**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

**FORM 10-Q**

| **(Mark One)** |
|----------------|
| ** **     |
| **x**          |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|           |   | ** ** |
|           |   | **For the  quarterly period ended July 1, 2007** |
|           |   | ** ** |
|           |   | **Or** |
|           |   | ** ** |
| **o**          |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|           |   | ** ** |
|           |   | **For the  transition period  from                to                ** |

 

**Commissionfile number: 001-33048**

**BareEscentuals, Inc.**

(Exact name of registrantas specified in its charter)

| **Delaware**                     |   | **20-1062857**       |
|----------------------------------|--------|----------------------|
| (State or other  jurisdiction of |   | (I.R.S. Employer     |
| incorporation or  organization)  |   | Identification  No.) |

 

**71 Stevenson Street, 22****nd Floor**

**San Francisco, CA 94105**

(Address ofprincipal executive offices with zip code)

**(415) 489-5000**

(Registrant’stelephone number, including area code)

**N/A**

(Former name,former address and former fiscal year, if changed since last report)

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  YES      x   NO      o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act).   Large AcceleratedFiler      o   Accelerated Filer      o    Non-Accelerated Filer      x

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).   YES      o  NO      x

At August 6, 2007, thenumber of shares outstanding of the registrant’s common stock, $0.001 parvalue, was 90,188,564.

 

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**Table of Contents**

**Bare Escentuals, Inc.**

**INDEX**
| **PART I—FINANCIAL  INFORMATION** |   |                                                                                                            |
|---------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------|
| Item 1                                 |   | Financial Statements  (unaudited):                                                                              |   |   |
|                                        |   | Condensed  Consolidated Balance Sheets — July 1, 2007 and December 31, 2006                                |   | 3 |
|                                        |   | Condensed  Consolidated Statements of Operations—Three and Six Months Ended July 1, 2007  and July 2, 2006 |   | 4 |
|                                        |   | Condensed  Consolidated Statements of Cash Flows—Six Months Ended July 1, 2007 and July  2, 2006           |   | 5 |
|                                        |   | Notes to  Condensed Consolidated Financial Statements                                                           |   | 6 |
| Item 2                                 |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                     |   | 22 |
| Item 3                                 |   | Quantitative  and Qualitative Disclosures About Market Risk                                                     |   | 35 |
| Item 4                                 |   | Controls and  Procedures                                                                                        |   | 36 |
|                                        |   |                                                                                                            |   |   |
| **PART II—OTHER  INFORMATION**    |   |                                                                                                            |
| Item 1                                 |   | Legal Proceedings                                                                                               |   | 37 |
| Item 1A                                |   | Risk  Factors                                                                                                   |   | 37 |
| Item 2                                 |   | Unregistered  Sales of Equity Securities and Use of Proceeds                                                    |   | 39 |
| Item 3                                 |   | Defaults Upon  Senior Securities                                                                                |   | 39 |
| Item 4                                 |   | Submission of  Matters to a Vote of Security Holders                                                            |   | 39 |
| Item 5                                 |   | Other Information                                                                                               |   | 39 |
| Item 6                                 |   | Exhibits                                                                                                        |   | 40 |
| Signatures                                  |   |                                                                                                            |   | 41 |
| Exhibit Index                          |   |                                                                                                            |   |   |
| Certifications                              |   |                                                                                                            |   |   |
|                                             |        |                                                                                                                 |  |  |  |  |

 

2

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**PART I—FINANCIAL INFORMATION**

**ITEM1.   FINANCIAL STATEMENTS**

**BAREESCENTUALS, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(in thousands,except per share data)**
| ** **                                                                                                                                                                            | ** ** | **July 1,  2007** | ** ** | **December 31,  2006 (a)** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                                                                                            | ** ** | **(unaudited)**        | ** ** | ** **                           | ** ** |
| **ASSETS**                                                                                                                                                                            | ** ** | ** **             | ** ** | ** **                           | ** ** |
| Current assets:                                                                                                                                                                       |       |                   |       |                                 |       |
| Cash and cash  equivalents                                                                                                                                                            |       | $                      | 22,564     |                                 | $          | 20,875 |   |
| Inventories                                                                                                                                                                           |       | 56,042                 |       | 62,006                               |       |
| Accounts  receivable, net of allowances of $5,875 and $3,427 at July 1, 2007 and  December 31, 2006, respectively                                                           |       | 34,477                 |       | 30,759                               |       |
| Prepaid expenses  and other current assets                                                                                                                                            |       | 10,507                 |       | 6,249                                |       |
| Prepaid income  taxes                                                                                                                                                                 |       | 3,055                  |       | —                               |       |
| Deferred tax  assets                                                                                                                                                                  |       | 7,772                  |       | 5,826                                |       |
| Total current assets                                                                                                                                                                  |       | 134,417                |       | 125,715                              |       |
| Property and equipment,  net                                                                                                                                                          |       | 32,049                 |       | 21,111                               |       |
| Intangible assets, net                                                                                                                                                                |       | 26,871                 |       | 6,085                                |       |
| Deferred tax assets                                                                                                                                                                   |       | —                 |       | 1,092                                |       |
| Other assets                                                                                                                                                                          |       | 2,289                  |       | 1,832                                |       |
| Total assets                                                                                                                                                                          |       | $                      | 195,626    |                                 | $          | 155,835 |   |
| ** **                                                                                                                                                                            | ** ** | ** **             | ** ** | ** **                           | ** ** |
| **LIABILITIES  AND STOCKHOLDERS’ DEFICIT**                                                                                                                                       | ** ** | ** **             | ** ** | ** **                           | ** ** |
| Current liabilities:                                                                                                                                                                  |       |                   |       |                                 |       |
| Current portion  of long-term debt                                                                                                                                                    |       | $                      | 17,624     |                                 | $          | 17,624 |   |
| Accounts payable                                                                                                                                                                      |       | 28,867                 |       | 25,357                               |       |
| Accrued  liabilities                                                                                                                                                                  |       | 20,122                 |       | 16,123                               |       |
| Accrued  restructuring charges                                                                                                                                                        |       | 23                     |       | 172                                  |       |
| Income taxes  payable                                                                                                                                                                 |       | —                 |       | 101                                  |       |
| Total current  liabilities                                                                                                                                                            |       | 66,636                 |       | 59,377                               |       |
|                                                                                                                                                                                  |       |                   |       |                                 |       |
| Long-term debt, less  current portion                                                                                                                                                 |       | 282,376                |       | 321,639                              |       |
| Other liabilities                                                                                                                                                                     |       | 8,270                  |       | 3,341                                |       |
|                                                                                                                                                                                  |       |                   |       |                                 |       |
| Commitments and  contingencies                                                                                                                                                        |       |                   |       |                                 |       |
|                                                                                                                                                                                  |       |                   |       |                                 |       |
| Stockholders’ deficit:                                                                                                                                                           |       |                   |       |                                 |       |
| Preferred stock;  $0.001 par value; 10,000 shares authorized; zero shares issued and  outstanding                                                                                |       | —                 |       | —                               |       |
| Common stock;  $0.001 par value; 200,000 shares authorized; 90,185 and 89,316  shares issued and outstanding at July 1, 2007 and December  31, 2006, respectively |       | 90                     |       | 89                                   |       |
| Additional paid–in  capital                                                                                                                                                      |       | 405,157                |       | 378,063                              |       |
| Cumulative  effect on accumulated deficit due to change in accounting principle                                                                                                       |       | (952                   | )          | —                               |       |
| Accumulated  other comprehensive income                                                                                                                                               |       | 103                    |       | —                               |       |
| Accumulated  deficit                                                                                                                                                                  |       | (566,054               | )          | (606,674                             | )          |
| Total stockholders’  deficit                                                                                                                                                     |       | (161,656               | )          | (228,522                             | )          |
| Total liabilities and stockholders’ deficit                                                                                                                                      |       | $                      | 195,626    |                                 | $          | 155,835 |   |

 

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(a)          Condensed consolidatedbalance sheet as of December 31, 2006 has been derived from the auditedconsolidated financial statements.

See accompanyingnotes.

3

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**BARE ESCENTUALS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(in thousands,except per share data)**
| ** **                                                                      | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                      | ** ** | **July 1,  2007**           | ** ** | **July 2,  2006**         | ** ** | **July 1,  2007** | ** ** | **July 2,  2006** | ** ** |
| ** **                                                                      | ** ** | **(unaudited)**                  | ** ** | **(unaudited)**                | ** ** |
| Sales, net                                                                      |       | $                                | 124,144    |                           | $          | 96,185 |   | $ | 239,757 |   | $ | 186,100 |   |
| Cost of goods  sold                                                             |       | 37,578                           |       | 26,937                         |       | 71,028 |   | 52,133 |   |
| Gross profit                                                                    |       | 86,566                           |       | 69,248                         |       | 168,729 |   | 133,967 |   |
| Expenses:                                                                       |       |                             |       |                           |       |   |   |   |   |
| Selling, general and administrative                                             |       | 43,536                           |       | 33,172                         |       | 82,721 |   | 62,856 |   |
| Depreciation and amortization, relating to selling,  general and administrative |       | 1,860                            |       | 506                            |       | 2,800 |   | 971 |   |
| Stock-based compensation, relating to selling,  general and administrative      |       | 1,779                            |       | 1,523                          |       | 3,390 |   | 2,467 |   |
| Operating income                                                                |       | 39,391                           |       | 34,047                         |       | 79,818 |   | 67,673 |   |
| Interest expense                                                                |       | (6,274                           | )          | (12,887                        | )          | (13,085 | ) | (21,870 | ) |
| Debt  extinguishment costs                                                      |       | —                           |       | (3,391                         | )          | — |   | (3,391 | ) |
| Interest income                                                                 |       | 487                              |       | 345                            |       | 828 |   | 631 |   |
| Income before  provision for income taxes                                       |       | 33,604                           |       | 18,114                         |       | 67,561 |   | 43,043 |   |
| Provision for  income taxes                                                     |       | 13,389                           |       | 7,640                          |       | 26,941 |   | 18,035 |   |
| Net income                                                                      |       | $                                | 20,215     |                           | $          | 10,474 |   | $ | 40,620 |   | $ | 25,008 |   |
|                                                                            |       |                             |       |                           |       |   |   |   |   |
| Basic                                                                           |       | $                                | 0.22       |                           | $          | 0.15 |   | $ | 0.45 |   | $ | 0.36 |   |
| Diluted                                                                         |       | $                                | 0.22       |                           | $          | 0.15 |   | $ | 0.44 |   | $ | 0.35 |   |
| Cash dividend  per common share                                                 |       | $                                | —     |                           | $          | 4.81 |   | $ | — |   | $ | 4.81 |   |
|                                                                            |       |                             |       |                           |       |   |   |   |   |
| Weighted-average  shares used in per share calculations:                        |       |                             |       |                           |       |   |   |   |   |
| Basic                                                                           |       | 90,021                           |       | 69,777                         |       | 89,725 |   | 69,461 |   |
| Diluted                                                                         |       | 93,091                           |       | 71,703                         |       | 92,804 |   | 71,785 |   |

 

See accompanying notes.

