarterly results may not be meaningful, and quarterly results during the
course of a year may not be indicative of the results that may be expected for
the entire year.  Orders generally do not provide for shipment over an extended
period of time. Instead, the Company generally is expected to ship orders as
soon as practicable following the receipt of all necessary raw materials and
components. Accordingly, the Company does not believe that the amount of its
open orders as of any given date is necessarily indicative of the results that
may be expected in future periods.





                                       4
<PAGE>   7
The Company sold products to approximately 50 customers in 1996.  During 1996,
sales to Sally, Avon Products, Victoria Jackson and Cosmair,
Inc./L'Oreal/Lancome accounted for approximately 26%, 19%, 12%, and 11%,
respectively, of net sales.  During 1995, sales to these customers accounted
for approximately 13%, 39%, 22%, and 6% respectively, of net sales. No other
customer accounted for more than 10% of net sales in 1996 or 1995.

With the exception of the Company's agreement with Sally, the Company does not
have any long-term contractual relationships with any of its customers, nor are
any of the Company's customers subject to any contractual provisions or other
restrictions which preclude them from purchasing products from the Company's
competitors.  The loss of one or more significant customers, or a material
reduction in the amount of orders placed by a significant customer, could have
a material, adverse effect on the Company's business and results of operations.

LABORATORY SERVICES

The Company's laboratory services comprise a key element of its business
strategy and provide for the timely development and production of a wide
variety of cosmetics and personal care products.  The Company's chemists and
technicians work closely with customers to develop products meeting the
customer's specific requirements and are able to develop formulas for finished
products based on general parameters provided by the customer.  The laboratory
staff also is able to develop products which are equivalent to or based upon
national brand products.  Services include the development of product formulas,
analytical assays, reformulations and quality control services.  The Company
provides or arranges for all necessary toxicological, microbiological and
stability testing.

The Company also manufactures products in accordance with proprietary formulas
provided by its customers.  The Company's laboratory staff develops and
implements appropriate manufacturing procedures and quality control programs
for these customers.  The laboratory staff also may assist these customers in
improving the quality and performance of their proprietary products.  At March
10, 1997, the Company had four chemists and five technicians on its laboratory
staff.

Product development generally is undertaken only in response to specific
customer requests.  The Company's efforts typically are focused on developing
products that are equivalent to or based upon products which already have been
marketed at the retail level.  The Company does not engage in basic research or
the development of products not yet accepted in the retail marketplace.  The
Company's development costs generally are not significant and typically are
incorporated into the prices charged to the customer for the resulting
products.

The Company generally retains the ownership of formulas developed for its
customers.  In certain instances, however, rights to the formulas may be
retained by the customer.  The Company believes that the formulas it develops
generally are not patentable, and the Company has not applied for patents on
any of such formulas.





                                       5
<PAGE>   8
MANUFACTURING

The Company's manufacturing facilities provide the Company with the capability
to manufacture, assemble and package a wide range of cosmetics and other
personal care products. The Company has manufactured color cosmetics since its
inception in 1986. The Company expanded its product offerings in 1992 to
include creams and lotions. In 1993, the Company upgraded its ability to
manufacture powder based cosmetics and creams and lotions in-house through the
purchase of certain manufacturing equipment from a related party.  During the
first quarter of 1994, the Company further expanded its manufacturing
capabilities with the installation, at a cost of approximately $400,000, of a
high capacity system for the manufacture of hair care products and creams and
lotions.  Prior to the installation of this system, the Company was able to
manufacture hair care products on only a limited basis.  The Company currently
utilizes this system to manufacture a substantial portion of the products
included in its Zegarelli product line.

The Company's manufacturing and processing equipment includes high speed
filling equipment, mixers, vacuum kettles, jacketed stainless steel processing
tanks, storage tanks, powder presses, blending machines and lipstick molding
facilities. The Company also has an assortment of versatile filling equipment
for many types and sizes of bottles, jars, tubes, lipstick containers and
compacts, including both automatic and hand operated equipment. Manufacturing
operations performed by the Company include compounding and blending powders,
mixing the components of creams, lotions and hair care products, heat
processing, lipstick molding and other procedures which transform individual
ingredients into stable products and pressing, filling and packaging of
finished products. Following the production of each batch, the production
equipment is cleaned and sanitized to prepare the equipment for the next
production run.

The Company's flexible manufacturing capabilities and the know-how of its
production staff facilitate the production of a wide variety of products of
different quantities, sizes and packaging, while maintaining a high level of
customer service and quality. The Company generally only manufactures products
in response to specific customer orders.  The Company is able to respond
quickly to customer orders and changes in manufacturing schedules.

The Company's customers generally provide to the Company the jars, bottles,
tubes, containers, cases and other components necessary for the assembly of
finished products, as well as any required labels or packaging materials.  For
certain customers, the Company sources and provides all components and
packaging materials.  Orders of this type result in increased working capital
requirements, as the Company typically must finance the procurement of the
components before the Company receives payment from its customer.  The Company
also maintains an inventory of components and packaging materials for the
products included in its Zegarelli line.

The Company maintains a strict quality control system to monitor the
manufacturing of products.  In addition to the Company's quality control
procedures, in certain instances, the Company develops with the customer a
customized quality control program to monitor the production of





                                       6
<PAGE>   9
a specific product order. The Company's quality control program includes
laboratory testing of each batch to assure that the product conforms to the
customer's specifications. The Company also utilizes quality assurance
inspectors who monitor the appearance of finished products and confirm that
each product includes the required product quantity or weight.

Alternative sources of supply for the raw materials and components purchased by
the Company generally are readily available.  In those instances where there
may be only a limited number of suppliers for a particular ingredient, there
generally are available a number of alternate ingredients that are functionally
equivalent.  The Company has no long-term contractual relationships with any of
its suppliers.

ZEGARELLI PRODUCT LINE

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
under the Zegarelli name. The line includes shampoos, conditioners and styling
and finishing products. The Company has entered into a license agreement with a
corporation owned by Mr.  Zegarelli which grants to the Company an exclusive,
non-transferable license to use the Zegarelli name in connection with the
manufacture and sale of hair care and other personal care products. The Company
also has entered into      a distribution agreement with Sally Beauty Company,
Inc ("Sally"), a subsidiary of Alberto-Culver Co., which grants to Sally the
exclusive right to distribute the Zegarelli product line in the United States
through beauty supply stores for sale to salons and professional hairdressers.
Sally has also been granted a right of first refusal to distribute these
products in foreign countries. The Company also uses independent distributors
to sell the Zegarelli product line directly to larger salons and salon chains,
and, in connection therewith, the Company generally expects to repurchase
products from Sally for sale to its independent distributors and to use
warehouse and shipping services provided by Sally. Sales of the Zegarelli
product line to Sally commenced in the second quarter of 1995, and sales to
independent distributors commenced in the third quarter of 1995.

Under the terms of the License Agreement with Mr. Zegarelli, he is entitled to
an annual minimum royalty payment of $150,000 per year plus an amount equal to
1% of the amount by which the Company's annual sales of products using the
Zegarelli name exceed $12.0 million.  The License Agreement also provides that
Zegarelli, in its sole discretion, may assist the Company in promoting the
Zegarelli product line, including participation in educational and training
seminars and marketing events, but it is under no obligation to do so.  The
License Agreement had an initial term of two years (expiring in October 1996
and renewed to October 1998) and automatically renews for successive terms of
two years each unless the Company elects to terminate the agreement.





                                       7
<PAGE>   10
The distribution agreement with Sally has an initial term of five years and
automatically will renew for additional five-year terms unless Sally elects to
terminate the agreement. In connection with the agreements with Sally, the
Company granted to Sally options to purchase 10% of the Company's outstanding
common stock.  See "Notes 6 and 7 of Notes to Financial Statements."

The Company's efforts during 1995 and 1996 with respect to its Zegarelli
product line primarily focused on introducing the product line to the
professional hair care industry through participation in trade shows and other
promotional and marketing activities and on seeking to establish relationships
with independent distributors.  The Company also expended a significant effort
in those years developing the sales programs, sales aids and other promotional
materials that the Company believes are necessary to establish relationships
with independent distributors and promote salon use and retail sales.  The
Company believes that it now has in place the promotional materials and
programs that are required to support its marketing efforts.

