2050 Motors, Inc. – ‘10KSB40’ for 12/31/96

As of:  Tuesday, 3/25/97   ·   For:  12/31/96   ·   Accession #:  950150-97-383   ·   File #:  1-13126

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Annual Report — Small Business — [x] Reg. S-B Item 405   —   Form 10-KSB
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10KSB40     Form 10-Ksb                                           43    177K 
 2: EX-23.1     Consent of Ernst & Young LLP                           1      5K 
 3: EX-27       Financial Data Schedule                                1      6K 

10KSB40   —   Form 10-Ksb
Document Table of Contents

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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) 

                                                                [Download Table]
                                                                    
          California                                95-4040591      
-------------------------------                     ----------      
(State or other jurisdiction of                  (I.R.S. Employer   
 incorporation or organization)                  Identification No.)

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.       

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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:

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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,                          

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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.                                                          

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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:                  

                                                                [Download Table]

                                        Percentage of Sales        
                                        -------------------        
                                       Year ended December 31,     
                                      ------------------------     

Contract manufacturing           1994          1995           1996 
----------------------          ------        ------         ------
                                                                   
  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% 
                                 ===           ===            ===  

_______________                                                                 

* Sales of the Zegarelli product line commenced in 1995.                      

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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.                                              

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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.                                                           

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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                 

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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.            

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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                                                               

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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                                            

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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.    

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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.                                                     

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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.                    

                                                                [Download Table]

                                        HIGH       LOW  
                                        ----       ---  
                                                        
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)                            

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(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.                                                                     

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                                                                [Download Table]

                                 Year ended        
                                December 31,       
                                ------------       
                                  1996      1995   
                                  ----      ----   
                                                   
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%)
                                 ====       =====  

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:.                                                                

                                                                [Download Table]

                                1996     1995 
                                ----     ---- 
                                              
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 

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                                                  

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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.            

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Sales to customers accounting for more than 10% of net sales in 1995 and 1994   
are as follows:.                                                                

                                                                [Download Table]

                                1995     1994 
                                ----     ---- 
                                              
Customer A                      39.2%    37.3%
Customer B                      22.2          
Customer C                      12.7          
Customer D                       6.3          
                                ----     ---- 
Total                           80.4     37.3 

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                                                  

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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                                                          

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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.                                 

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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

                                                                [Download Table]

                                                                            Page
                                                                            ----
                                                                                
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

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

Not applicable.                                                                 

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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.                                             

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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)  

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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.   

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(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.               

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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.                                                                

                                                        [Enlarge/Download Table]

           Signature                          Title                          Date          
------------------------------  ---------------------------------  ------------------------
                                                                                           
/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                                                                             

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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                                                               

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COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1996 

                                                                [Download Table]
                                                                 
       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 
                                                     =========== 

See accompanying notes.                                                         

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COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS 

                                                                [Download Table]

                                                  Year ended        
                                                  December 31       
                                             1996           1995    
                                         -------------------------- 
                                                                    
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 
                                          ========================= 

See accompanying notes.                                                         

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

                                                                [Download Table]

                                 Common Stock                               
                               ----------------                             
                        Number of                 Retained                  
                         Shares       Amount      (Deficit)         Total   
                       -----------------------------------------------------
                                                                            
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 
                         ================================================== 

See accompanying notes.                                                         

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COSMETIC GROUP U.S.A., INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS 

                                                                [Download Table]

                                                Year ended         
                                                December 31        
                                             1996         1995     
                                                                   
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  
                                           ----------------------  

(Continued)                                                               

See accompanying notes.                                                   

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COSMETIC GROUP U.S.A, INC.
STATEMENT OF CASH FLOWS (Continued) 

                                                                [Download Table]

                                               Year ended          
                                               December 31         
                                             1996        1995      
                                          -------------------------
                                                                   
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   

See accompanying notes.                                                     

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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.          

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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:                                     

                                                                [Download Table]
                                            
Raw materials and components      $1,132,000
Work-in-process                    1,301,000
Finished goods                       702,000
                                  ----------
                                  $3,135,000
                                  ==========

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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:                 

                                                                [Download Table]
                                             
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
                                   ==========

4. Income Taxes                                                                 

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

                                                                [Download Table]
                                                         
Accelerated  depreciation and amortization    $ (321,000)
Net operating loss                               921,000 
Valuation allowance                             (742,000)
Other                                            142,000 
                                              ---------- 
                                                    -    
                                              ===========

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

                    1996        1995

                                                                [Download Table]
                                                             
Computed expected provision                                  
 (benefit)                            $ 140,000    $(668,000)
Valuation allowance                     (20,000)     653,000 
Net operating loss                     (140,000)             
Other                                      -          15,000 
                                      ---------------------- 
                                      $ (20,000)         -   
                                      =======================

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.                                                                           

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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.                                                                  

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 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:                                                                     

                                                                [Download Table]

                                                        Exercise    Expiration 
                                              Number      price        date    
                                            ---------   --------    ---------- 
                                                                               
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

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.                                                                          

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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:                                                                

                                                                [Download Table]

                            Shares                   Price       
                           outstanding  Exercisable   Range      
                          -----------  -----------  -------      
                                                                 
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
                          =========    =========   ==============

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.                                                                           
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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:                          

                                                                [Download Table]

                                           1996         1995     
                                           ----         ----     
                                                                 
Pro forma net income (loss)              $296,000    $(2,088,000)
Pro forma net income (loss) per share        $.06          $(.49)

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.                  

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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.                

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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:                                                   

                                                                [Download Table]

                                     1996               1995      
                                     ----               ----      
                                                                  
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 
                                    ==========        =========== 

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

9. Industry Segment Data (continued)                                            

                                                                [Download Table]

                                          1996               1995   
                                          ----               ----   
                                                                    
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                                  -                 -   

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:                                                                     

                                                                [Download Table]

                         % of contract          % of   
                        packaging sales     total sales
                        ---------------     -----------
                         1996    1995       1996   1995
                         ----    ----       ----   ----
                                                       
Customer A               22%     42%        19%    39% 
Customer B               14      24         12     22  
Customer C               12       7         11      6  

                                                                [Download Table]

                         % of hair care               
                         products sales               
                         --------------               
                                                      
Customer D               98%     96%        26     12 

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.               

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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.                                      

F-17

Dates Referenced Herein   and   Documents Incorporated by Reference

				Referenced-On Page
This ‘10KSB40’ Filing		Date		First		Last			Other Filings
		3/31/99		13
		4/30/97		2		22
Filed on:		3/25/97
		3/21/97		26
		3/12/97		2		14
		3/10/97		6		13
		2/28/97		27
For Period End:		12/31/96		1		43
		9/20/96		25					8-K
		9/1/96		37
		5/10/96		24		25			8-K
		12/31/95		16		42
		12/15/95		34
		11/14/95		23
		10/25/95		24
		10/2/95		24
		9/1/95		19
		7/26/95		23		24
		6/30/95		25
		5/16/95		24		25
		4/7/95		19
		3/22/95		25
		3/17/95		23		24
		12/31/94		17
		8/29/94		24		25
		7/14/94		25
		7/12/94		25
		6/23/94		25
		5/13/94		25
		2/18/94		24
		12/31/93		24
		10/1/93		23
		5/21/93		24
		4/1/93		23
		3/15/93		23
		2/18/93		23
		12/16/92		23
		6/21/92		23
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