4

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**BARE ESCENTUALS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**
| ** **                                                                              | ** ** | **Six months ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                              | ** ** | **July 1,  2007**         | ** ** | **July 2,  2006** | ** ** |
| ** **                                                                              | ** ** | **(unaudited)**                | ** ** |
| **Operating  activities**                                                               |       |                           |       |   |   |
| Net income                                                                              |       | $                              | 40,620     |   | $ | 25,008 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:      |       |                           |       |   |   |
| Depreciation of property and equipment                                                  |       | 1,995                          |       | 971 |   |
| Amortization of intangible assets                                                       |       | 805                            |       | — |   |
| Amortization of debt issuance costs                                                     |       | 139                            |       | 80 |   |
| Debt extinguishment costs                                                               |       | —                         |       | 3,391 |   |
| Stock-based compensation                                                                |       | 3,390                          |       | 2,467 |   |
| Excess tax benefit from stock option exercises and  disqualifying disposition of shares |       | (2,286                         | )          | (7,507 | ) |
| Deferred income tax provision (benefit)                                                 |       | (827                           | )          | (34 | ) |
| Other                                                                                   |       | 42                             |       | — |   |
| Changes in assets and liabilities:                                                      |       |                           |       |   |   |
| Inventories                                                                             |       | 7,909                          |       | (9,398 | ) |
| Accounts receivable                                                                     |       | (2,021                         | )          | (10,670 | ) |
| Income taxes                                                                            |       | 1,337                          |       | 2,539 |   |
| Prepaid expenses and other current assets                                               |       | (981                           | )          | (78 | ) |
| Other assets                                                                            |       | (596                           | )          | (879 | ) |
| Accounts payable and accrued liabilities                                                |       | (2,186                         | )          | 4,608 |   |
| Other liabilities                                                                       |       | 667                            |       | 259 |   |
| Net cash  provided by operating activities                                              |       | 48,007                         |       | 10,757 |   |
| ** **                                                                              | ** ** | ** **                     | ** ** | ** ** | ** ** |
| **Investing  activities**                                                               |       |                           |       |   |   |
| Purchase of  property and equipment                                                     |       | (12,206                        | )          | (4,293 | ) |
| Acquisition of  business, net of $1,847 of cash and cash equivalents acquired           |       | (18,657                        | )          | — |   |
| Net cash used in  investing activities                                                  |       | (30,863                        | )          | (4,293 | ) |
| ** **                                                                              | ** ** | ** **                     | ** ** | ** ** | ** ** |
| **Financing  activities**                                                               |       |                           |       |   |   |
| Proceeds from  issuance of Senior Term Loans and First and Second Lien Term Loans       |       | —                         |       | 206,583 |   |
| Repayments on  Senior Term Loans and First and Second Lien Term Loans                   |       | (39,263                        | )          | (7,657 | ) |
| Proceeds from  issuance of Subordinated Notes Payable                                   |       | —                         |       | 125,000 |   |
| Payments for  debt issuance costs                                                       |       | —                         |       | (4,122 | ) |
| Dividend paid in  connection with the Recapitalization transactions                     |       | —                         |       | (340,427 | ) |
| Proceeds from  issuance of common stock in public offerings                             |       | 22,645                         |       | — |   |
| Payment of  transaction costs in connection with public offerings                       |       | (1,562                         | )          | — |   |
| Excess tax  benefit from stock option exercises and disqualifying disposition of shares |       | 2,286                          |       | 7,507 |   |
| Exercise of  stock options                                                              |       | 336                            |       | 1,309 |   |
| Proceeds from  issuance of common stock to directors                                    |       | —                         |       | 300 |   |
| Net cash used in  financing activities                                                  |       | (15,558                        | )          | (11,507 | ) |
| Effect of  foreign currency exchange rate changes on cash                               |       | 103                            |       | — |   |
| Net increase  (decrease) in cash and cash equivalents                                   |       | 1,689                          |       | (5,043 | ) |
| Cash and cash  equivalents, beginning of period                                         |       | 20,875                         |       | 18,675 |   |
| Cash and cash  equivalents, end of period                                               |       | $                              | 22,564     |   | $ | 13,632 |   |
|                                                                                    |       |                           |       |   |   |
| **Supplemental  disclosure of cash flow information**                                   | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Cash paid for  interest                                                                 |       | $                              | 13,133     |   | $ | 25,689 |   |
| Cash paid for  income taxes                                                             |       | $                              | 28,903     |   | $ | 15,526 |   |
|                                                                                    |       |                           |       |   |   |
| **Supplemental  disclosure of noncash investing and financing activities**              |       |                           |       |   |   |
| Shares issued in lieu  of transaction fees                                              |       | $                              | —     |   | $ | 2,442 |   |

 

See accompanying notes.

5

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**BAREESCENTUALS, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

**1.     Business**

Bare Escentuals, Inc.,together with its subsidiaries (“Bare Escentuals” or the “Company”),develops, markets, and sells branded cosmetics, skin care and body careproducts under the *i.d. bareMinerals, i.d.,RareMinerals* and namesake *BareEscentuals* brands, and professional skin care products under the *md formulations* brand. The *i.d. bareMinerals*cosmetics, particularlythe core foundation products which are mineral-based, offer a highlydifferentiated, healthy alternative to conventional cosmetics. The Company usesa multi-channel distribution model consisting of infomercials, specialtybeauty retailers, Company-owned boutiques, home shopping television, andspas and salons. The Company’s international distributors are primarily locatedin Western Europe, Asia, and Australia.

**2.     Summary of Significant Accounting Policies**

***Unaudited Interim Financial Information***

The accompanyingcondensed consolidated balance sheet as of July 1, 2007, the condensedconsolidated statements of operations for the three and six months ended July1, 2007 and July 2, 2006, and the condensed consolidated statements of cashflows for the six months ended July 1, 2007 and July 2, 2006, are unaudited.These unaudited interim condensed consolidated financial statements have beenprepared in accordance with U.S. generally accepted accounting principles forinterim financial information, Form 10-Q and Article 10 of RegulationS-X. In the opinion of the Company’s management, the unaudited interimcondensed consolidated financial statements have been prepared on the samebasis as the annual consolidated financial statements and include alladjustments of a normal recurring nature necessary for the fair presentation ofthe Company’s financial position as of July 1, 2007, its results of operationsfor the three and six months ended July 1, 2007 and July 2, 2006, and its cashflows for the six months ended July 1, 2007 and July 2, 2006.  The results for the interim periods are notnecessarily indicative of the results to be expected for any future period orfor the fiscal year ending December 30, 2007. The condensed consolidatedbalance sheet as of December 31, 2006 has been derived from the auditedconsolidated balance sheet as of that date.

These unauditedinterim condensed consolidated financial statements should be read inconjunction with the Company’s consolidated financial statements and relatednotes included in the Company’s 2006 Annual Report on Form 10-K filed with theSEC on March 30, 2007.

***Principles of Consolidation***

The accompanyingcondensed consolidated financial statements include the accounts of the Companyand its wholly owned subsidiaries. All significant intercompany accounts andtransactions have been eliminated.

***Fiscal Quarter***

TheCompany’s fiscal quarters end on the Sunday closest to March 31, June 30,September 30 and December 31.  The threemonths ended July 1, 2007 and July 2, 2006 each contained 13 weeks.  Thesix months ended July 1, 2007 and July 2, 2006 each contained 26 weeks.

***Use of Estimates***

The preparation offinancial statements in conformity with U.S. generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the balance sheet dates and the reported amounts ofrevenues and expenses for the periods presented. Actual results could differfrom those estimates, and such differences may be material to the consolidatedfinancial statements.

In determining itsquarterly provision for income taxes, the Company uses an estimated annualeffective tax rate, which is based on expected annual income, statutory taxrates and tax planning opportunities available in the various jurisdictions inwhich the Company operates.  Certainsignificant or unusual items are separately recognized in the quarter in whichthey occur and can be a source of variability in the effective tax rates fromquarter to quarter.

6

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***Cash and CashEquivalents***

Cash equivalents areconsidered to be highly liquid investments with maturities of three months orless at the time of the purchase.

***Supply andFulfillment Concentration Risks***

All of the Company’sproducts are contract manufactured or supplied by third parties. The Companyhas a long-term contract with only one of its suppliers. The term of thiscontract expires on April 30, 2011. The fact that the Company does nothave long-term contracts with all of its third-party manufacturers meansthat any of those manufacturers could cease manufacturing the Company’sproducts at any time and for any reason.

Additionally, the Companycurrently depends on one third party for the fulfillment of its infomercialsales, including inventory management, call center operation, website hostingand packing and shipping of product to customers. The Company’s contract withthis service provider expires on December 31, 2007.

***Concentration ofCredit Risk and Credit Risk Evaluation***

Financial instrumentsthat potentially subject the Company to concentrations of credit risk consistprimarily of cash and cash equivalents and accounts receivable. Cash and cashequivalents are held by or invested in various domestic financial institutionswith high credit standing. Management believes that these financialinstitutions are financially sound and, accordingly, minimal credit risk existswith respect to these balances.

Sales generated throughcredit card purchases for the three and six months ended July 1, 2007 wereapproximately 46.5% and 47.9%, respectively, and approximately 49.2% and 49.7%for the three and six months ended July 2, 2006, respectively.  The Company uses third parties to collect itscredit card receivables and believes that its credit risk related to thesesales is limited. The Company performs ongoing credit evaluations of itswholesale customers not paying by credit card and acquires credit insurance forcertain international customers. Generally, the Company does not requirecollateral. An allowance for doubtful accounts is determined with respect tothose amounts that the Company has determined to be doubtful of collection usingspecific identification of doubtful accounts and an aging of receivablesanalysis based on invoice due dates. Actual collection losses may differ frommanagement’s estimates, and such differences could be material to the Company’sconsolidated financial position, results of operations, and cash flows.Uncollectible receivables are written off against the allowance for doubtfulaccounts when all efforts to collect them have been exhausted, and recoveriesare recognized when they are received. Generally, accounts receivable are pastdue after 30 days of an invoice date unless special payment terms areprovided.

The table below setsforth the percentage of consolidated accounts receivable, net for customers whorepresented 10% or more of consolidated accounts receivable, which are includedin the wholesale segment:
|            | ** ** | **July 1,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------|------------|------------------------|------------|-----------------------------|------------|
| Customer A |       | 25                     | %          | 11                          | %          |
| Customer B |       | 16                     | %          | 23                          | %          |
| Customer C |       | 31                     | %          | 31                          | %          |

 

The table belowsets forth the percentage of consolidated sales, net for customers whorepresented 10% or more of consolidated net sales:
|            | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** ** | ** ** | **July 1,  2007**           | ** ** | **July 2,  2006**         | ** ** | **July 1,  2007** | ** ** | **July 2,  2006** | ** ** |
| Customer A |       | 12                               | %          | 16                             | %          | 12 | % | 15 | % |
| Customer B |       | 15                               | %          | 11                             | %          | 14 | % | 12 | % |
| Customer C |       | 15                               | %          | 15                             | %          | 15 | % | 14 | % |

 

As of July 1, 2007and December 31, 2006, the Company had no off-balance sheet concentrations ofcredit risk, such as option contracts or other hedging arrangements.

7

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***Fair Value ofFinancial Instruments***

Financial instrumentsconsist principally of cash and cash equivalents, accounts receivable, accountspayable, and long-term debt. The estimated fair value of cash, cashequivalents, accounts receivable, and accounts payable approximates theircarrying value due to the short period of time to their maturities. At July 1,2007, all of the Company’s outstanding debt was variable-rate debt. Theestimated fair value of the Company’s variable-rate debt approximates itscarrying value, since the rate of interest on the variable-rate debt isdetermined at a margin over LIBOR or the lenders’ base rate plus an applicablemargin based on a grid in which the pricing depends on the Company’sconsolidated total leverage ratio, and such rates are revised frequently, basedupon current LIBOR or the lenders’ base rate.

***Inventories***

Inventories consist offinished goods and raw materials and are stated at the lower of cost or market.Cost is determined on a weighted-average basis. The Company regularlymonitors inventory quantities on hand and records write-downs for excessand obsolete inventories based primarily on the Company’s estimated forecast ofproduct demand and production requirements. Such write-downs establish anew cost basis of accounting for the related inventory. Actual inventory lossesmay differ from management’s estimates, and such differences could be materialto the Company’s consolidated financial position, results of operations, andcash flows.

***Property andEquipment***

Property and equipmentare stated at cost, net of accumulated depreciation and amortization. Furnitureand equipment, including computers and software, are depreciated using thestraight-line method over the estimated useful lives of the various assets,which are generally three to seven years. Fixtures and leasehold improvementsare amortized using the straight-line method over the lesser of the lease term,which ranges from five to ten years, or the estimated useful lives of theassets. For leases with renewal periods at the Company’s option, the Company generallyuses the original lease term, excluding renewal option periods, to determineestimated useful lives.

***Impairment ofLong-Lived Assets and Long-Lived Assets to Be Disposed of***

The Company periodicallyevaluates whether changes have occurred that would require revision of theremaining useful life of equipment and improvements and purchased intangibleassets or render them not recoverable. If such circumstances arise, the Companyuses an estimate of the undiscounted sum of expected future operating cashflows during their holding period to determine whether the long-lived assetsare impaired. If the aggregate undiscounted cash flows are less than thecarrying amount of the assets, the resulting impairment charge to be recordedis calculated based on the excess of the carrying value of the assets over thefair value of such assets, with the fair value determined based on an estimateof discounted future cash flows.