The Company's relationship with Sally provides a distribution channel to small
salons and independent beauticians and stylists.  Zegarelli products currently
are available at approximately 40 Sally beauty supply stores located in
Maryland, Virginia and New Jersey. Distribution is expected to be expanded to
include additional Sally beauty supply stores located in the United Kingdom.

The Company's strategy for marketing the line to larger salons and salon chains
is to establish relationships with distributors serving regional and local
markets.  Through the end of 1996, the Company entered into relationships with
approximately 14 distributors located primarily in the Eastern and Western
regions of the United States and internationally.  Sales to independent
distributors commenced in the third quarter of 1995.  During 1997, the Company
will seek to expand its distribution network into other regions of the United
States as well as internationally.  In order to support the activities of the
Company's independent distributors, Sally has agreed to pay commissions to
local distributors based on its sales of Zegarelli products to professionals
from Sally beauty supply stores located in the distributor's market.  Because
of these arrangements, the Company anticipates that, in certain regions of the
United States, Sally may defer the introduction of the Zegarelli product line
into its stores until the Company has in place independent distributors who are
making sales to larger salons and salon chains in sufficient quantities to
generate activity in the Zegarelli product line in the local salon market.

To support the marketing efforts for the Zegarelli product line, the Company
provides education and training programs to beauty salon professionals.  This
is accomplished through in-salon training, distributor shows and other
programs.

The success of the Zegarelli product line will depend to a significant extent
upon the Company's ability to establish and maintain a network of independent
distributors.  It is anticipated that all or substantially all of the Company's
distributors will be multi-line distributors, i.e., distributors that will
offer for sale both the Company's Zegarelli product line and products sold by
competitors.  Because many of the Company's competitors have substantially
greater resources





                                       8
<PAGE>   11
and name recognition than the Company, the Company's competitors may be able to
provide greater incentives to independent distributors to sell their respective
products rather than the Zegarelli product line.  In addition, some
distributors (in particular, larger distributors) may be reluctant to take on
the Zegarelli product line for fear of jeopardizing their relationship with the
Company's larger competitors.  There can be no assurance that the Company will
be successful in establishing and maintaining the required network of
independent distributors.

For information regarding the effects of the Zegarelli product line on the
Company's results of operation, see "Management's Discussion and Analysis or
Plan of Operation - Results of Operations" and "Note 9 of Notes to Financial
Statements."

COMPETITION

Contract Packaging

The market for the contract manufacturing of cosmetics and other personal care
products is highly competitive. The industry is characterized by a large number
of small to medium-sized manufacturers who may operate on a national, regional
or local scale. The Company's principal direct competitors include CCL
Industries Corp., Kolmar Laboratories, Inc., Mana Products, Packaging
Corporation of America, Paco Laboratories, Inc.  and PLC, Inc. Most of the
Company's competitors are larger and have greater financial and other resources
than the Company. In addition to direct competition, the Company also faces
indirect competition from present and potential customers who from time to time
evaluate the "make or buy" decision of whether to manufacture a particular
product or purchase the product from outside sources.

The Company believes that competition is based primarily on product quality,
customer service, timeliness of shipment and price. The product lines
manufactured by the Company frequently involve different competitive factors.
Product quality and customer service, including the ability to assist the
customer in product formulations, are particularly important competitive
factors in sales of color cosmetics. The Company believes that only a
relatively small number of contract manufacturers offer a full line of color
cosmetics and that the Company's ability to formulate and manufacture an
extensive line of color cosmetics provides it with an advantage over many of
its competitors. The ability to offer consistent product quality at competitive
prices tends to be the key competitive factor in sales of creams and lotions
and hair care products.  The Company believes that it competes favorably on all
these factors.

Zegarelli Product Line

The Company's Zegarelli hair care product line competes in the professional
hair care products segment of the health and beauty aids industry.  The market
for professional hair care products also is highly competitive.  Competitors
include divisions or subsidiaries of large, nationally- known consumer products
companies and small to medium-sized independent professional hair care
companies.  The Company's competitors generally are larger and have
substantially greater resources and name recognition than the Company.  The
Company believes that competition is





                                       9
<PAGE>   12
based primarily on product quality, packaging, customer service (including
educational and training programs for hair care professionals) and price.  The
Company historically has operated as a contract manufacturer and has not
manufactured products for sale under its own brand name, nor has the Company
competed directly in the professional hair care products market.  Although the
founders of the Company, Mr. Alfred Booth and Ms. Judith Zegarelli, have been
in the professional hair care industry for over 20 years, there can be no
assurance that the Company will be able to successfully introduce its Zegarelli
product line or otherwise successfully compete in the professional hair care
products market.

GOVERNMENT REGULATION

The Company's products and manufacturing operations are subject to regulation
by federal and state governmental agencies. In particular, certain products
which the Company manufactures or is capable of manufacturing, such as
sunscreens and medicated shampoos, are treated as over-the-counter
pharmaceutical products and are subject to regulation by the United States Food
and Drug Administration ("FDA"). The Company is licensed by the FDA as a
manufacturer of over-the-counter pharmaceutical products intended for external
use by the consumer.

The class of pharmaceutical products manufactured by the Company requires no
prior approval from the FDA before manufacture or marketing, but the products
must comply with applicable FDA monographs which specify, among other things,
required ingredients, label contents and permitted uses. These monographs may
be changed from time to time, and the FDA may adopt monographs applicable to
personal care products which previously were unregulated. The Company does not
believe any such actions by the FDA would have a material effect on its
operations.

In its manufacture of products regulated by the FDA, the Company must comply
with the "Current Good Manufacturing Practices for Finished Pharmaceuticals"
promulgated by the FDA. These practices include strict quality control
standards at all stages of production, including the receipt and storage of raw
materials, manufacturing and labeling. Pursuant to these practices, raw
materials are sampled and tested in the Company's laboratory facilities and
products are sampled and tested during production. Although only a small
portion of the products manufactured by the Company are subject to FDA
regulation, the Company generally adheres to these practices in the manufacture
of all products on a voluntary basis.

The Company believes that its products and manufacturing procedures comply in
all material respects with existing regulations. The Company does not believe
that existing regulations have had a material effect on its operations. There
can be no assurance, however, that future FDA action, or other federal or state
regulatory activity, would not be material to the operations of the Company.





                                       10
<PAGE>   13
INSURANCE

The Company maintains product liability insurance which provides coverage in
the amount of $1.0 million per occurrence, with an annual limit of $2.0
million.  Although no material product liability claims ever have been asserted
against the Company, there can be no assurance that such claims will not arise
in the future.  See Note 10 to the financial statements for information
concerning settlement of litigation in 1996 for a complaint alleging defective
products delivered by the Company. A product liability claim that results in a
judgement or settlement in excess of the Company's insurance coverage could
have a material adverse effect on the Company's business and results of
operations.  The Company also maintains commercial general liability insurance
which provides coverage in the amount of $1.0 million per occurrence, with an
annual limit of $2.0 million, property insurance for its own tangible assets
and the property of its customers in the amount of $5.0 million and business
interruption insurance which provides coverage in the amount of $3.0 million
per claim and in the aggregate (determined annually).  The Company's property
and business interruption insurance policies do not provide coverage against
losses caused by earthquake or flood.  There can be no assurance that, in the
event of a casualty loss, the proceeds of the property and business
interruption insurance will be sufficient to compensate the Company for any
resulting loss or that any such loss will not have a material adverse effect on
the Company's business and results of operations.

EMPLOYEES

At March 10, 1997, the Company employed 287 persons (including part-time
employees), of whom 238 were engaged in manufacturing and distribution
operations, 20 were engaged in marketing and customer service, nine were
engaged in laboratory services and quality control and 20 were engaged in
management and administration. None of the Company's employees is covered by a
collective bargaining agreement, and the Company considers its relations with
its employees to be good.


ITEM 2.  DESCRIPTION OF PROPERTY

The Company maintains its manufacturing, laboratory, sales and administrative
facilities in two adjacent buildings located in Sun Valley, California.  The
buildings include an aggregate of approximately 70,000 square feet.  The
facility is occupied pursuant to a lease which expires in January 2001 and
provides for an option to renew for an additional three-year period.  The
current annual rent for the facility is approximately $322,000, subject to
annual cost-of-living adjustments, and the Company generally is responsible for
the payment of all expenses incurred in connection with the operation of the
facility.  In October 1995, the Company moved its sales and warehousing
operation for the Zegarelli division to an approximately 20,000 square foot
facility in Pacoima, California.  The Company has a three year lease on the
property, expiring in March 31, 1999, with annual rent at approximately
$142,680, subject to cost-of-living adjustments.  The Company believes that all
of its facilities are adequate for the Company's current operating levels and
present foreseeable growth.