***Goodwill andIntangible Assets***

Goodwill and otherpurchased intangible assets have been recorded as a result of the Company’sacquisitions.  Goodwill and indefinite-livedintangibles are not amortized, but rather are subject to an annual impairmenttest. Other intangible assets are amortized over their estimated useful lives,generally two to three years.

The Company is requiredto perform an annual impairment test of goodwill and indefinite-livedintangible assets. Should certain events or indicators of impairment occurbetween annual impairment tests, the Company performs the impairment test of goodwilland indefinite-lived intangible assets at that date.  In evaluating goodwill, management comparesthe total book value of the reporting unit to the fair value of those reportingunits. The fair value of the Company is determined using the income approach.The income approach focuses on the income-producing capability of anasset, measuring the current value of the asset by calculating the presentvalue of its future economic benefits such as cash earnings, cost savings, taxdeductions, and proceeds from disposition. Value indications are developed bydiscounting expected cash flows to their present value at a rate of return thatincorporates the risk-free rate for the use of funds, the expected rate ofinflation, and risks associated with the particular investment. Through July 1,2007, no impairment charge has been required.

8

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***Debt IssuanceCosts***

Debt issuance costs are capitalized and amortized overthe terms of the underlying debt instruments using the effective-interestmethod. Debt issuance costs paid directly to lending institutions are recordedas a debt discount, while debt issuance costs paid to third parties arerecorded as other assets.

***Stock-BasedCompensation***

Statement ofFinancial Accounting Standards No. 123(R), *Share-BasedPayment*(‘‘Statement 123(R)’’) is applicable for stock-basedawards exchanged for employee services and in certain circumstances fornon-employee directors. Pursuant to Statement 123(R), stock-based compensationcost is measured at the grant date, based on the fair value of the award, andis recognized as expense over the requisite service period for awards expectedto vest. The estimation of the number of stock awards that will ultimately vestrequires judgment, and to the extent actual results differ from the Company’sestimates, such amounts will be recorded as a cumulative adjustment in theperiod estimates are revised. The Company considers several factors whenestimating expected forfeitures, such as types of awards. Actual results maydiffer substantially from these estimates.

The compensation costcharged to operations pursuant to Statement 123(R) was $1,779,000 and$3,390,000 for the three and six months ended July 1, 2007, respectively, and$1,345,000 and $2,289,000 for the three and six months ended July 2, 2006,respectively.  The Company records stock-basedcompensation on a separate operating expense line item in its statement ofoperations due to the fact that, to date, all of its stock-based awardshave been made to employees whose salaries are classified as selling, generaland administrative expenses.

***Foreign Currency Translation***

The assets and liabilities of foreign subsidiaries,where the local currency is the functional currency, are translated from theirrespective functional currencies into U.S. dollars at the rates in effect atthe balance sheet date, with resulting foreign currency translation adjustmentsrecorded as other comprehensive income in the accompanying consolidatedstatements of changes in stockholders’ equity (deficit) and comprehensive income.Revenue and expense amounts are translated at average rates during the period.

***RevenueRecognition***

TheCompany’s revenue recognition policy is consistent with the requirements ofStaff Accounting Bulletin No. 104 *RevenueRecognition*, and other applicable revenue recognition guidance andinterpretations. The Company records revenue when all four of the followingcriteria are met: (i) persuasive evidence that an arrangement exists;(ii) delivery of the products and/or services has occurred; (iii) theselling price is fixed or determinable; and (iv) collectibility isreasonably assured.

The Company recognizessales when merchandise is shipped from a warehouse directly to wholesalecustomers (except in the case of a consignment sale), infomercial customers,and online shopping customers or when purchased by customers at Company-ownedboutiques, each net of estimated returns. For consignment sales, which includesales to QVC and a Japanese distributor, the Company recognizes sales, net ofexpected returns from consignees, upon the consignee’s shipment to thecustomer. Postage and handling charges billed to customers are also recognizedas sales upon shipment of the related merchandise. Shipping terms are FOBshipping point, and title passes to the customer at the time and place ofshipment or purchase by customers at retail locations. For consignment sales,title passes to the consignee concurrent with the consignee’s shipment to thecustomer. The customer has no cancellation privileges after shipment or uponpurchase at retail locations, other than customary rights of return that areaccounted for in accordance with Statement 48, *RevenueRecognition When Right of Return Exists.* The Company’s standardterms for retail sales, including infomercial sales and sales at Company-ownedboutiques, limit returns to approximately 30 to 90 days after the sale ofthe merchandise. For wholesale sales, as is customary in the cosmeticsindustry, the Company allows returns from wholesale customers if properlyrequested and approved.  The Companyregularly evaluates returns and accrues for expected future returns that relateto sales prior to the balance sheet date utilizing a combination of historicaland current trends. Deferred revenue reflects amounts received from customersrelated to merchandise to be shipped in future periods.

9

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***Payments toCustomers***

For wholesalecustomers, the Company makes payments to certain customers for cooperativeadvertising, royalties, commissions and shared employee costs. In accordancewith the provisions of EITF 01-9, *Accountingfor Consideration Given by a Vendor to a Customer (Including a Reseller of theVendor’s Products)*, these fees are recorded as a reduction of netsales in the accompanying consolidated statements of operations, unless the Companydetermines it has received an identifiable benefit and can reasonably estimatethe fair value of that benefit, in which case the costs would be recorded asexpenses.

***Shipping andFulfillment Costs***

Freight costs incurredrelated to shipment of merchandise from the Company’s distribution facilitiesto customers are recorded in cost of goods sold. Third-party fulfillmentcosts relating to warehousing, storage, and order processing are included inselling, general and administrative expenses.

***Pre-OpeningCosts***

Costs incurred inconnection with the start-up and promotions of new Company-owned boutiques areexpensed as incurred.

***Operating Leases***

The Company leases retailboutiques, distribution facilities, and office space under operating leases.Most lease agreements contain rent holidays, rent escalation clauses,contingent rent provisions and/or tenant improvement allowances. For purposesof recognizing incentives and minimum rental expenses on a straight-line basisover the original terms of the leases, the Company uses the date of initialpossession to begin amortization, which is generally when the Company entersthe space and begins to make improvements in preparation of intended use. TheCompany does not assume renewals in its determination of the lease term unlessthe renewals are deemed by management to be reasonably assured at leaseinception.  For tenant improvementallowances recorded as assets, the Company also records a deferred rentliability in the consolidated balance sheets and amortizes the deferred rentover the terms of the leases as reductions to rent expense in the consolidatedstatements of income. For scheduled rent escalation clauses and rent holidaysduring the lease terms or for rental payments commencing at a date other thanthe date of initial occupancy, the Company records minimum rental expenses on astraight-line basis over the terms of the leases.  Certain leases provide for contingent rents,which are determined as a percentage of gross sales in excess of specifiedlevels. The Company records a rent liability in the consolidated balance sheetsand the corresponding rent expense when management determines that achievingthe specified levels during the fiscal year is probable.

***Research andDevelopment***

Research anddevelopment costs are charged to selling, general and administrative expensesas incurred. Major components of research and development expenses consist ofproduct formulation, testing, regulatory analysis, and compliance.

***AdvertisingCosts***

The Companypurchases commercial airtime on various television stations throughout theUnited States in order to air its direct-response program, or “infomercial.”The Company expenses costs associated with purchasing airtime as incurred.  The Company expenses production costs associatedwith advertising as incurred, except for production costs for its infomercials,which are capitalized and amortized over their expected period of futurebenefit. The capitalized production costs for each infomercial are amortizedover a twelve-month period following the first airing of the infomercial.

Other advertisingcosts such as media placements and public relations are expensed as incurred.Marketing brochures are accounted for as prepaid assets and are expensed basedon usage, or at such time that they are no longer expected to be used, in whichcase their cost is expensed at that time.

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***Income Taxes***

Deferred taxassets and liabilities are recognized for the expected tax consequences oftemporary differences between the tax bases of assets and liabilities and theirreported amounts using enacted tax rates in effect for the year the differencesare expected to reverse. The Company records a valuation allowance to reducedeferred tax assets to the amount that is expected to be realized on a more-likely-than-notbasis. Deferred tax expense results from changes in net deferred tax assets orliabilities between periods.

Effective January1, 2007, the Company adopted FASB Interpretation No. 48, *Accountingfor Uncertainty in Income Taxes* (Note 13). In connection withthe adoption of FIN 48, the Company changed its accounting policy and nowrecognizes accrued interest and penalties related to income tax matters inincome tax expense. These amounts were previously classified in selling,general and administrative expenses.

***Earnings perShare***

A calculation ofearnings per share, as reported is as follows (in thousands, except per sharedata):
|                                                                               | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                    | ** ** | **July 1,  2007**           | ** ** | **July 2,  2006**         | ** ** | **July 1,  2007** | ** ** | **July 2,  2006** | ** ** |
| *Numerator:*                                                                  |       |                             |       |                           |       |   |   |   |   |
| Net income                                                                    |       | $                                | 20,215     |                           | $          | 10,474 |   | $ | 40,620 |   | $ | 25,008 |   |
|                                                                          |       |                             |       |                           |       |   |   |   |   |
| *Denominator:*                                                                |       |                             |       |                           |       |   |   |   |   |
| Weighted average common shares used in per share  calculations — basic   |       | 90,021                           |       | 69,777                         |       | 89,725 |   | 69,461 |   |
| Add: Common stock equivalents from exercise of stock  options                 |       | 3,070                            |       | 1,926                          |       | 3,079 |   | 2,324 |   |
| Weighted-average common shares used in per share  calculations — diluted |       | 93,091                           |       | 71,703                         |       | 92,804 |   | 71,785 |   |
| Net income per  share                                                         |       |                             |       |                           |       |   |   |   |   |
| Basic                                                                         |       | $                                | 0.22       |                           | $          | 0.15 |   | $ | 0.45 |   | $ | 0.36 |   |
| Diluted                                                                       |       | $                                | 0.22       |                           | $          | 0.15 |   | $ | 0.44 |   | $ | 0.35 |   |

 

For the three and six months ended July 1, 2007,options to purchase 56,000 and 116,000 shares of common stock, respectively,were excluded from the calculation of weighted average shares for diluted netincome per share as they were anti-dilutive. For the three and six months ended July 2, 2006, no shares of commonstock were excluded from the calculation of weighted average shares for dilutednet income per share.

***Comprehensive Income***

Comprehensive income consists of net income and othercomprehensive income. Other comprehensive income includes certain changes inequity that under U.S. generally accepted accounting principles are excludedfrom results of operations. Specifically, the Company’s other comprehensiveincome is comprised of foreign currency translation adjustments fromsubsidiaries not using the U.S. dollar as their functional currency.  Other comprehensive income was $103,000 forthe three and six months ended July 1, 2007. There was no other comprehensive income for the three and six monthsended July 2, 2006.

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***RecentAccounting Pronouncements***

In September 2006,the FASB issued SFAS No. 157*, FairValue Measurements*. Statement 157 defines fair value, establishes aframework for measuring fair value, and expands disclosures about fair valuemeasurements. Statement 157 also applies under other accounting pronouncementsthat require or permit fair value measurements, but does not require any newfair value measurements. The provisions of Statement 157 are effective forfiscal years beginning after November 15, 2007. The Company will adoptStatement 157 during its fiscal year ending December 28, 2008. The Companyis currently in the process of determining the impact, if any, of adopting theprovisions of Statement 157 but it is not expected to have a material impact onthe Company’s financial position or results of operations.

In February 2007, theFASB issued SFAS No. 159, *Fair Value Option forFinancial Assets and Financial Liabilities. *Statement 159 permits entities to choose to measure manyfinancial instruments, and certain other items, at fair value.Statement 159 also establishes presentation and disclosure requirementsdesigned to facilitate comparisons between entities that choose differentmeasurement attributes for similar types of assets and liabilities. Theprovisions of Statement 159 are effective for fiscal years beginning afterNovember 15, 2007.  The Company willadopt Statement 159 during its fiscal year ending December 28, 2008. TheCompany is currently in the process of determining the impact, if any, ofadopting the provisions of Statement 159 but it is not expected to have amaterial impact on the Company’s financial position or results of operations.

**3.****              Acquisition**

OnApril 3, 2007, the Company completed its acquisition of U.K.-basedCosmeceuticals Limited (“Cosmeceuticals”), which distributes Bare Escentuals’ *bareMinerals*, *md formulations* and *MDForte* brands primarily to spas and salons and QVC U.K.  Theacquired entity has been renamed Bare Escentuals UK Ltd.  Theconsideration for the purchase was cash of $22.9 million, comprised of$19.8 million in cash consideration and $3.1 million of transactioncosts. The Company’s consolidated financial statements include the operatingresults of the business acquired from the date of acquisition. Pro formaresults of operations have not been presented because the effect of theacquisition was not material.

Thetotal purchase price of $22.9 million has been preliminarily allocated asfollows: $12.8 million to goodwill, $8.8 million to identifiableintangible assets comprised of customer relationships of $8.0 million and$0.8 million for non-compete agreements, $4.2 million to net tangibleassets acquired, and $2.9 million to deferred tax liability. The estimateduseful economic lives of the identifiable intangible assets acquired are threeyears. As of July 1, 2007, the purchase price allocation is preliminary andsubject to adjustment for final valuation of assets and taxes.

As ofJuly 1, 2007, approximately $2.3 million of the purchase price was unpaid andis included in accrued liabilities. Additionally, included in prepaid expenses and other current assets is$3.2 million due from the previous shareholders of the acquired company.

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# **4.****              Inventories**

Inventoriesconsisted of the following (in thousands):
|                               | ** ** | **July 1,  2007** | ** ** | **December 31,  2006** | ** ** |
|-------------------------------|------------|------------------------|------------|-----------------------------|------------|
| Raw materials  and components |       | $                      | 3,179      |                        | $          | 2,737 |   |
| Finished goods                |       | 52,863                 |       | 59,269                      |       |
|                          |       | $                      | 56,042     |                        | $          | 62,006 |   |

 

# **5.****              Propertyand Equipment, Net**

Property andequipment, net, consisted of the following (in thousands):
|                                            | ** ** | **July 1,  2007** | ** ** | **December 31,  2006** | ** ** |
|--------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| Furniture and  equipment                   |       | $                      | 5,201      |                        | $          | 4,234 |   |
| Computers and  software                    |       | 9,340                  |       | 4,732                       |       |
| Leasehold  improvements                    |       | 17,683                 |       | 13,891                      |       |
|                                       |       | 32,224                 |       | 22,857                      |       |
| Accumulated depreciation  and amortization |       | (7,262                 | )          | (5,170                      | )          |
|                                       |       | 24,962                 |       | 17,687                      |       |
| Construction-in-progress                   |       | 7,087                  |       | 3,424                       |       |
| Property and equipment,  net               |       | $                      | 32,049     |                        | $          | 21,111 |   |

 

# **6.****              IntangibleAssets, Net**

Intangible assets,net, consisted of the following (in thousands):
|                                 | ** ** | **July 1,  2007** | ** ** | **December 31,  2006** | ** ** |
|---------------------------------|------------|------------------------|------------|-----------------------------|------------|
| Goodwill                        |       | $                      | 15,643     |                        | $          | 2,852 |   |
| Customer  relationships         |       | 8,000                  |       | —                      |       |
| Trademarks                      |       | 3,233                  |       | 3,233                       |       |
| Domestic  customer base         |       | 939                    |       | 939                         |       |
| International  distributor base |       | 820                    |       | 820                         |       |
| Non-compete  agreements         |       | 800                    |       | —                      |       |
|                            |       | 29,435                 |       | 7,844                       |       |
| Accumulated  amortization       |       | (2,564                 | )          | (1,759                      | )          |
| Intangible assets, net          |       | $                      | 26,871     |                        | $          | 6,085 |   |

 

# **7.****              OtherAssets**

Other assetsconsisted of the following (in thousands):

|                                                                                                                            | ** ** | **July 1,  2007** | ** ** | **December 31,  2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| Debt issuance  costs, net of accumulated amortization of $139 and $61 at July 1, 2007 and  December 31, 2006, respectively |       | $                      | 918        |                        | $          | 1,057 |   |
| Other assets                                                                                                               |       | 1,371                  |       | 775                         |       |
|                                                                                                                       |       | $                      | 2,289      |                        | $          | 1,832 |   |

 

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# **8.****              Accrued Liabilities**

Accruedliabilities consisted of the following (in thousands):
|                                             | ** ** | **July 1,  2007** | ** ** | **December 31,  2006** | ** ** |
|---------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| Interest                                    |       | $                      | 1,183      |                        | $          | 1,438 |   |
| Employee  compensation and benefits         |       | 6,106                  |       | 7,437                       |       |
| Purchase price  for acquisition             |       | 2,392                  |       | —                      |       |
| Gift  certificates and customer liabilities |       | 1,627                  |       | 1,975                       |       |
| Sales taxes and  local business taxes       |       | 1,797                  |       | 1,339                       |       |
| Royalties                                   |       | 1,559                  |       | 1,192                       |       |
| Deferred revenue                            |       | 1,705                  |       | 898                         |       |
| Other                                       |       | 3,753                  |       | 1,844                       |       |
|                                        |       | $                      | 20,122     |                        | $          | 16,123 |   |

 

# **9.****              RevolvingLines of Credit**

In February 2005,the Company established a revolving credit facility of up to $15,000,000 (the “Revolver”),the proceeds of which were to provide financing for working capital and othergeneral corporate purposes of the Company. The Revolver has a term of six yearsexpiring on February 18, 2011. In June 2006, the Company increased theRevolver up to $25,000,000. In December 2006, the terms of the Revolverwere further amended to eliminate the requirement that the net proceeds fromthe issuance of equity securities by us or any of our subsidiaries be appliedto prepay loans under the credit agreement. The amendment also reduced theinterest rate margins applicable to LIBOR loans and base rate loans, providedfor a further reduction in the interest rate margins if we achieve a specifiedconsolidated leverage ratio and specified debt rating, and amended some of thefinancial covenants. Amounts available under the Revolver are based on eligiblecollateral that includes certain accounts receivable and inventory and may beused for working capital and capital expenditure needs, as well as the issuanceof documentary and standby letters of credit. At July 1, 2007, $24,900,000 was available and $100,000 was outstandingin letters of credit. Borrowings under the Revolver bear interest at a rateequal to, at the Company’s option, either a margin over LIBOR or the lenders’base rate, plus an applicable margin based on a grid in which the pricingdepends on the Company’s consolidated total leverage ratio and debt rating(2.25% plus LIBOR or 1.25% plus lenders’ base rate; actual rate of 7.57% atJuly 1, 2007 and 7.85% at December 31, 2006). The Company is also requiredto pay commitment fees of 0.5% per annum on any unused portions of thefacility.

# **10.****       Long-TermDebt**

Long-term debtconsisted of the following (in thousands):
|                                               | ** ** | **July 1,  2007** | ** ** | **December 31,  2006** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| First Lien Term  Loan                         |       | $                      | 300,000    |                        | $          | 339,263 |   |
| Less current  portion                         |       | (17,624                | )          | (17,624                     | )          |
| Total long-term  debt, net of current portion |       | $                      | 282,376    |                        | $          | 321,639 |   |

 

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## **First and Second Lien Term Loans**

On June 7, 2006,the Company and its lenders agreed to restructure its existing senior securedcredit facilities to increase the Company’s borrowings by an additionalaggregate principal amount of $331,583,000 to a total of $588,759,000,comprised of additional first lien term loans (the “First Lien Term Loans”) of$118,583,000 to a total of $354,759,000, and additional second lien term loans(the “Second Lien Term Loans”) of $88,000,000 to a total of $234,000,000. OnOctober 4, 2006, the Company used a portion of the net proceeds receivedfrom its initial public offering to repay in full the Second Lien Term Loansand to repay a portion of the First Lien Term Loans. The First Lien Term Loanshave an original term of seven years expiring on February 18, 2012. TheFirst Lien Term Loans bear interest at a rate equal to, at the Company’soption, either LIBOR or the lenders’ base rate, plus an applicable marginvarying based on the Company’s consolidated total leverage ratio. As of July 1,2007 and December 31, 2006, the interest rates on the First Lien TermLoans were accruing at 7.57% and 7.85%, respectively.  As of July 1, 2007, $300,000,000 wasoutstanding on the First Lien Term Loans.

On December 20,2006, the Company amended its First Lien Credit Agreement to eliminate therequirement that the net proceeds from the issuance of equity securities of theCompany or any of its subsidiaries be applied to prepay loans under the creditagreement. The amendment also reduced the interest rate margins if the Companyachieves a specified consolidated leverage ratio and specified debt rating, andeliminated the minimum cash interest ratio financial covenant and amended someof the other financial covenants. The maturity date of the First Lien Term Loanwas not adjusted.

On March 23, 2007, theCompany further amended its First Lien Credit Agreement to permit the abilityto make acquisitions of up to $30,000,000 in any one fiscal year and up to$60,000,000 in the aggregate as well as to permit additional investments inforeign subsidiaries of up to $25,000,000.

Borrowings under theRevolver (Note 9) and the First Lien Term Loans are secured by substantiallyall of the Company’s assets, including, but not limited to, all accountsreceivable, inventory, property and equipment, and intangibles. The terms ofthe senior secured credit facilities require the Company to comply withfinancial covenants, including maintaining a leverage ratio, entering intointerest rate swap or similar agreements with respect to 40% of the principalamounts outstanding under the Company’s senior secured credit facilities as ofOctober 2, 2007.  The secured creditfacility also contains nonfinancial covenants that restrict some of the Company’sactivities, including its ability to dispose of assets, incur additional debt,pay dividends, create liens, make investments, and engage in specifiedtransactions with affiliates.

**ScheduledMaturities of Long-Term Debt**

At July 1, 2007,future scheduled principal payments on long-term debt were as follows (inthousands):
| Year ending:                                    |   |    |    |
|-------------------------------------------------|--------|---------|---------|
| Remainder of the  year ending December 30, 2007 |   | $       | 8,812   |   |
| December 28,  2008                              |   | 17,624  |    |
| January 3, 2010                                 |   | 17,624  |    |
| January 2, 2011                                 |   | 17,624  |    |
| January 1, 2012                                 |   | 202,676 |    |
| December 30,  2012                              |   | 35,640  |    |
|                                            |   | $       | 300,000 |   |

 

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# **11.  Commitments and Contingencies**

## ***Lease Commitments***

TheCompany leases retail boutiques, distribution facilities, and office spaceunder noncancelable operating leases with various expiration dates throughMarch 2018. Additionally, the Company subleases certain real property tothird parties.  Portions of thesepayments are denominated in foreign currencies and were translated in thetables below based on their respective U.S. dollar exchange rates at July 1,2007. These future payments are subject to foreign currency exchange raterisk.  The future minimum annual paymentsand anticipated sublease income under such leases in effect at July 1, 2007,were as follows (in thousands):
|                                                | ** ** | **Minimum  Rental  Payments** | ** ** | **Sublease  Rental  Income** | ** ** | **Net  Minimum  Lease  Payments** | ** ** |
|------------------------------------------------|------------|-------------------------------|------------|------------------------------|------------|-----------------------------------|------------|
| Year ending:                                   |       |                          |       |                         |       |                              |       |
| Remainder of the year ending December 30, 2007 |       | $                             | 2,568      |                         | $          | 16                                |       | $ | 2,552 |   |
| December 28, 2008                              |       | 7,853                         |       | 30                           |       | 7,823                             |       |
| January 3, 2010                                |       | 7,999                         |       | 30                           |       | 7,969                             |       |
| January 2, 2011                                |       | 7,606                         |       | 30                           |       | 7,576                             |       |
| January 1, 2012                                |       | 7,316                         |       | 30                           |       | 7,286                             |       |
| Thereafter                                     |       | 32,234                        |       | —                       |       | 32,234                            |       |
|                                           |       | $                             | 65,576     |                         | $          | 136                               |       | $ | 65,440 |   |

 

Many of theCompany’s retail boutique leases require additional contingent rents whencertain sales volumes are reached. Total rent expense was $4,209,000 and$6,760,000 for the three and six months ended July 1, 2007, respectively, and$2,238,000 and $3,694,000 for the three and six months ended July 2, 2006,respectively.  Total rent expenseincluded contingent rentals of $563,000 and $1,094,000 for the three and six monthsended July 1, 2007, respectively, and $394,000 and $723,000 for the three andsix months ended July 2, 2006, respectively. Several leases entered into by the Company include options that mayextend the lease term beyond the initial commitment period, subject to termsagreed to at lease inceptions.  As ofJuly 1, 2007, under the terms of its corporate office lease, the Company issuedan irrevocable standby letter of credit of $100,000 to the lessor for the termof the lease.