                                       11
<PAGE>   14
ITEM 3.  LEGAL PROCEEDINGS

The Company and its subsidiaries are defendants in two lawsuits relating to
routine matters incidental to their business. Management does not believe that
the outcome of such litigation, in the aggregate, will have a material effect
on the companies' financial condition or operations.

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

There were no matters submitted to shareholders during the fourth quarter of
the fiscal year ended December 31, 1996.

                                    PART II

ITEM 5.  MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
SHAREHOLDER MATTERS

                          PRICE RANGE OF COMMON STOCK

The Common Stock is listed on the National Association of Securities Dealers
Automated Quotation System/SmallCap Market ("NASDAQ") Stock Market under the
symbol "CUSA."  The following table sets forth the range of closing high and
low bid prices per share of the Common Stock for each of the periods indicated,
as provided by National Quotation Bureau, Inc. These quotations reflect
inter-dealer prices, without retail mark-up, mark-down or commissions, may not
necessarily represent actual transactions and may not be valid indications of
market value due to the limited trading in the Common Stock.
<TABLE>
<CAPTION>
                                              HIGH       LOW
                                              ----       ---
      <S>                                     <C>        <C>
      1995
        First quarter ....................    3.25        1.50
        Second quarter....................    2.37        2.06
        Third quarter.....................    4.25        1.75
        Fourth quarter....................    4.62        3.12

                                                          1996
        First quarter......................   3.70        2.00
        Second quarter.....................   3.06        2.25
        Third quarter......................   2.56        1.56
        Fourth quarter.....................   2.13        1.25

      1997
        First quarter......................   1.75       1.00
          (through March 12, 1997)
</TABLE>





                                       12
<PAGE>   15
(a)  Holders:
         The approximate number of holders of record of Common Shares as of
         March xx, 1997, was 1,114 including shares held by approximately 859
         accounts in "nominee" or "street" name.

(b)  Dividends:
         The Company has not paid cash dividends on its common stock since its
         inception.  The Company has no present intention to pay any cash
         dividends in the foreseeable future.  In addition, the Company's
         credit agreement with one of its lenders contains a covenant which
         prohibits the payment of dividends.


ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

The following discussion and analysis should be read together with the
financial statements and notes thereto included elsewhere herein.

RESULTS OF OPERATIONS

Net sales in 1996 increased more than 50% in 1996 from 1995 and the Company
reported earnings in 1996 compared to a significant loss in the prior year.
Operating results for 1996 were adversely affected by a charge relating to the
settlement of litigation and the continuing expenditures for the further
development and marketing of the Zegarelli line of professional hair care
products. Net sales for the Zegarelli product line were $4,034,000 in 1996, an
increase of $2,735,000 from 1995. However, the operations of this segment
resulted in an operating loss (before corporate expenses and interest) of
$1,696,000 in 1996.  Shipments of the Zegarelli product line were expanded in
1996 and further expansion, both in the United States and foreign countries is
expected in 1997.

The current sales levels of the Zegarelli line are not sufficient to cover the
related costs and expenses. The Company's ability to increase sales of the
Zegarelli line to the level necessary to meet ongoing costs and expenses is
dependent upon continued 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 its Zegarelli product line or otherwise successfully
compete in the professional hair care products market.

The following table sets forth, for the years indicated the percentage of net
sales represented by certain items included in the Consolidated Statements of
Operations.





                                       13
<PAGE>   16


<TABLE>
<CAPTION>
                                          Year ended
                                         December 31,
                                         ------------
                                           1996      1995
                                           ----      ----
         <S>                             <C>         <C>
         Net sales                       100.0%      100.0%
         Cost of sales                    57.6        76.2
                                          ----        ----
         Gross profit                     42.4        23.8
                                          ----        ----
         Selling, general and
         administrative expenses          36.0        39.8
         Interest expense                  2.3         4.0
         Settlement of litigation          1.6           -
                                           ---           -

                                          39.9        43.8
                                          ----        ----

         Net income (loss)                 2.7%      (20.0%)
                                          ====       =====
</TABLE>

Year ended December 31, 1996 Compared to Year Ended December 31, 1995

Net sales increased $5,347,000, or 54.4% in 1996, from 1995. Sales of Zegarelli
hair care products (principally to one customer) amounted to $4,034,000 in
1996, compared to $1,299,000 in 1995, an increase of $2,735,000. The balance of
the increase was from the contract packaging segment.

Sales to customers accounting for more than 10% of net sales in 1996 and 1995
are as follows:.

<TABLE>
<CAPTION>
                                     1996     1995
                                     ----     ----
     <S>                             <C>      <C>
     Customer A                      25.9%    12.7%
     Customer B                      19.0     39.2
     Customer C                      11.8     22.2
     Customer D                      11.0      6.3
                                     ----     ----
     Total                           67.7     80.4
</TABLE>

Cost of sales increased $1,246,000, or 16.7%, from 1995 to 1996. As a
percentage of net sales, cost of sales decreased from 76.2% in 1995 to 57.6% in
1996. In 1995 the Company recorded an allowance of approximately $363,000 to
reduce the carrying amount of finished goods inventory of body contouring
cream. The product was purchased as a finished product for resale by the
Company. The Company does not generally purchase finished products, and,
therefore, it is not anticipated that write-downs of this type will continue in
the future. Without the effect





                                       14
<PAGE>   17
of this adjustment, cost of sales as a percentage of net sales would have been
72.5% for 1995. The decrease in the cost of sales percentage in 1996 is
primarily attributable to changes in the sales mix and the reduction of fixed
costs per sales unit as a result of higher sales and related manufacturing
efficiencies.

Selling, general and administrative expenses were $5,470,000 in 1996 and
$3,915,000 in 1995, an increase of $1,555,000, or 39.7%. As a percentage of net
sales, these expenses were 36.0% in 1996, compared to 39.8% for 1995. The
increase in the dollar amount is primarily attributable to expenses incurred in
connection with the continuing development and marketing of the Company's
Zegarelli hair care line and increases in personnel required to support the
increased contract packaging business. Start-up expenses included in selling,
general and administrative expenses amounted to approximately $1,000,000 in
1995.

Interest expense amounted to $346,000 for 1996, compared to $389,000 for 1995,
a decrease of $43,000. The decrease is principally attributable to the lower
interest rate under the accounts receivable credit facility.

The Company recorded a charge to income in 1996 of $240,000 in 1996 for the
settlement of litigation and related fees. There was no such charge in 1995.

An income tax credit of $20,000 was recorded for 1996 relating to deferred
income tax liability written off. No provision for income taxes was provided
because of the availability of operating loss carryovers.

For 1996, the Company had net income of $405,000, compared to a net loss of
$1,964,000 for 1995. The primary reasons for the improvement were increased
sales and resulting gross profit, offset by increased selling general and
administrative expenses and the charge relating to settlement of litigation.

Net income per share was $.08 for 1996, compared to a net loss of ($.46) per
share for 1995. The per share amounts for 1996 are based on a greater number of
shares resulting from private placements of common stock during the latter part
of 1995.

Year Ended December 31, 1995 Compared to Year Ended December 31, 1994

Net sales for 1995 increased $1,569,000, or 19.0%, as compared to 1994. Sales
of Zegarelli hair care products (principally to one customer) accounted for
$1,299,000, of the increase; there were no sales of this product prior to 1995.
The balance of the increase was from the contract packaging segment.





                                       15
<PAGE>   18

Sales to customers accounting for more than 10% of net sales in 1995 and 1994
are as follows:.
<TABLE>
<CAPTION>
                                     1995     1994
                                     ----     ----
     <S>                             <C>      <C>
     Customer A                      39.2%    37.3%
     Customer B                      22.2
     Customer C                      12.7
     Customer D                       6.3         
                                     ----     ----
     Total                           80.4     37.3
</TABLE>

Cost of sales increased $1,918,000, or 34.4%, from 1994 to 1995. As a
percentage of net sales, cost of sales increased from 67.5% in 1994 to 76.2% in
1995. In 1995 the Company recorded an allowance of approximately $363,000 to
reduce the carrying amount of finished goods inventory of a body contouring
cream. The product was purchased as a finished product for resale by the
Company. The Company does not generally purchase finished products, and,
therefore, it is not anticipated that write-downs of this type will continue in
the future. Without the effect of this adjustment, cost of sales as a
percentage of net sales would have been 72.5% for 1995. The remaining increase
in the cost of sales percentage in 1995 is primarily attributable to changes in
the sales mix and the effect of special promotional offerings for the Zegarelli
hair care line of products.