## ***Royalty Agreements***

The Company is aparty to a license agreement (the “License”) for use of certain patentsassociated with some of the skin care products sold by the Company. The Licenserequires that the Company pay a quarterly royalty of 4% of the net sales ofcertain skin care products for an indefinite period of time. The License alsorequires minimum annual royalty payments of $600,000 from the Company. TheCompany can terminate the agreement at any time with six months written notice.The Company’s royalty expense under the License for the three and six monthsended July 1, 2007 was $150,000 and $300,000, respectively, and $150,000 and$300,000 for the three and six months ended July 2, 2006, respectively.

The Company has obtained a worldwide exclusive rightto license, develop, commercialize, and distribute certain licensed ingredientsto be used in products to be sold by the Company. This agreement requires theCompany to make payments upon achievement of certain product milestones. Inaddition, this agreement requires the Company to pay a royalty of 3.5% of the netsales upon successful launch of the first product, subject to certain minimumannual royalty amounts. The Company launched commercial sales of the productscontaining the licensed ingredients during the year ended December 31,2006. The minimum royalty amount is $400,000 for 2007 and $500,000 for 2008after which time the Company may renegotiate the minimum royalties or othercompensation within 120 days after the second anniversary of the commerciallaunch. The Company’s expense under this agreement for the three and six monthsended July 1, 2007 was $213,000 and $426,000, respectively, and $44,000 and$192,000 for the three and six months ended July 2, 2006, respectively.

***Contingencies***

The Company is involvedin various legal and administrative proceedings and claims arising in theordinary course of its business. The ultimate resolution of such claims wouldnot, in the opinion of management, have a material effect on the Company’sfinancial position or results of operation.

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# **12.  Related-Party Transactions**

On June 10, 2004,the Company entered into a Management Agreement (‘‘Berkshire Agreement’’) withBerkshire Partners LLC (“Berkshire”). Under the Berkshire Agreement, theCompany engaged Berkshire to provide management advisory services in connectionwith the general business operations of the Company. In compensation for suchservices, the Company agreed to pay a management fee in an amount of $300,000per annum for the term of the agreement. The Berkshire Agreement was terminatedupon completion of our initial public offering on October 4, 2006. Totalmanagement fees plus expenses recognized under the Berkshire Agreement for thethree and six months ended July 2, 2006 was $92,000 and $181,000, respectively,which was recorded as selling, general and administrative expenses in theaccompanying consolidated statements of operations.

On June 10, 2004,the Company also entered into a Management Agreement (‘‘JHP Agreement’’) withJH Partners, LLC (“JHP”). Under the JHP Agreement, the Company engaged JHP toprovide management advisory services in connection with the general businessoperations of the Company.  Incompensation for such services, the Company agreed to pay a management fee inan amount of $300,000 per annum for the term of the JHP Agreement. The JHP Agreementwas terminated upon completion of our initial public offering on October 4,2006. Total management fees plus expenses recognized under this Agreement forthe three and six months ended July 2, 2006 was $75,000 and $207,000,respectively, which was recorded as selling, general and administrativeexpenses in the accompanying consolidated statements of operations.

FH CapitalPartners LLC is 50%-owned by an affiliate of the Company’s former chairman, amajor stockholder. In December 2001 and May 2002, the Company entered intoagreements with FH Capital Partners LLC to rent certain computer hardware,software, and licenses under operating lease agreements. During the six monthsended July 1, 2007, the Company purchased the equipment under these lease agreements.  Total expense recognized relating to thesearrangements for the three and six months ended July 1, 2007 was zero and$16,900, respectively, and for the three and six months ended July 2, 2006 was$7,500 and $12,500, respectively, which was recorded as selling, general andadministrative expenses in the accompanying consolidated statements ofoperations.

# **13.  Income Taxes**

In June 2006, the Financial Accounting Standards Board(“FASB”) issued FASB Interpretation 48 (“FIN 48”), *Accounting for Uncertainty in Income Taxes*. FIN 48 clarifiesthe accounting for uncertainty in income taxes recognized in accordance withSFAS 109, *Accounting for Income Taxes*.FIN 48 prescribes a comprehensive model for how a company should recognize,measure, present and disclose in its financial statements uncertain taxpositions that the Company has taken or expects to take on a tax return.

The Company adopted FIN 48 on January 1, 2007.  As a result of the adoption of FIN 48, thechanges to the Company’s reserve for uncertain tax positions was accounted foras a $952,000 cumulative effect adjustment to increase the beginning balance ofaccumulated deficit on the Company’s balance sheet.  As of July 1, 2007, the total amount ofunrecognized tax benefits, including related interest, was $4,135,000.  This amount includes $2,207,000 ofunrecognized tax benefits which would decrease the Company’s effective tax rateif recognized.

The Company believes that it is reasonably possiblethat the amount of unrecognized tax benefits could increase or decrease withinthe next twelve months and that change could be significant.  However, the Company is unable to estimatethe range of possible changes to the amount of unrecognized tax benefits withinthe next twelve months.

As of July 1, 2007,the Company had approximately $817,000 of accrued interest related to uncertaintax positions. The Company files United States federal income tax returns andincome tax returns in multiple state jurisdictions.  The tax years 2003-2006 remain open to examinationby the major taxing jurisdictions. In July 2007, the U.S. Internal RevenueService completed its audit of the Company’s U.S. federal income tax returnsfor 2004, which resulted in no changes to reported tax for that year.  The outcome of this audit had no impact tothe amounts recorded in the financial statements.

**14.  Stockholders’ Equity**

On March 19, 2007, the Company completed afollow-on underwritten public offering pursuant to which the Company sold575,000 shares and selling stockholders sold an additional 13,225,000 shares,which includes 1,800,000 shares sold pursuant to the exercise of theunderwriters’ over-allotment option. The Company received net proceeds ofapproximately $18.1 million, after deducting underwriting discounts andcommissions and estimated offering expenses.

On June 19, 2007, the Company completed afollow-on underwritten public offering pursuant to which the Company sold100,000 shares and selling stockholders sold an additional 7,900,000shares.  The Company received net proceedsof approximately $3.0 million, after deducting underwriting discounts andcommissions and estimated offering expenses.

17

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# **15.  Stock-Based Employee Compensation Plans**

As of July 1,2007, the Company had reserved 10,622,782 shares of common stock for issuance.

## **2004 EquityIncentive Plan**

On June 10, 2004,the board of directors adopted the 2004 Equity Incentive Plan (the “2004 Plan”).  The 2004 Plan provides for the issuance ofnon-qualified stock options for common stock to employees, directors,consultants, and other associates. The options generally vest at a rate of 20%per year from the date of grant and have a maximum term of ten years.

In conjunction with theadoption of the 2006 Equity Incentive Plan in September 2006, noadditional options are permitted to be granted under the 2004 Plan. Inaddition, any outstanding options cancelled under the 2004 Plan will becomeavailable to grant under the 2006 Equity Incentive Plan.

A summary ofactivity under the 2004 Plan is set forth below. 
|                                                        | ** ** | ** **                             | ** ** | **Options Outstanding** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------|------------|------------------------------|------------|
| ** **                                             | ** ** | **Options  Available  for Grant** | ** ** | **Number of  Shares**   | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| Balance at December 31,  2006                          |       | —                                 |       | 6,211,293                    |       | $ | 2.68 |   |
| Exercised                                              |       | —                                 |       | (194,708                     | )          | 1.73 |   |
| Canceled                                               |       | 118,477                                |       | (118,477                     | )          | 4.36 |   |
| Cancellation of  remaining options available for grant |       | (118,477                               | )          | —                       |       | — |   |
| Balance at July 1, 2007                                |       | —                                 |       | 5,898,108                    |       | $ | 2.68 |   |

 

# AtJuly 1, 2007, total outstanding options vested under the 2004 Plan were 530,321at a weighted-average exercise price of $4.34.

The totalintrinsic value of options exercised under the 2004 Plan for the six monthsended July 1, 2007 was $6,998,000.

**2006Equity Incentive Plan**

On September 12,2006, the stockholders of the Company approved the 2006 Equity Incentive AwardPlan (the “2006 Plan”) for executives, directors, employees and consultants ofthe Company. A total of 4,500,000 shares of the Company’s Common Stock have beenreserved for issuance under the 2006 Plan. Awards are granted with an exerciseprice equal to the market price of the Company’s Common Stock at the date ofgrant. Those awards generally vest over a period of five years from the date ofgrant and have a maximum term of ten years.

A summary ofactivity under the 2006 Plan is set forth below:
|                               | ** ** | ** **                             | ** ** | **Options Outstanding** | ** ** |
|-------------------------------|------------|----------------------------------------|------------|------------------------------|------------|
| ** **                    | ** ** | **Options  Available  for Grant** | ** ** | **Number of  Shares**   | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| Balance at December 31,  2006 |       | 4,441,947                              |       | 164,250                      |       | $ | 30.95 |   |
| Rolled over from 2004  Plan   |       | 118,477                                |       | —                       |       | — |   |
| Granted                       |       | (121,625                               | )          | 121,625                      |       | 37.18 |   |
| Canceled                      |       | 3,500                                  |       | (3,500                       | )          | 22.00 |   |
| Balance at July 1, 2007       |       | 4,442,299                              |       | 282,375                      |       | $ | 33.74 |   |

                                                                                                                                                                                                                                                

At July 1, 2007,there were no outstanding options vested under the 2006 Plan.

18

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The total cashreceived from employees as a result of employee stock option exercises underall plans for the six months ended July 1, 2007 was $336,000. In connectionwith these exercises, the tax benefits realized by the Company for the sixmonths ended July 1, 2007 was $2,286,000.

**16.          Segment and Geographic Information**

Operatingsegments are defined as components of an enterprise engaging in businessactivities about where separate financial information is available that is evaluatedregularly by the Chief Operating Decision Maker (“CODM”) in deciding how toallocate resources and assessing performance. The Company’s Chief ExecutiveOfficer has been identified as the CODM as defined by Statement 131, *Disclosures about Segments of an Enterprise andRelated Information*.  TheCompany has determined that it operates in two business segments: Retail withsales to end users, and Wholesale with sales to resellers. These reportablesegments are strategic business units that are managed separately based on thefundamental differences in their operations. The Retail segment consists ofsales directly to end users through Company-owned boutiques andinfomercials. The Wholesale segment consists of sales to resellers, homeshopping television, specialty beauty retailers, spas and salons, andinternational distributors. The following table presents certain financialinformation for each segment. Operating income is the gross margin of thesegment less direct expenses of the segment. Some direct expenses, such asmedia and advertising spend, do impact the performance of the other segment,but these expenses are recorded in the segment they directly relate to and arenot allocated out to each segment. The Corporate column includes unallocatedselling, general and administrative expenses, depreciation and amortization,stock-based compensation expenses, restructuring charges and assetimpairment charges. Corporate selling, general and administrative expensesinclude headquarters facilities costs, distribution center costs, productdevelopment costs, corporate headcount costs and other corporate costs,including information technology, finance, accounting, legal and humanresources costs.
| ** **                                | ** ** | **Retail** | ** ** | **Wholesale** | ** ** | **Corporate** | ** ** | **Total**  | ** ** |
|-------------------------------------------|------------|------------|------------|---------------|------------|---------------|------------|------------|------------|
| **Three Months ended July 1, 2007**       | ** ** | ** ** | ** ** | ** **    | ** ** | ** **    | ** ** | ** ** | ** ** |
| Sales, net                                |       | $          | 50,979     |          | $          | 73,165        |       | $          | —     |   | $ | 124,144 |   |
| Cost of goods sold                        |       | 10,642     |       | 26,936        |       | —        |       | 37,578     |       |
| Gross profit                              |       | 40,337     |       | 46,229        |       | —        |       | 86,566     |       |
| Operating expenses:                       |       |       |       |          |       |          |       |       |       |
| Selling, general  and administrative      |       | 22,969     |       | 3,807         |       | 16,760        |       | 43,536     |       |
| Depreciation and  amortization            |       | 309        |       | 21            |       | 1,530         |       | 1,860      |       |
| Stock-based  compensation                 |       | —     |       | —        |       | 1,779         |       | 1,779      |       |
| Total expenses                            |       | 23,278     |       | 3,828         |       | 20,069        |       | 47,175     |       |
| Operating income (loss)                   |       | 17,059     |       | 42,401        |       | (20,069       | )          | 39,391     |       |
| Interest expense                          |       |       |       |          |       |          |       | (6,274     | )          |
| Interest income                           |       |       |       |          |       |          |       | 487        |       |
| Income before provision  for income taxes |       |       |       |          |       |          |       | 33,604     |       |
| Provision for income  taxes               |       |       |       |          |       |          |       | 13,389     |       |
| Net income                                |       |       |       |          |       |          |       | $          | 20,215     |   |
|                                           |            |            |            |               |            |               |            |            |            |  |  |  |  |

 

 
| ** **                                | ** ** | **Retail** | ** ** | **Wholesale** | ** ** | **Corporate** | ** ** | **Total**  | ** ** |
|-------------------------------------------|------------|------------|------------|---------------|------------|---------------|------------|------------|------------|
| **Three Months ended July 2, 2006**       | ** ** | ** ** | ** ** | ** **    | ** ** | ** **    | ** ** | ** ** | ** ** |
| Sales, net                                |       | $          | 44,553     |          | $          | 51,632        |       | $          | —     |   | $ | 96,185 |   |
| Cost of goods sold                        |       | 8,774      |       | 18,163        |       | —        |       | 26,937     |       |
| Gross profit                              |       | 35,779     |       | 33,469        |       | —        |       | 69,248     |       |
| Operating expenses:                       |       |       |       |          |       |          |       |       |       |
| Selling, general  and administrative      |       | 19,849     |       | 2,435         |       | 10,888        |       | 33,172     |       |
| Depreciation and  amortization            |       | 169        |       | —        |       | 337           |       | 506        |       |
| Stock-based  compensation                 |       | —     |       | —        |       | 1,523         |       | 1,523      |       |
| Total expenses                            |       | 20,018     |       | 2,435         |       | 12,748        |       | 35,201     |       |
| Operating income (loss)                   |       | 15,761     |       | 31,034        |       | (12,748       | )          | 34,047     |       |
| Interest expense                          |       |       |       |          |       |          |       | (12,887    | )          |
| Debt extinguishment  costs                |       |       |       |          |       |          |       | (3,391     | )          |
| Interest income                           |       |       |       |          |       |          |       | 345        |       |
| Income before provision  for income taxes |       |       |       |          |       |          |       | 18,114     |       |
| Provision for income  taxes               |       |       |       |          |       |          |       | 7,640      |       |
| Net income                                |       |       |       |          |       |          |       | $          | 10,474     |   |
|                                           |            |            |            |               |            |               |            |            |            |  |  |  |  |

 

19

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| ** **                                | ** ** | **Retail** | ** ** | **Wholesale** | ** ** | **Corporate** | ** ** | **Total**  | ** ** |
|-------------------------------------------|------------|------------|------------|---------------|------------|---------------|------------|------------|------------|
| **Six Months ended July 1, 2007**         | ** ** | ** ** | ** ** | ** **    | ** ** | ** **    | ** ** | ** ** | ** ** |
| Sales, net                                |       | $          | 102,387    |          | $          | 137,370       |       | $          | —     |   | $ | 239,757 |   |
| Cost of goods sold                        |       | 21,554     |       | 49,474        |       | —        |       | 71,028     |       |
| Gross profit                              |       | 80,833     |       | 87,896        |       | —        |       | 168,729    |       |
| Operating expenses:                       |       |       |       |          |       |          |       |       |       |
| Selling, general  and administrative      |       | 45,033     |       | 6,838         |       | 30,850        |       | 82,721     |       |
| Depreciation and  amortization            |       | 674        |       | 36            |       | 2,090         |       | 2,800      |       |
| Stock-based  compensation                 |       | —     |       | —        |       | 3,390         |       | 3,390      |       |
| Total expenses                            |       | 45,707     |       | 6,874         |       | 36,330        |       | 88,911     |       |
| Operating income (loss)                   |       | 35,126     |       | 81,022        |       | (36,330       | )          | 79,818     |       |
| Interest expense                          |       |       |       |          |       |          |       | (13,085    | )          |
| Interest income                           |       |       |       |          |       |          |       | 828        |       |
| Income before provision  for income taxes |       |       |       |          |       |          |       | 67,561     |       |
| Provision for income  taxes               |       |       |       |          |       |          |       | 26,941     |       |
| Net income                                |       |       |       |          |       |          |       | $          | 40,620     |   |
|                                           |            |            |            |               |            |               |            |            |            |  |  |  |  |

 
| ** **                                | ** ** | **Retail** | ** ** | **Wholesale** | ** ** | **Corporate** | ** ** | **Total**  | ** ** |
|-------------------------------------------|------------|------------|------------|---------------|------------|---------------|------------|------------|------------|
| **Six Months ended July 2, 2006**         | ** ** | ** ** | ** ** | ** **    | ** ** | ** **    | ** ** | ** ** | ** ** |
| Sales, net                                |       | $          | 86,617     |          | $          | 99,483        |       | $          | —     |   | $ | 186,100 |   |
| Cost of goods sold                        |       | 17,742     |       | 34,391        |       | —        |       | 52,133     |       |
| Gross profit                              |       | 68,875     |       | 65,092        |       | —        |       | 133,967    |       |
| Operating expenses:                       |       |       |       |          |       |          |       |       |       |
| Selling, general  and administrative      |       | 38,496     |       | 4,495         |       | 19,865        |       | 62,856     |       |
| Depreciation and  amortization            |       | 327        |       | —        |       | 644           |       | 971        |       |
| Stock-based  compensation                 |       | —     |       | —        |       | 2,467         |       | 2,467      |       |
| Total expenses                            |       | 38,823     |       | 4,495         |       | 22,976        |       | 66,294     |       |
| Operating income (loss)                   |       | 30,052     |       | 60,597        |       | (22,976       | )          | 67,673     |       |
| Interest expense                          |       |       |       |          |       |          |       | (21,870    | )          |
| Debt extinguishment  costs                |       |       |       |          |       |          |       | (3,391     | )          |
| Interest income                           |       |       |       |          |       |          |       | 631        |       |
| Income before provision  for income taxes |       |       |       |          |       |          |       | 43,043     |       |
| Provision for income  taxes               |       |       |       |          |       |          |       | 18,035     |       |
| Net income                                |       |       |       |          |       |          |       | $          | 25,008     |   |
|                                           |            |            |            |               |            |               |            |            |            |  |  |  |  |

 

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The Company’slong-lived assets, excluding goodwill and intangibles, by segment were asfollows (in thousands):
|           | ** ** | **July 1,  2007** | ** ** | **December 31,  2006** | ** ** |
|-----------|------------|------------------------|------------|-----------------------------|------------|
| Retail    |       | $                      | 11,711     |                        | $          | 8,398 |   |
| Wholesale |       | 572                    |       | 138                         |       |
| Corporate |       | 19,956                 |       | 12,715                      |       |
|      |       | $                      | 32,239     |                        | $          | 21,251 |   |

 

Long-lived assetsallocated to the retail segment consist of fixed assets and deposits for retailstores. Long-lived assets allocated to the wholesale segment consist of fixedassets located at a wholesale customer. Long-lived assets in thecorporate segment consist of fixed assets and deposits related to the Company’scorporate offices and distribution center.

Noindividual geographical area outside of the United States accounted for morethan 10% of net sales in any of the periods presented. The Company’s sales bygeographic area were as follows (in thousands):
|               | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|---------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **    | ** ** | **July 1,  2007**           | ** ** | **July 2,  2006**         | ** ** | **July 1,  2007** | ** ** | **July 2,  2006** | ** ** |
| North America |       | $                                | 114,335    |                           | $          | 91,954 |   | $ | 221,600 |   | $ | 177,719 |   |
| International |       | 9,809                            |       | 4,231                          |       | 18,157 |   | 8,381 |   |
| Sales, net    |       | $                                | 124,144    |                           | $          | 96,185 |   | $ | 239,757 |   | $ | 186,100 |   |

 

# **17.****       RestructuringCosts**

As a result of theCompany’s growth and a change in strategy to improve its operations, theCompany relocated both the corporate and distribution center facilities duringthe year ended January 1, 2006. Related to these relocations, the Companyexited two facilities that had operating lease commitments through June 2007.These exit costs were accounted for in accordance with Statement 146, *Accounting for Costs Associated with Exit or DisposalActivities. *Costs primarilyrepresent closure and relocation costs of the Company’s corporate headquartersand distribution center. Closure costs include payments required under leasecontracts after the properties were abandoned, less any applicable estimatedsublease income during the period after abandonment. To determine the closurecosts, certain estimates were made related to the (1) time period overwhich the relevant building would remain vacant, (2) sublease terms, and(3) sublease rates, including common area charges. The accrual is anestimate and will be adjusted in the future upon triggering events (such aschanges in estimates of time to sublease and actual sublease rates). During theyear ended December 31, 2006, the Company discontinued the use of one ofits office floors located at its former corporate facility and recordedadditional restructuring costs of $114,000. As of December 31, 2006 andJuly 1, 2007, the remaining $172,000 and $23,000 accrual, respectively, oflease termination costs, net of estimated sublease income, is expected to bepaid on various dates through August 2007.

The followingtable set forth the exit activities for the six months ended July 1, 2007 (inthousands):
| Accrual balance at December  31, 2006 |   | $    | 172 |   |
|---------------------------------------|--------|------|-----|--------|
| Cash paid                             |   | (149 | )   |
| Accrual balance at July 1, 2007       |   | $    | 23  |   |

 

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**ITEM 2.****    MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

**Forward-LookingStatements**

This section and other parts of this Quarterly Reporton Form 10-Q contain forward-looking statements that involve risks anduncertainties. In some cases, forward-looking statements can be identified bywords such as “anticipates,” “expects,” “believes,” “plans,” “predicts,” andsimilar terms. Such forward-looking statements are based on currentexpectations, estimates and projections about our industry, management’sbeliefs and assumptions made by management. Forward-looking statements are notguarantees of future performance and our actual results may differ materiallyfrom the results discussed below and in the forward-looking statements. Factorsthat might cause such differences include, but are not limited to thosediscussed in Part II, Item 1A, “Risk Factors” below and Item 1A of our AnnualReport on Form 10-K for the year ended December 31, 2006 filed with the SEC onMarch 30, 2007.  The following discussionshould be read in conjunction with the Company’s consolidated financialstatements and related notes hereto included elsewhere in this Quarterly Reporton Form 10-Q. Except as required by law, we expressly disclaim anyobligation to update publicly any forward-looking statements, whether as resultof new information, future events or otherwise.

## **ExecutiveOverview**

Founded in 1976,Bare Escentuals is one of the fastest growing prestige beauty companies inthe U.S. and a leader by sales and consumer awareness in mineral-basedcosmetics. We develop, market and sell branded cosmetics, skin care and bodycare products under our *i.d. bareMinerals,i.d., RareMinerals* and namesake *Bare Escentuals*brands, and professional skin care products under our *md formulations* brand.

We utilize a distinctivemarketing strategy and a multi-channel distribution model consisting ofinfomercials, premium wholesale, including Sephora and Ulta, company-ownedboutiques, home shopping television on QVC, spas and salons and online shopping.We believe that this strategy provides convenience to our consumers and allowsus to reach the broadest possible spectrum of consumers.

Ourbusiness is comprised of two strategic business units constituting reportablesegments that we manage separately based on fundamental differences in theiroperations:

·                  Ourretail segment, which is characterized by sales directly to end users, includesour infomercials, which include sales of our infomercial offers through ourwebsites *www.bareminerals.com* and*www.bareescentuals.com,* and company-ownedboutiques, which include sales through our websites *www.mdformulations.com and www.bareescentuals.com*. Webelieve that our infomercial business helps us to build brand awareness,communicate the benefits of our core products and establish a base of recurringrevenue because a substantial percentage of new consumers participate in ourcontinuity program. Our company-owned boutiques enhance our ability tobuild strong consumer relationships and promote additional product use throughpersonal demonstrations and product consultations.