Selling, general and administrative expenses amounted to $3,915,000 for 1995,
an increase of $1,666,000, or 74.1% from the $2,249,000 reported for 1994. As a
percentage of net sales, these expenses were 39.8% in 1995, compared to 27.2%
for 1994. The dollar increase is primarily attributable to expenses incurred in
connection with the development and introduction of the Company's Zegarelli
hair care line. These expenses include the addition of executive and support
staff required for current and anticipated operations. Start-up expenses
included in selling, general and administrative expenses amounted to
approximately $1,000,000 in 1995. There were no significant expenses for the
Zegarelli hair care line in 1994.

Interest expense increased to $389,000 for 1995, compared to $92,000 for 1994,
an increase of $297,000. The increase is principally attributable to the higher
interest rate and greater balances outstanding under the accounts receivable
credit facility and to the higher interest rate on the new term loan.

The Company recorded a charge to income of $325,000 in 1994 for the settlement
of litigation and related fees. There was no such charge in 1995.

No income tax benefit was recorded for 1995 because the Company was not able to
utilize the loss for income tax purposes. No provision for income taxes was
required for 1994 because of the availability of operating loss carryovers.

For 1995, the Company incurred a net loss of $1,964,000, compared to net income
of $23,000 for 1994. The principal factors contributing to the deterioration in
operating results for 1995 are





                                       16
<PAGE>   19
an increase in selling, general and administrative expenses of approximately
$1,666,000, principally from the start-up and operating expenses incurred in
connection with the Zegarelli product line, the write-down of finished goods
inventory of $363,000 and increased interest expense of $297,000, offset by the
$325,000 charge in 1994 for settlement of litigation.

For 1995, net loss per share was $.46, compared to net income per share of $.01
for 1994. The per share amounts for 1995 are based on a greater number of
shares resulting from private placements of common stock during 1995.


LIQUIDITY AND CAPITAL RESOURCES

The Company has satisfied its working capital requirements during the past two
years primarily through proceeds from equity and debt financings and borrowings
under its credit facilities.

In March 1995, the Company entered into an agreement with a lender pursuant to
which the Company sold accounts receivable at a discount of 10% at inception of
the agreement and subsequently reduced to 6% (subject to certain rebates if the
assigned receivables are paid within 60 days).  The Company was required to pay
a fee of 4% a month for receivables outstanding over 60 days. The maximum
amount which could be outstanding at any time under this agreement was
$900,000.

In July 1995, the Company borrowed $360,000 from another lender and used the
proceeds (net of expenses) to pay the balance due to a bank under term loans,
the repayment of which had been guaranteed by the Company's chief executive
officer. The new loan is payable in 24 monthly installments of $15,000,
commencing September 1, 1995, plus interest at the prime rate plus 4 1/2% and a
monthly service charge equal to 0.4% of the average daily principal balance.

In May 1996, the Company entered into a new Accounts Receivable Security
Agreement and terminated the above accounts receivable agreement. This
agreement, as amended, provides for advances up to 75% of eligible receivables
(maximum $1,250,000) and interest at 16% per annum, subject to increase if the
prime rate exceeds 8 1/4%. The agreement, among other things) prohibits the
payment of dividends and requires the Company to maintain a specified amount of
net worth and minimum working capital ratio.

The Company's obligations to the above lenders are secured by a security
interest in substantially all of the assets of the Company.

On April 7, 1995, the Company reduced the conversion price of its 8%
Convertible Subordinated Notes from $3.97 per share to $2.25 per share. In 1995
all of the outstanding





                                       17
<PAGE>   20
Notes were converted into 222,220 shares of common stock. An officer/director
of the Company owned $50,000 of such notes which were converted into 22,222
shares of common stock.

In September 1996, the Company sold $300,000 principal amount of 10%
Subordinated Convertible Notes to a partnership, of which the general partner
is a director of the Company. The notes are convertible into common stock at $2
per share.

Between March 1995 and August 1995 the Company sold 642,320 shares of common
stock in a private placement and in October 1995 completed a private placement
of 600,000 Units (each Unit consists of one share of common stock and a warrant
to purchase one share of common stock, at any time prior to October 1997, at
$3.75 per share. Proceeds from the aforementioned private placements
approximated $1,833,000, net of expenses (of which $141,000 of expenses were
incurred in 1996). In connection with the private placements, the Company
issued warrants to selling agents to purchase 38,250 shares of common stock at
$1.95 per share from 1996 to 2000 and warrants to purchase 60,000 Units at
$2.70 per Unit from September 1996 to September 1998; the Units contain the
same features as the Units discussed in this paragraph.

Working capital amounted to $2,484,000, at December 31, 1996 as compared to
$1,891,000 at December 31, 1995, an increase of $593,000.  Operations resulted
in a cash flow deficiency of $140,000 in 1996, compared to a cash flow
deficiency of $2,308,000 in 1995. Operating cash flow in 1996 was principally
the result of net income plus depreciation and amortization. Operating uses of
cash in 1996 was principally from increases in inventory ($1,378,000) and
accounts receivable ($789,000). The inventory increase is the result of
increased business, a portion of which requires the Company to purchase greater
amounts of components and the increase in receivables is the result of higher
sales in the latter part of the fourth quarter of 1996 compared to the same
quarter last year. In 1996, $621,000 was used for the purchase of equipment,
compared to $402,000 in 1995. The funds for these purposes were provided
principally from the proceeds from the sale of common stock in private
placements during 1995, and, in 1996 from increased availability under accounts
receivable financing agreement, proceeds from convertible notes and other debt.

The Company has no material commitments for capital expenditures at December
31, 1996. The Company believes that funds generated from operations and
available borrowings under its credit arrangements will be sufficient to
finance its working capital and capital expenditure requirements through the
end of 1997. 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.





                                       18
<PAGE>   21

 ITEM 7.  FINANCIAL STATEMENTS

The following consolidated financial statements are included as a separate
section following the signature page to this Form 10-KSB and are incorporated
herein by reference:


                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                                  Page
                                                                                  ----
      <S>                                                                         <C>
      Report of Independent Auditors...........................................   F-1

      Consolidated Balance Sheet as of
       December 31, 1996.......................................................    F-2

      Consolidated Statements of Operations for the years
       ended December 31, 1995 and 1996........................................    F-3

      Consolidated Statements of Shareholders' Equity for the
        years ended December 31, 1995 and 1996..................................   F-4

      Consolidated Statements of Cash Flows for the years
        ended December 31, 1995 and 1996........................................   F-5

      Notes to Consolidated Financial Statements................................   F-7
</TABLE>


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

Not applicable.





                                       19
<PAGE>   22



                                    PART III

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

The following information concerns the directors and executive officers of the
Company as of December 31, 1996.

The information contained in the Company's Proxy Statement to be filed with the
Securities and Exchange Commission, on or before April 30, 1997, with respect
to directors and executive officers of the Company and "Compliance with Section
16(a) of the Securities Exchange Act of 1934" is hereby incorporated by
reference in response to this item.


ITEM 10.  EXECUTIVE COMPENSATION

The information contained in the Company's Proxy Statement to be filed with the
Securities and Exchange Commission, on or before April 30, 1997, with respect
to executive compensation and transactions, is incorporated herein by reference
in response to this item.


ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
          MANAGEMENT

The information contained in the Company's Proxy Statement to be filed with the
Securities and Exchange Commission, on or before April 30, 1997, with respect
to security ownership of certain beneficial owners and management, is
incorporated herein by reference in response to this item.

ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information contained in the Company's Proxy Statement to be filed with the
Securities and Exchange Commission, on or before April 30, 1997, with respect
to certain relationships and related transactions, is incorporated herein by
reference in response to this item.