·                  Our wholesalesegment, which is characterized by sales to resellers, includes premiumwholesale; home shopping television; spas and salons; and internationaldistributors. Our sales through home shopping television help us to build brandawareness, educate consumers through live product demonstrations and develop close connections with our consumers.We also sell to retailers that we believe feature our products in settings thatsupport and reinforce our brand image and provide a premium in-storeexperience. Similarly, our spa and salon customers provide an informative andtreatment-focused environment in which aestheticians and spaprofessionals can communicate the benefits of our core products. Finally, weprimarily sell our products in a number of international markets through anetwork of third-party distributors.

We manage our businesssegments to maximize sales growth and market share. We believe that our multi-channeldistribution strategy maximizes convenience for our consumers, reinforces brandawareness, increases consumer retention rates, and drives corporate cash flowand profitability. Further, we believe that the broad diversification withinour segments provides us with expanded opportunities for growth and reduces ourdependence on any single distribution channel. Within individual distributionchannels, particularly those in our wholesale segment, financial results areoften affected by the timing of shipments as well as the impact of keypromotional events.

In evaluating ourbusiness, we also consider and use Adjusted EBITDA as a supplemental measure ofour operating performance. We use EBITDA only to assist in the reconciliationof net income to Adjusted EBITDA. We define EBITDA as net income beforeinterest, income tax, depreciation and amortization. We define Adjusted EBITDAas EBITDA adjusted for items that we do not consider reflective of our ongoingoperations. See “—Non-GAAP Measures.”

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**Basis of Presentation**

Werecognize revenue in accordance with the requirements of Staff AccountingBulletin No. 104 *RevenueRecognition*, and other applicable revenue recognition guidance andinterpretations. The Company records revenue when all four of the followingcriteria are met: (i) persuasive evidence that an arrangement exists;(ii) delivery of the products and/or services has occurred; (iii) theselling price is fixed or determinable; and (iv) collectibility isreasonably assured.  Revenue isrecognized when merchandise is shipped from a warehouse to wholesale customers,infomercial customers and online shopping customers or when purchased byconsumers at company-owned boutiques, each net of estimated returns(except in the case of our consignment sales). For our consignment sales, we recognizesales, net of estimated returns, upon shipment from our consignment partners totheir customers. We recognize postage and handling charges we bill to customersas revenue upon shipment of the related merchandise.

Our cost of goods soldconsists of the costs associated with the sourcing of our products, includingthe cost of the product and associated manufacturing costs, inbound freightcharges, royalties and internal transfer costs. Additionally, cost of goodssold includes postage and handling costs incurred upon shipment of merchandise.Our gross profit is dependent upon a variety of factors, including changes inthe relative sales mix between our business segments, changes in the mix ofproducts sold and fluctuations in material costs. Our gross margins differsignificantly between product lines and our business segments, with sales inour retail segment generally yielding higher gross margins than our wholesalesegment. These factors may cause gross profit and margins to fluctuate fromquarter to quarter. We anticipate that our cost of goods sold will increase inabsolute dollars as we increase our total sales but will remain generallyconsistent with historical periods on an annual basis as a percentage of netsales depending on the mix of sales among our distribution channels.

Selling, general andadministrative expenses include infomercial production and media costs,advertising costs, rent and other store operating costs and corporate costssuch as management salaries, information technology, professional fees, financeand accounting personnel, human resources personnel and other administrativefunctions. Selling, general, and administrative expenses also include all ofour distribution center and fulfillment costs, including all warehousing costsassociated with our third-party fulfillment provider and receiving andinspection costs that we do not include in cost of goods sold, which arecomprised primarily of headcount-related costs at our own distribution centerand at our third-party fulfillment provider. Receiving and inspectioncosts and warehousing costs are excluded from our gross margins and, therefore,our gross margins may not be comparable to those of other companies that chooseto include certain of these costs in cost of goods sold. We are unable toprovide an estimate of these costs, but we believe these costs are notmaterial. Fluctuations in selling, general and administrative expenses resultprimarily from changes in media and advertising expenditures, changes infulfillment costs which increase proportionately with net sales, particularlyinfomercial sales, changes in store operating costs, which are affected by thenumber of stores opened in a period, and changes in corporate costs such as forheadcount and infrastructure to support our operations. We anticipate that ourselling, general and administrative expenses will increase in absolute dollarsas we expect to continue to invest in corporate infrastructure and incuradditional expenses associated with being a public company, such as increasedlegal and accounting costs, investor relations costs and higher insurancepremiums.

Depreciation andamortization includes charges for the depreciation of property and equipmentand the amortization of intangible assets. We anticipate that our depreciation and amortization expense willincrease in absolute dollars as we continue to open new boutiques, invest ininformation systems and amortize intangible assets in connection with ourrecent acquisition. We record our depreciation and amortization as a separateline item in our statement of operations because all such expense relates toselling, general and administrative costs.

Stock-basedcompensation includes charges incurred in recognition of compensation expenseassociated with grants of stock options and stock purchases. On January 3, 2005we adopted the fair value recognition and measurement provisions of SFAS No. 123(R),*Share-Based Payment*(SFAS 123(R)).We record our stock-based compensation on a separate operating expense line itemin our statement of operations due to the fact that, to date, all of ourstock-based awards have been made to employees whose salaries are classified asselling, general and administrative costs.

Interest expenseincludes interest costs associated with our credit facilities and theamortization of deferred financing costs associated with these creditfacilities. We anticipate that our interest expense in the future will decreasein absolute terms and as a percentage of net sales as we continue to make scheduledrepayments of our outstanding indebtedness.

Provision for incometaxes depends on the statutory tax rates in the countries where we sell ourproducts. Historically, we have only been subject to taxation in the UnitedStates because we have either sold to consumers in the United States or sold todistributors in the United States who resold our products here and abroad.However, as a result of our acquisition in the second fiscal quarter of 2007,we began to sell our products directly to customers located outside of theUnited States and we became subject to taxation based on the foreign statutoryrates in the countries where those sales took place.  Our effective tax rate could fluctuateaccordingly. For fiscal 2007, we anticipate that our effective tax rate will beapproximately 40% of our income before provision for income taxes.

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## **Results of Operations**

The following is adiscussion of our results of operations for the three months ended July 1, 2007compared to the three months ended July 2, 2006 and for the six months endedJuly 1, 2007 compared to the six months ended July 2, 2006.

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**
| ** **                                | ** ** | **Three months ended**                      | ** ** | **Six months ended** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                | ** ** | **July 1,  2007**                                | ** ** | **July 2,  2006**         | ** ** | **July 1,  2007** | ** ** | **July 2,  2006** | ** ** |
| ** **                                | ** ** | **(in thousands, except percentages)** | ** ** |
| Sales, net                                |       | $                                                     | 124,144    |                           | 100        | % | $ | 96,185 |   | 100.0 | % | $ | 239,757 |   | 100.0 | % | $ | 186,100 |   | 100.0 | % |
| Cost of goods sold                        |       | 37,578                                                |       | 30.3                           |       | 26,937 |   | 28.0 |   | 71,028 |   | 29.6 |   | 52,133 |   | 28.0 |   |
| Gross profit                              |       | 86,566                                                |       | 69.7                           |       | 69,248 |   | 72.0 |   | 168,729 |   | 70.4 |   | 133,967 |   | 72.0 |   |
| Expenses:                                 |       |                                                  |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling, general  and administrative      |       | 43,536                                                |       | 35.1                           |       | 33,172 |   | 34.5 |   | 82,721 |   | 34.5 |   | 62,856 |   | 33.8 |   |
| Depreciation and  amortization            |       | 1,860                                                 |       | 1.5                            |       | 506 |   | 0.5 |   | 2,800 |   | 1.2 |   | 971 |   | 0.5 |   |
| Stock-based  compensation                 |       | 1,779                                                 |       | 1.4                            |       | 1,523 |   | 1.6 |   | 3,390 |   | 1.4 |   | 2,467 |   | 1.3 |   |
| Total operating  expenses                 |       | 47,175                                                |       | 38.0                           |       | 35,201 |   | 36.6 |   | 88,911 |   | 37.1 |   | 66,294 |   | 35.6 |   |
| Operating income                          |       | 39,391                                                |       | 31.7                           |       | 34,047 |   | 35.4 |   | 79,818 |   | 33.3 |   | 67,673 |   | 36.4 |   |
| Other income (expense):                   |       |                                                  |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest expense                          |       | (6,274                                                | )          | (5.0                           | )          | (12,887 | ) | (13.4 | ) | (13,085 | ) | (5.5 | ) | (21,870 | ) | (11.8 | ) |
| Debt extinguishment  costs                |       | —                                                |       | —                         |       | (3,391 | ) | (3.5 | ) | — |   | — |   | (3,391 | ) | (1.8 | ) |
| Interest income                           |       | 487                                                   |       | 0.4                            |       | 345 |   | 0.3 |   | 828 |   | 0.3 |   | 631 |   | 0.3 |   |
| Income before provision  for income taxes |       | 33,604                                                |       | 27.1                           |       | 18,114 |   | 18.8 |   | 67,561 |   | 28.1 |   | 43,043 |   | 23.1 |   |
| Provision for income  taxes               |       | 13,389                                                |       | 10.8                           |       | 7,640 |   | 7.9 |   | 26,941 |   | 11.2 |   | 18,035 |   | 9.7 |   |
| Net income                                |       | $                                                     | 20,215     |                           | 16.3       | % | $ | 10,474 |   | 10.9 | % | $ | 40,620 |   | 16.9 | % | $ | 25,008 |   | 13.4 | % |

 

Net sales bybusiness segment and distribution channel and percentage of net sales for thethree and six months ended July 1, 2007 and the three and six months ended July2, 2006 are as follows:
|                             | ** ** | **Three Months Ended**                      | ** ** | **Six Months Ended** | ** ** |
|-----------------------------|------------|-------------------------------------------------------|------------|--------------------------------|------------|
| ** **                  | ** ** | **July 1,  2007**                                | ** ** | **July 2,  2006**         | ** ** | **July 1,  2007** | ** ** | **July 2,  2006** | ** ** |
| ** **                  | ** ** | **(in thousands, except percentages)** | ** ** |
| Retail                      |       |                                                  |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Infomercial                 |       | $                                                     | 31,583     |                           | 25.4       | % | $ | 31,790 |   | 33.0 | % | $ | 65,857 |   | 27.5 | % | $ | 62,338 |   | 33.5 | % |
| Boutiques                   |       | 19,396                                                |       | 15.6                           |       | 12,763 |   | 13.3 |   | 36,530 |   | 15.2 |   | 24,279 |   | 13.0 |   |
| Total retail                |       | 50,979                                                |       | 41.0                           |       | 44,553 |   | 46.3 |   | 102,387 |   | 42.7 |   | 86,617 |   | 46.5 |   |
| Wholesale                   |       |                                                  |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Premium  wholesale          |       | 37,599                                                |       | 30.3                           |       | 25,077 |   | 26.1 |   | 73,179 |   | 30.5 |   | 48,905 |   | 26.3 |   |
| Home shopping  television   |       | 16,270                                                |       | 13.1                           |       | 14,916 |   | 15.5 |   | 29,964 |   | 12.5 |   | 27,282 |   | 14.7 |   |
| Spas and salons             |       | 14,099                                                |       | 11.4                           |       | 7,409 |   | 7.7 |   | 24,058 |   | 10.0 |   | 14,915 |   | 8.0 |   |
| International  distributors |       | 5,197                                                 |       | 4.2                            |       | 4,230 |   | 4.4 |   | 10,169 |   | 4.3 |   | 8,381 |   | 4.5 |   |
| Total wholesale             |       | 73,165                                                |       | 59.0                           |       | 51,632 |   | 53.7 |   | 137,370 |   | 57.3 |   | 99,483 |   | 53.5 |   |
| Sales, net                  |       | $                                                     | 124,144    |                           | 100.0      | % | $ | 96,185 |   | 100.0 | % | $ | 239,757 |   | 100.0 | % | $ | 186,100 |   | 100.0 | % |

 

Gross profit andgross margin by business segment for the three and six months ended July 1,2007 and the three and six months ended July 2, 2006 are as follows:
|                           | ** ** | **Three Months Ended**                      | ** ** | **Six Months Ended** | ** ** |
|---------------------------|------------|-------------------------------------------------------|------------|--------------------------------|------------|
| ** **                | ** ** | **July 1,  2007**                                | ** ** | **July 2,  2006**         | ** ** | **July 1,  2007** | ** ** | **July 2,  2006** | ** ** |
| ** **                | ** ** | **(in thousands, except percentages)** | ** ** |
| Retail                    |       | $                                                     | 40,337     |                           | 79.1       | % | $ | 35,779 |   | 80.3 | % | $ | 80,833 |   | 78.9 | % | $ | 68,875 |   | 79.5 | % |
| Wholesale                 |       | 46,229                                                |       | 63.2                           |       | 33,469 |   | 64.8 |   | 87,896 |   | 64.0 |   | 65,092 |   | 65.4 |   |
| Gross profit/gross margin |       | $                                                     | 86,566     |                           | 69.7       | % | $ | 69,248 |   | 72.0 | % | $ | 168,729 |   | 70.4 | % | $ | 133,967 |   | 72.0 | % |

 

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##### **Three months ended July 1, 2007 compared tothree months ended July 2, 2006**

##### **Sales, net**

Net sales for thethree months ended July 1, 2007 increased to $124.1 million from$96.2 million in the three months ended July 2, 2006, an increase of$28.0 million, or 29.1%. This increase was primarily attributable to continuedgrowth in sales of our *i.d. bareMinerals*lineof cosmetics, as we continued to broaden our distribution throughout our saleschannels and increase awareness through greater media spending. The increase inour net sales was realized within both our retail and wholesale segments.