                                       20
<PAGE>   23
                                    PART IV

ITEM 13.  EXHIBITS AND REPORTS ON FORM 8-K

The following documents are filed as part of this report:

         A.  LISTING OF EXHIBITS

 2.1        Plan and Agreement of Reorganization, dated February 18, 1993, among
            Cosmetic Group USA,Inc., K7 Capital Corporation and certain
            shareholders of Cosmetic Group USA, Inc.(1)

 3.1        Articles of Incorporation of the Registrant, as amended.(4)

 3.2        Amended and Restated Bylaws of the Registrant.(4)

10.1        Equipment Security Agreement and Secured Promissory Note dated July
            26, 1995 between Foothill Capital Corporation and the Registrant.
            (7)

10.1a       Security Agreement dated July 26, 1995 between Foothill Capital
            Corporation and Arnold Zegarelli Products, Inc.(7)

10.1b       Continuing Guaranty by Zegarelli Products, Inc. to Premium
            Commercial Services Corp. dated March 17, 1995. (9)

10.4        Employment Agreement, dated June 21, 1992, between the
            Registrant and Alfred E. Booth, Jr.(2)

10.5        Employment Agreement, dated April 1, 1993, between the Registrant
            and Judith E. Zegarelli.(2)

10.6        K7 Capital Corporation 1990 Stock Incentive Plan.(3)

10.7        Amended and Restated Cosmetic Group U.S.A., Inc. 1990 Stock
            Incentive Plan.(4)

10.8        Manufacturing Agreement, dated October 1, 1993, between the
            Registrant and Victoria Jackson Cosmetics, Inc.(2)

10.9        Form of 8% Subordinated Convertible Notes.(2)

10.13       Lease, dated December 12, 1989, between the Registrant and
            Joyce E. Eisenberg and David J. Cohen, as trustees for the Ben B.
            Eisenberg Administrative Trust, and Peter Wald, together with
            amendments dated April 22, 1991, May 14, 1991 and December 16,
            1992.(2)

10.14       Lease, dated August 28, 1990, between the Registrant and Ben B.
            Eisenberg Properties and Peter S. Wald, together with amendment
            dated December 16, 1992. (2)

10.15       Lease, dated April 22, 1991, between the Registrant and Ben B.
            Eisenberg Properties and Peter S. Wald, together with Addendum dated
            December 16, 1992. (2)

10.15a      Amendment dated November 14, 1995 to Lease dated April 22, 1991 and
            to Addendum dated December 16, 1992 between Ben B. Eisenberg
            Properties and Peter S. Wald and the Registrant.(9)

10.16       Bill of Sale of Machinery and Equipment, dated March 15, 1993. (2)





                                       21
<PAGE>   24

10.18       Promissory Note, dated February 18, 1994, by the Registrant in favor
            of Judith E. Zegarelli.(4)

10.19       Form of Indemnification Agreement between the Registrant and its
            directors and executive officers.(4)

10.21       Accounts Receivable Loan Agreement dated August 29, 1994, between
            Registrant and City National Bank.(5)

10.22       Cash and Carry Distribution Agreement, dated May 16, 1995, between
            Arnold Zegarelli Products, Inc. and Sally Beauty Supply. (8)*

10.22a      Services Agreement dated May 16, 1995, between the Arnold Zegarelli
            Products, Inc. and Sally Beauty Supply. (8)*

10.22b      Stock Option Agreement dated May 16, 1995 between the Registrant and
            Sally Beauty Supply. (8)

10.22c      Trademark License and Option Agreement. (8)

10.23       Lease dated October 2, 1995, between the Registrant and Enterprise
            Business Center Ltd. (9)

23.1        Consent of Ernst & Young LLP.

99.1        Account Purchase and Finance Agreement, dated March 17, 1995,
            between Registrant and Premium Commercial Services Corp.(6)

99.1a       Form of 10% Subordinated Convertible Note (11)

99.2        Addendum dated October 25, 1995 to the Account Purchase and Finance
            Agreement dated March 17, 1995 between Registrant and Premium
            Commercial Services Corp. (9)

99.2        Accounts Receivable Security Agreement, dated May 10, 1996, between
            Registrant and First Community Financial Corporation. (10)

99.2b        Form of Promissory Note Purchase Agreement (11)

99.3        Intercreditor Agreement dated July 26, 1995 between Foothill Capital
            Corporation and Premium Commercial Services Corp. and Acknowledgment
            By Borrower (Registrant). (9)

99.3a       Guaranty and Subordination Agreement, dated May 10, 1996, between
            Registrant and First Community Financial Corporation. (10)
                      
----------------------

  *      Filed under an application for confidential treatment.

 (1)     Incorporated by reference to the Registrant's Current Report on Form
         8-K dated May 21, 1993.

 (2)     Incorporated by reference to the Registrant's Annual Report on Form
         10-KSB for the fiscal year ended December 31, 1993.

 (3)     Incorporated by reference to the Registrant's Registration Statement
         on Form S-18 (No. 33-36333LA) filed August 10, 1990 and amended on
         October 15, 1990, November 19, 1990, and December 12, 1990.





                                       22
<PAGE>   25
 (4)     Incorporated by reference to the Registrant's Registration Statement
         on Form SB-2 (No. 33-78936) filed on May 13, 1994 and amended on June
         23, 1994, July 12, 1994, and July 14, 1994.

 (5)     Incorporated by reference to the Registrant's Form 8-K dated August
         29, 1994.

 (6)     Incorporated by reference to the Registrant's Form 8-K dated March 22,
         1995.

 (7)     Incorporated by reference to the Registrant's Form 10-QSB for the
         quarter ended June 30, 1995.

 (8)     Incorporated by reference to the Registrant's Form 8-K dated May 16,
         1995.

 (9)    Incorporated by reference to the Registrant's Form 10-KSB for the year
        ended December          31, 1995.

(10)   Incorporated by reference to the Registrant's Form 8-K dated May 10,
1996

 (11)   Incorporated by reference to the Registrant's Form 8-K dated September
        20, 1996

         B.  REPORTS ON FORM 8-K

No reports on Form 8-K were filed for the fourth quarter of 1996.





                                       23
<PAGE>   26
                                   SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.

                                        COSMETIC GROUP U.S.A., INC.


Date:  March 21, 1997                   By:/s/ Alfred E. Booth, Jr.
                                           ----------------------------
                                           Alfred E. Booth, Jr.
                                           President

In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated.

<TABLE>
<CAPTION>
           Signature                                 Title                                Date          
------------------------------         ---------------------------------        ------------------------
<S>                                       <C>                                        <C>
/s/ Alfred E. Booth, Jr.                   Chief Executive Officer                   March 21, 1997
------------------------                                                                           
Alfred E. Booth, Jr.                       and Director

/s/ Frank S. McGarvey                      Vice President and Director               March 21, 1997
---------------------                                                                              
Frank X. McGarvey

/s/ Jennifer Eggers                        Chief Financial Officer and               March 21, 1997
-------------------                                                                                
Jennifer Eggers                           Chief Accounting Officer

/s/ Judith E. Zegarelli                    Vice President and                        March 21, 1997
-----------------------                                                                            
Judith E. Zegarelli                        Director

/s/ Howard Simon                           Secretary                                 March 21, 1997
----------------                                                                                   
Howard Simon

/s/ William B. Barnett                     Director                                  March 21, 1997
----------------------                                                                             
William B. Barnett

/s/ Jack Brehm                             Director                                  March 21, 1997
----------------------                                                                             
Jack Brehm

/s/ Eric Nickerson                         Director                                  March 21, 1997
-------------------                                                                                
Eric Nickerson
</TABLE>





                                       24
<PAGE>   27
                         Report of Independent Auditors

The Board of Directors and Shareholders
Cosmetic Group U.S.A., Inc.

We have audited the accompanying consolidated balance sheets of Cosmetic Group
U.S.A., Inc. and subsidiary as of December 31, 1996, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
each of the two years in the period then ended.  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 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Cosmetic Group U.S.A., Inc. and subsidiary at December 31, 1996 and the results
of its operations and its cash flows for each of the two years in the period
then ended, in conformity with generally accepted accounting principles.


                                        ERNST & YOUNG L.L.P.



Los Angeles, California
February 28, 1997




                                      F-1
<PAGE>   28
                   COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
                           CONSOLIDATED BALANCE SHEET
                               DECEMBER 31, 1996

<TABLE>
<S>                                                 <C>
       ASSETS (Note 5)
CURRENT ASSETS
   Cash                                              $    67,000
   Accounts receivable, less allowance of $128,000     2,768,000
   Inventory (Note 2)                                  3,135,000
   Prepaid expenses and other                            282,000
   Due from officer/director/shareholder                  72,000
                                                     -----------
     TOTAL CURRENT ASSETS                              6,324,000

PROPERTY, PLANT AND EQUIPMENT, net of accumulated
   depreciation and amortization of $1,768,000
   (Notes 3 and 5)                                     2,278,000

OTHER ASSETS                                             158,000
                                                     -----------
                                                     $ 8,760,000
                                                     ===========

    LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
   Due under accounts receivable
     agreement (Notes 3 and 5)                       $ 1,044,000
   Accounts payable                                    2,052,000
   Accrued liabilities                                   429,000
   Current portion of notes payable
     and capital leases (Note 5)                         315,000 
                                                      -----------
     TOTAL CURRENT LIABILITIES                         3,840,000

NOTES PAYABLE AND CAPITAL LEASES,
  less current portion (Note 5)                          110,000
10% SUBORDINATED CONVERTIBLE NOTES (Note 5)              300,000

COMMITMENTS AND CONTINGENCIES (Note 8)

SHAREHOLDERS' EQUITY (Notes 6 and 7)
   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 5,163,756 shares   6,480,000
Retained deficit                                     (1,970,000)
                                                     ---------- 
                                                       4,510,000
                                                      ----------
                                                     $ 8,760,000
                                                     ===========
</TABLE>

See accompanying notes.



                                      F-2
<PAGE>   29
                   COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                  Year ended
                                                  December 31
                                             1996           1995   
                                         --------------------------
<S>                                      <C>           <C>
Net sales                                $15,180,000     $9,833,000
Cost of sales                              8,739,000      7,493,000
                                          -------------------------
Gross profit                               6,441,000      2,340,000

Selling, general and
 administrative expenses                   5,470,000      3,915,000
Interest expense - net                       346,000        389,000
Settlement of litigation (Note 10)           240,000            
                                          ----------------------
                                           6,056,000      4,304,000
                                          -------------------------
Income (loss) before income taxes            385,000     (1,964,000)
Income tax credit (Note 4)                    20,000               
                                          -------------------------
Net income (loss)                        $   405,000    $(1,964,000)
                                          ========================= 

Net income (loss) per share                    $.08          $(.46)
                                          =========================
Weighted average number of shares
 outstanding                              5,085,214       4,231,725
                                          =========================
</TABLE>


See accompanying notes.




                                      F-3

<PAGE>   30
                   COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                 Common Stock  
                               ----------------
                        Number of                 Retained
                         Shares       Amount      (Deficit)         Total  
                       -----------------------------------------------------
<S>                     <C>          <C>          <C>            <C>
Balance at December
31, 1994                 3,591,716   $4,009,000   $  (411,000)   $3,598,000
  Net loss                                         (1,964,000)   (1,964,000)
  Conversion of
   convertible notes       222,220      500,000                     500,000
  Issuance of common
   stock                 1,242,320    1,974,000                   1,974,000
                         --------------------------------------------------
Balance at December
31, 1995                 5,056,256    6,483,000    (2,375,000)    4,108,000
  Net income                                          405,000       405,000
  Issuance of common
   stock                   107,500      138,000                     138,000
  Expenses in connection
   with registration of
   common stock sold
   in 1995 private
   placements                          (141,000)                   (141,000)
                         ---------------------------------------------------
Balance at December
31, 1996                 5,163,756   $6,480,000   $(1,970,000)   $4,510,000
                         ==================================================
</TABLE>




See accompanying notes.





                                      F-4
<PAGE>   31
                   COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                Year ended
                                                December 31
                                             1996         1995
<S>                                      <C>          <C>
OPERATING ACTIVITIES
Net income (loss)                        $   405,000  $(1,964,000)
Adjustments to reconcile net (loss)
 income to net cash used in
 operations:
  Depreciation and amortization              453,000      363,000
  Changes in operating assets and
   liabilities:
    Accounts receivable                     (789,000)    (841,000)
    Inventory                             (1,378,000)    (270,000)
    Income tax receivable                       -          26,000
    Prepaid expenses and other assets         41,000      (87,000)
    Accounts payable                       1,083,000      560,000
    Accrued liabilities                       65,000      (95,000)
    Deferred income taxes                    (20,000)        -    
                                         -------------------------
Net cash used in operating
  activities                                (140,000)   (2,308,000)
                                         --------------------------

INVESTING ACTIVITIES
 Purchase of property, plant and equipment  (621,000     (402,000)
                                          ------------------------
 Net cash used in investing activities       (621,000)    (402,000)
                                           ------------------------
FINANCING ACTIVITIES
 Proceeds from issuance of common stock         -       1,974,000
 Expenses for registration of common
  stock sold in 1995 private placements     (141,000)        -
 Expenses paid by issuing common stock       138,000         -
 Payment of bank debt                           -      (1,174,000)
 Proceeds from convertible notes             300,000         -
 Net proceeds under finance agreement        439,000         -
 Proceeds from other debt                    528,000      965,000
 Payments on other debt and capital
  lease obligations                         (453,000)     (84,000)
 Loan to/payment of loan from
  officer/director/shareholder                (5,000)      25,000
                                           ----------------------
Net cash provided by financing
 activities                                  806,000    1,706,000
                                           ----------------------
</TABLE>



   (Continued)

   See accompanying notes.

                                      F-5
<PAGE>   32
                           COSMETIC GROUP U.S.A, INC.
                      STATEMENT OF CASH FLOWS (Continued)

<TABLE>
<CAPTION>
                                               Year ended
                                               December 31
                                             1996        1995   
                                          -------------------------
<S>                                       <C>          <C>   
Net increase (decrease) in cash and
 cash equivalents                          $ 45,000  $(1,004,000)
 Cash and cash equivalents at beginning
  of year                                    22,000    1,026,000
                                          ======================

 Cash and cash equivalents at end of year  $ 67,000   $   22,000     


Schedule of noncash investing and
 financing transactions:
  Debt converted to common stock           $    -     $  500,000
  Debt incurred to acquire equipment         378,000      60,000

Additional disclosures:
 Cash paid during the year for:
  Interest                                 $ 381,000   $ 370,000
  Income taxes                                 1,600       2,000
</TABLE>




  See accompanying notes.



                                      F-6
<PAGE>   33
                   COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
                         NOTES TO FINANCIAL STATEMENTS
                               DECEMBER 31, 1996

1.  Accounting Policies

Principles of Consolidation

The financial statements include the accounts of the Company and its
wholly-owned subsidiary.

Inventory

Inventory is carried at the lower of cost or market using the first-in,
first-out (FIFO) method of accounting. The Company reviews the net realizable
value of inventory on a periodic basis and, if there is a determination that
impairment of the carrying amount has taken place, a provision for loss is
recorded.

Property, Plant and Equipment

Property, plant and equipment is stated at cost. Depreciation and amortization
are calculated using the straight-line method over ten years for machinery and
equipment and generally five to seven years for other fixed assets for
financial reporting purposes. Leasehold improvements are amortized over the
shorter of the economic useful life or the term of the lease.

Income Taxes

Income taxes have been provided using the liability method.

Cash Equivalents

The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.

Revenue Recognition

Revenues are recognized when the product is shipped to customers. Returns and
allowances have not been material.

Per Share Data

Net income (loss) per share has been computed based on the weighted average
number of shares of common stock outstanding. Common stock options, warrants
and the shares issuable upon conversion of convertible notes have not been
considered because the effect was either not material or antidilutive.


                                      F-7
<PAGE>   34
                   COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
                   NOTES TO FINANCIAL STATEMENTS (continued)
                               DECEMBER 31, 1996

1. Accounting Policies (continued)

Use of Estimates

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the amounts reported in the financial statements and accompanying
notes. Actual results could differ from those estimates.

Long-Lived Assets

Long-lived assets used in operations are reviewed periodically to determine
that the carrying values are not impaired and, if indications of impairment or,
if long-lived assets are expected to be disposed of, impairment losses are
recorded.

Stock-Based Compensation

The Company accounts for its stock compensation arrangements under the
provisions of APB 25, "Accounting for Stock Issued to Employees".

In October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123, "Accounting for Stock- Based
Compensation" (SFAS 123). SFAS 123 establishes a fair value-based method of
accounting for compensation cost related to stock options and other forms of
stock-based compensation plans. However, SFAS 123 allows an entity to continue
to measure compensation costs using the principles of APB 25 if certain pro
forma disclosures are made. SFAS 123 is effective for fiscal years beginning
after December 15, 1995. The Company adopted the provisions for pro forma
disclosure requirements of SFAS 123 in the accompanying financial statements.
See Note 6.

2. Inventory

Inventory at December 31, 1996 consists of:

<TABLE>
             <S>                               <C>
             Raw materials and components      $1,132,000
             Work-in-process                    1,301,000
             Finished goods                       702,000
                                               ----------
                                               $3,135,000
                                               ==========
</TABLE>




                                      F-8
<PAGE>   35
                   COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
                   NOTES TO FINANCIAL STATEMENTS (continued)
                               DECEMBER 31, 1996


3. Property, Plant and Equipment

Property, plant and equipment at December 31, 1996 consists of:

<TABLE>
             <S>                                <C>
             Machinery and equipment            $3,168,000
             Office and display furniture
              and equipment                        492,000
             Leasehold improvements                386,000
                                                ----------
                                                 4,046,000
             Less accumulated depreciation
              and amortization                   1,768,000
                                                ----------
                                                $2,278,000
                                                ==========
</TABLE>

4. Income Taxes

The deferred tax liability at December 31, 1996 consists of:

<TABLE>
     <S>                                           <C>
     Accelerated  depreciation and amortization    $ (321,000)
     Net operating loss                               921,000
     Valuation allowance                             (742,000)
     Other                                            142,000                                                  
                                                   ----------
                                                         - 
                                                   =========== 
</TABLE>

A rate reconciliation of computed expected total provision (benefit) for income
taxes to the amount recorded is as follows:

                                          1996        1995    

<TABLE>
 <S>                                   <C>          <C>
 Computed expected provision
  (benefit)                            $ 140,000    $(668,000)
 Valuation allowance                     (20,000)     653,000
 Net operating loss                     (140,000)
 Other                                      -          15,000
                                       ----------------------
                                       $ (20,000)         -  
                                       =======================
</TABLE>

At December 31, 1996, the Company had net operating loss carryforwards (NOL) of
approximately $2,500,000 for federal income tax purposes which expire through
2010.





                                      F-9
<PAGE>   36
                   COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
                   NOTES TO FINANCIAL STATEMENTS (continued)
                               DECEMBER 31, 1996

5. Debt

In March 1995, the Company entered into an Account Purchase and Finance
Agreement which provided that the Company may sell accounts receivable at a
discount of 6% (originally 10%). Further, a fee of 4% a month would be charged
for accounts outstanding over 60 days. The maximum amount which could be
outstanding under the agreement was $900,000. Amounts owing under this
agreement were              collateralized by substantially all the assets of
the Company.

In May 1996, the Company terminated the above agreement and entered into a new
Accounts Receivable Security Agreement. The new agreement, as amended, provides
for advances up to 75% of eligible accounts receivable, with a maximum of
$1,250,000 and interest at 16% per annum, which rate may increase if the prime
rate exceeds 8 1/4%. The initial proceeds of this financing were used to repay
the balance due under the prior financing. The new agreement, among other
things, prohibits the payment of dividends and requires the Company to maintain
a specified amount of net worth and minimum working capital ratio.

Notes payable and capital leases bear interest principally at the rate of 4
1/2% above the prime rate and a monthly service charge of 0.4% of the daily
outstanding principal balance.

The Company's obligations to the above lenders are secured by a security
interest in substantially all of the assets of the Company and its subsidiary.

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% per annum. As additional
incentive for making the loan, the Company issued the director 7,500 shares of
common stock; the fair market value of the shares has been charged to interest
expense.

In September 1996, the Company sold $300,000 principal amount of 10%
Subordinated Convertible Notes to a partnership, of which the general partner
is a director of the Company. Interest 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 - total 150,000 shares (subject to
anti-dilution provisions).

Principal payments required on long-term debt at December 31, 1996 is due as
follows: $315,000 - 1997, $74,000 - 1998, $323,000 - 1999, $10,000 - 2000 and
$3,000 - 2001.


                                      F-10
<PAGE>   37
                         COSMETIC GROUP U.S.A., INC. AND
                          SUBSIDIARY NOTES TO FINANCIAL
                              STATEMENTS (continued)
                               DECEMBER 31, 1996

6. Shareholders' Equity

Common Stock

During 1995, the Company sold in private placements 642,320 shares of common
stock at $1.50 per share and 600,000 Units at $2.25 per Unit. Each Unit
consists of one share of common stock and a warrant to purchase one share of
common stock. In connection with the placements, the Company issued warrants to
selling agents.

A summary of outstanding warrants, including the above, at December 31, 1996 is
as follows:

<TABLE>
<CAPTION>
                                                        Exercise    Expiration
                                              Number      price        date
                                            ---------   --------    ----------
<S>                                   <C>             <C>        <C>
Issued in connection with 1994
  public offering (as adjusted)
  redeemable at $.04 per warrant
  if the closing bid price per
  share of common stock exceeds
  $4.45 per share for specified
  period                              471,698 shares  $3.18          July 1999
Issued to underwriter in public
  offering. Each Unit consists of
  two shares of common stock and
  a warrant to purchase 1.18 shares
  of common stock. The warrant
  contains the same features as
  the above warrant                    40,000 units    7.35          July 1999

Issued in connection with private
placements                            600,000 shares   3.75       October 1997
                                      189,961 shares   3.00        August 1997

Issued to selling agents in
private placements. The units
consist of one share of common
stock and a warrant containing
the same features as the warrants
for 600,000 shares above.              38,250 shares    1.95      December 2000
                                        60,000 units    2.70     September 1998
</TABLE>

No warrants have been exercised to December 31, 1996.

During 1995, the Company reduced the conversion price of the 8% Convertible
Subordinated Notes due September 1, 1996 to $2.25 per share and the total
$500,000 of outstanding Notes were converted into 222,220 shares of common
stock.

                                      F-11
<PAGE>   38
                   COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
                   NOTES TO FINANCIAL STATEMENTS (continued)
                               DECEMBER 31, 1996

6. Shareholders' Equity (continued)

Stock Options

The Company has a 1990 Stock Incentive Plan, as amended, ("Plan") under which
the Company may grant options for the purchase of up to a maximum of 1,000,000
shares of common stock. The exercise price for all options is not less than the
fair market value on the date the option is granted, or 110% of the fair market
value if such option is granted to an individual owning more than 10% of the
Company's outstanding common stock on the date of grant. The grant of options,
term and exercise price are determined by the Board of Directors acting as the
Stock Option Committee.

Information on stock options, including 160,000 options granted in 1994 not
under the above plan and options granted under the agreement discussed in Note
7 is as follows:

<TABLE>
<CAPTION>
                                Shares                   Price
                               outstanding  Exercisable   Range 
                              -----------  -----------  -------
    <S>                       <C>          <C>         <C>
    Balance at December 31,
      1994                      688,000      389,267   $3.00 to $4.00
    Granted - 1995              683,626      579,626    1.50 to 3.75
    Cancelled - 1995             (6,000)        (667)   2.25 to 3.00
    Became exercisable                        59,367                 
                                --------     --------   -------------
    Balance at December 31,
      1995                    1,365,626    1,027,593    1.50 to 4.00
    Granted - 1996              120,750       30,750    1.23 to 2.25
    Cancelled - 1996            (12,500)      (8,333)   3.00
    Became exercisable                        90,866                
                              ----------   ----------   ------------
    Balance at December 31,
      1996                    1,473,876    1,140,876   $1.23 to $4.00
                              =========    =========   ==============
</TABLE>

No options have been exercised and, at December 31, 1996, options for 1,140,876
shares are exercisable.

The following pro forma disclosure shows the effect of valuing options granted
to employees and consultants during 1995 and 1996. The values have been
determined using the Black-Scholes option pricing model with the following
weighted average assumptions for 1996 and 1995, respectively: risk-free
interest rates of approximately 5.5% in each year, dividend yields of 0% in
each year, weighted average volatility factors of the expected market price of
the Company's common stock of approximately 64% and 42%, respectively, and
expected life of the options of 10 years and 8.8 years, respectively. These
assumptions resulted in average values per option of $1.89 in 1996 and $1.42 in
1995 and a total value of options granted of $208,000 in 1996 and $237,000 in
1995.
                                      F-12
<PAGE>   39
                   COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
                   NOTES TO FINANCIAL STATEMENTS (continued)
                               DECEMBER 31, 1996

6. Shareholders' Equity (continued)

The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options. The Company's stock options have
characteristics significantly different from those of traded options such as
vesting restrictions and extremely limited transferability. In addition, the
assumptions used in option valuation models (see above) are highly subjective,
particularly the expected stock price volatility of the underlying stock.
Because changes in these subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
provide a reliable single measure of the fair value of its employee stock
options.

For purposes of pro forma disclosures, the estimated fair value of the options
is amortized over the options vesting periods. The pro forma effect on
operating results for 1996 and 1995 is not representative of the pro forma
effects on operating results in future years because it does not take into
account pro forma compensation expense for grants made prior to 1995. Pro forma
information in future years will include the amortization of options granted in
succeeding years. Pro forma information is as follows:

<TABLE>
<CAPTION>
                                              1996         1995
                                              ----         ----
   <S>                                      <C>
   Pro forma net income (loss)              $296,000    $(2,088,000)
   Pro forma net income (loss) per share        $.06          $(.49)
</TABLE>

7. Distribution Agreement

In May 1995, Arnold Zegarelli Products, Inc. a wholly-owned subsidiary ("AZP"),
entered into agreements with Sally Beauty Company, Inc.  ("SBC"). Under the
distribution agreement, SBC has been granted the exclusive right to distribute
the Zegarelli product line in the United States through beauty supply stores.
Sales may be made only to salon professionals. The agreement is for a period of
five years and automatically renews for successive terms of five years at SBC's
election. The Company also uses full service distributors to sell AZP products
directly to salons and licensed cosmetologists and, in connection therewith,
AZP may purchase products from SBC for resale to its independent distributors
and may use warehouse and shipping services provided by SBC pursuant to a
service agreement. Sales to AZP's independent distributors are from products
purchased by AZP from SBC at prices equivalent to that charged by SBC to AZP.

Net sales in the accompanying statements of operations include sales to SBC;
the purchase of products by AZP from SBC and the subsequent resale to
independent distributors are not included in  such statements.


                                      F-13
<PAGE>   40
                   COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
                   NOTES TO FINANCIAL STATEMENTS (continued)
                               DECEMBER 31, 1996

7. Distribution Agreement (continued)

In connection with the aforementioned agreements with SBC, the Company granted
to SBC options to purchase 10% of the outstanding stock at such date; the
options may be exercised at any time from May 1996 through May 2000 provided
SBC continues providing services pursuant to one of the agreements referred to
in the first paragraph hereof. The Company will issue additional options to SBC
if, at any time prior to the expiration of the above option, the Company issues
additional shares of common stock: a) other than for the exercise of stock
options, SBC shall have the option to purchase 10% of the number of shares
issued at an exercise price equal to the issuance price of such shares, and b)
if the Company issues an aggregate of 100,000 shares of common stock upon the
exercise of stock options, SBC shall have the option to purchase 10,000 shares
of common stock at an exercise price equal to the market price of the common
stock on the day preceding the date on which the last shares are issued by the
Company to reach the 100,000 share threshold. Thereafter, upon each succeeding
issuance of 100,000 shares of common stock upon the exercise of stock options,
SBC shall have the option to purchase an additional 10,000 shares on the terms
and conditions set forth in the preceding sentence. The number of shares
subject to option and the exercise prices are subject to adjustment for stock
splits and stock dividends. Outstanding options are included in the stock
option table in Note 6.

8. Commitments and Contingencies

The Company leases office and warehouse facilities under operating leases
expiring through 2001. Future minimum lease payments are approximately $460,000
in 1997, $420,000 in 1998, $310,000 in 1999, $300,000 in 2000 and $25,000 in
2001 (total - $1,515,000).

Rent expense approximated $457,000 in 1996 and $335,000 in 1995.





                                      F-14
<PAGE>   41

                   COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
                   NOTES TO FINANCIAL STATEMENTS (continued)
                               DECEMBER 31, 1996


9. Industry Segment Data

Since 1995 the Company operates in two segments - custom developing,
formulating and manufacturing color cosmetics and other personal care products
for customers that market products for sale under their own brand names
("contract packaging") and manufacture and sale of professional hair care
products under the name "Zegarelli" ("hair care products"). The following
summarizes certain segment information at December 31, 1996 and 1995 and for
each of the years then ended:

<TABLE>
<CAPTION>
                                     1996               1995
                                     ----               ----
<S>                                 <C>               <C>
Net sales
   Contract packaging               $13,172,000        $9,305,000
   Hair care products                 4,034,000         1,299,000
                                     ----------        ----------
                                     17,206,000        10,604,000
   Elimination-intersegment sales     2,026,000           771,000
                                     ----------        ----------
Total sales                         $15,180,000        $9,833,000
                                    -----------        ----------

Operating profit (loss)
   Contract packaging               $ 2,798,000        $  378,000
   Hair care products                (1,696,000)       (1,632,000)
                                     ----------        -----------
Total operating profit (loss)         1,102,000        (1,254,000)
   Corporate expenses                   372,000           321,000
   Interest expense                     345,000           389,000
   Tax credit                           (20,000)                  
                                     -----------        ----------
Net income (loss)                   $   405,000       $(1,964,000)
                                    ===========       ============

Identifiable assets
   Contract packaging               $7,083,000         $5,001,000
   Hair care products                1,538,000          1,326,000
                                     ---------         ----------
                                     8,621,000          6,327,000
   Corporate assets                    139,000             89,000
                                     ---------         ----------
Total assets                        $8,760,000         $6,416,000
                                    ==========        ===========
</TABLE>





                                      F-15
<PAGE>   42

                   COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
                   NOTES TO FINANCIAL STATEMENTS (continued)
                               DECEMBER 31, 1996

9. Industry Segment Data (continued)
<TABLE>
<CAPTION>
                                          1996               1995
                                          ----               ----
<S>                                    <C>                <C>
Depreciation and amortization expense
   Contract packaging                  $  393,000         $  332,000
   Hair care products                      60,000             31,000
   Corporate                                  -                  -

Capital expenditures
   Contract packaging                  $  570,000         $  253,000
   Hair care products                      51,000            149,000
   Corporate                                  -                 -
</TABLE>

Intersegment sales are accounted for at prices comparable to unaffiliated
customer sales. Operating profit is total revenue less operating expenses,
excluding interest and corporate expenses. Identifiable assets by industry
segment include assets directly identified with those operations. Corporate
assets consist of cash and receivable from officer/director.

Sales to customers which represented more than 10% of sales in 1996 or 1995 are
as follows:

<TABLE>
<CAPTION>
                             % of contract          % of
                            packaging sales     total sales
                            ---------------     -----------
                             1996    1995       1996   1995
                             ----    ----       ----   ----
    <S>                     <C>     <C>        <C>    <C>
    Customer A               22%     42%        19%    39%
    Customer B               14      24         12     22
    Customer C               12       7         11      6
</TABLE>

<TABLE>
<CAPTION>
                             % of hair care
                             products sales
                             --------------
    <S>                     <C>     <C>         <C>    <C>
    Customer D               98%     96%        26     12
</TABLE>

In 1996 the Company recorded a charge of $240,000 for the settlement of
litigation relating to the contract packaging segment. See Note 10.

For the year ended December 31, 1995, the Company provided an allowance of
approximately $363,000 in the contract packaging segment to reduce the carrying
amount of certain finished products resulting from a lower of cost or market
adjustment for a discontinued product applicable to that segment.





                                      F-16
<PAGE>   43
                   COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
                   NOTES TO FINANCIAL STATEMENTS (continued)
                               DECEMBER 31, 1996


10. Litigation and Other Items

The Company was a defendant in a lawsuit filed in March 1996. The complaint
alleged that a portion of the 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 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 1996 in connection with the
settlement, of which $100,000 is attributable to the cash payment, $122,500 is
attributable to the value of the shares of common stock issued and the balance
to fees and expenses incurred.

In October 1996 a lawsuit was filed against the Company with regard to a
dispute for certain development costs charged to the Company.  Management
believes that the claimed obligation was previously settled, that the plaintiff
has reneged on the settlement agreement and the ultimate outcome of the matter
will not adversely affect the Company's financial position or operations.

In 1996 the Company commenced a defined contribution plan ('the Plan") which
qualifies under Section 401 (k) of the Internal Revenue Code. The Plan covers a
majority of employees with over one year of service. and provides for a 25%
match of the participants' eligible contributions.  The Company recognized an
expense under the plan of $14,000 in 1996.



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