***Retail.***Net retail sales increased14.4% to $51.0 million in the three months ended July 1, 2007 from $44.6million in the three months ended July 2, 2006. Net sales from boutiquesincreased 52.0% to $19.4 million in the three months ended July 1, 2007 from$12.8 million in the three months ended July 2, 2006, due to improvedproductivity at our existing locations as well as a net increase of nineboutiques open as of July 1, 2007 compared to July 2, 2006. As of July 1, 2007and July 2, 2006, we had 39 and 30 open company owned boutiques,respectively. Offset against this was a decrease of 0.7% in net sales frominfomercials to $31.6 million in the three months ended July 1, 2007 from $31.8million in the three months ended July 2, 2006, following the launch of our newinfomercial in the second fiscal quarter of 2007.

***Wholesale.***Net wholesale salesincreased 41.7% to $73.2 million in the three months ended July 1, 2007 from$51.6 million in the three months ended July 2, 2006. Net sales in our premiumwholesale channel increased 49.9% to $37.6 million in the three months endedJuly 1, 2007 from $25.1 million in the three months ended July 2, 2006,resulting from strong consumer demand and expansion into additional retaillocations at Ulta and Sephora.  Net salesto our home shopping television customer grew by 9.1% to $16.3 million in thethree months ended July 1, 2007 from $14.9 million in the three months endedJuly 2, 2006, as a result of increased sales of our products through QVC’swebsite, catalogs and continuity programs and the inclusion of sales to QVC inthe UK in the three months ended July 1, 2007.  Net sales to spas and salons increased 90.3%to $14.1 million in the three months ended July 1, 2007 from $7.4million in the three months ended July 2, 2006, largely due to thecontinued growth in sales of our core *i.d.bareMinerals*cosmetics line in this channel and the inclusion ofsales to spas and salons in the UK in the three months ended July 1, 2007. Netsales to our international distributors increased by 22.9% to $5.2 million inthe three months ended July 1, 2007 from $4.2 million in the three months endedJuly 2, 2006, primarily as a result of the increased penetration of our *i.d. bareMinerals*cosmetics line into thisdistribution channel.

##### **Gross profit**

Gross profitincreased 25.0% to $86.6 million in the three months ended July 1, 2007 from$69.2 million in the three months ended July 2, 2006. Our retail segment grossprofit increased 12.7% to $40.3 million in the three months ended July 1, 2007from $35.8 million in the three months ended July 2, 2006, driven principallyby growth in our boutiques sales channels. Our wholesale segment gross profitincreased 38.1% to $46.2 million in the three months ended July 1, 2007 from$33.5 million in the three months ended July 2, 2006, due to increases in salesacross all wholesale distribution channels.

Gross margindecreased approximately 2.3% to 69.7% in the three months ended July 1, 2007from 72.0% in the three months ended July 2, 2006. This overall decrease in thethree months ended July 1, 2007 is due both to a decrease in gross margins withinboth retail and wholesale segments as well as to wholesale sales comprising alarger percentage of total net sales compared to the three months ended July 2,2006, which have lower gross margins than retail segment sales. Within theretail segment, gross margin decreased to 79.1% in the three months ended July1, 2007 from 80.3% in the three months ended July 2, 2006, primarily due toincreased royalty costs associated with sales of our products through theweb.  Within the wholesale segment, grossmargin decreased to 63.2% in the three months ended July 1, 2007 from 64.8% inthe three months ended July 2, 2006, primarily as a result of a change inproduct mix and sales mix between channels and customers.

##### **Selling,general and administrative expenses**

Selling, generaland administrative expenses increased 31.2% to $43.5 million in the threemonths ended July 1, 2007 from $33.2 million in the three months ended July 2,2006. The increase was primarily due to a significant increase in investment inour corporate infrastructure of $5.9 million, including increased headcountcosts, headquarters facilities costs, distribution center costs, othercorporate costs and infrastructure costs relating to our UK acquisition, aswell as increased expenses to support sales growth, including $2.3 million inincreased store operating costs, $1.0 million in increased payroll expenses and$0.8 million in increased media spending. As a percentage of net sales,selling, general and administrative expenses increased 0.6% to 35.1% from34.5%, primarily due to corporate expenses increasing at a greater rate thannet sales.

##### **Depreciationand amortization**

Depreciation andamortization expenses increased 267.6% to $1.9 million in the three monthsended July 1, 2007 from $0.5 million in the three months ended July 2, 2006.This increase was primarily attributable to $0.8 million of amortization ofintangible assets from our recent acquisition and higher depreciation expenseas a result of an increase in depreciable assets as we continue to increase thenumber of company-owned boutiques and invest in our corporate infrastructure.

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##### **Stock-based compensation**

Stock-basedcompensation expense increased 16.8% to $1.8 million in the three months endedJuly 1, 2007 from $1.5 million in the three months ended July 2, 2006. Thisincrease resulted primarily from the granting of additional stock options inthe last half of 2006 and the first half of 2007.

##### **Operating income**

Operating incomeincreased 15.7% to $39.4 million in the three months ended July 1, 2007 from$34.0 million in the three months ended July 2, 2006. This increase was largelydue to increases in operating income in both our retail and wholesale segments,reflecting growth across all sales channels, partially offset by an increasedoperating loss in our corporate segment.

 Our retail segment operating income increased8.2% to $17.1 million in the three months ended July 1, 2007 from $15.8 millionin the three months ended July 2, 2006, which was largely driven by growth inall of our boutiques sales channels. Our increased sales in the retail segmentcontributed to an increase in gross profit of $4.6 million which was partiallyoffset by an increase in operating expenses of $3.3 million. The increase inoperating expenses was largely due to increased store operating costs of $2.3million as a result of an increase in the number of boutiques open as of July1, 2007 and $0.8 million in increased media spending.

Our wholesalesegment operating income increased 36.6% to $42.4 million in the three monthsended July 1, 2007 from $31.0 million in the three months ended July 2, 2006,due to increased sales gains across all wholesale sales channels. Our increasedsales in the wholesale segment contributed to an increase in gross profit of$12.8 million which was partially offset by an increase in operating expense of$1.4 million.

Our corporatesegment operating loss increased 57.4% to $20.1 million in the three monthsended July 1, 2007 from $12.7 million in the three months ended July 2, 2006.This increase was largely due to an increase in corporate segment selling,general and administrative expense of $5.9 million, an increase in depreciationand amortization of $1.4 million and stock-based compensation of $0.3million.  The increase in corporateselling, general and administrative expense was as a result of the increase inthe investment in our corporate infrastructure to support sales growth andadditional expenses associated with being a public company.

##### **Interest expense**

Interest expensedecreased 51.3% to $6.3 million in the three months ended July 1, 2007 from$12.9 million in the three months ended July 2, 2006. The decrease wasattributable to decreased debt balances in the three months ended July 1, 2007,primarily associated with repayment of outstanding indebtedness from proceedsof our initial public offering completed on October 4, 2006.

##### **Interestincome**

Interest incomeincreased 41.2% to $0.5 million in the three months ended July 1, 2007 from$0.3 million in the three months ended July 2, 2006.  The increase was primarily due to an increasein interest rates on our cash balances and higher average cash balancescompared to the three months ended July 2, 2006.

##### **Provisionfor income taxes**

The provision forincome taxes was $13.4 million, or 39.8% of income before provision for incometaxes, in the three months ended July 1, 2007 compared to $7.6 million, or42.2% of income before provision for income taxes, in the three months endedJuly 2, 2006. The increase resulted from higher income before provision forincome taxes offset by a lower effective rate in the three months ended July 1,2007 compared to the three months ended July 2, 2006. The decrease in theeffective rate is mainly due to the elimination of the non-deductible interestas a result of our repayment in full of our aggregate principal amountoutstanding of $125.0 million of our 15.0% subordinated notes on October 4,2006.

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##### **Six months ended July 1, 2007 compared to sixmonths ended July 2, 2006**

##### **Sales, net**

Net sales for thesix months ended July 1, 2007 increased to $239.8 million from $186.1 millionin the six months ended July 2, 2006, an increase of $53.7 million, or 28.8%.This increase was primarily attributable to continued growth in sales of our *i.d. bareMinerals*line of cosmetics, as wecontinued to broaden our distribution throughout our sales channels andincrease awareness through greater media spending. The increase in our netsales was realized within both our retail and wholesale segments.

***Retail.***Net retail sales increased18.2% to $102.4 million in the six months ended July 1, 2007 from $86.6 millionin the six months ended July 2, 2006. Net sales from infomercials increased5.6% to $65.9 million in the six months ended July 1, 2007 from $62.3 millionin the six months ended July 2, 2006, as a result of increased media spendingand the growth of sales in our continuity program.  Net sales from boutiques increased 50.5% to$36.5 million in the six months ended July 1, 2007 from $24.3 million in thesix months ended July 2, 2006, due to improved productivity at our existinglocations as well as a net increase of 9 boutiques open as of July 1, 2007compared to July 2, 2006. As of July 1, 2007 and July 2, 2006, we had 39 and 30open company owned boutiques, respectively.

***Wholesale.***Net wholesale salesincreased 38.1% to $137.4 million in the six months ended July 1, 2007 from$99.5 million in the six months ended July 2, 2006. Net sales in our premiumwholesale channel increased 49.6% to $73.2 million in the six months ended July1, 2007 from $48.9 million in the six months ended July 2, 2006, resulting fromstrong consumer demand and expansion into additional retail locations at Ultaand Sephora, including new Sephora locations in France.  Net sales to our home shopping televisioncustomer grew by 9.8% to $30.0 million in the six months ended July 1, 2007from $27.3 million in the six months ended July 2, 2006, as a result ofincreased sales of our products through QVC’s website, catalogs and continuityprograms and the inclusion of sales to QVC in the UK in the six months endedJuly 1, 2007. Net sales to spas and salons increased 61.3% to $24.1 million inthe six months ended July 1, 2007 from $14.9 million in the six months endedJuly 2, 2006, largely due to the continued growth in sales of our core *i.d. bareMinerals*cosmetics line and theinclusion of sales to spas and salons in the UK in the six months ended July 1,2007.  Net sales to our internationaldistributors increased by 21.3% to $10.2 million in the six months ended July1, 2007 from $8.4 million in the six months ended July 2, 2006, primarily as aresult of the increased penetration of our *i.d.bareMinerals*cosmetics line into this distribution channel.

##### **Gross profit**

Gross profitincreased 25.9% to $168.7 million in the six months ended July 1, 2007 from$134.0 million in the six months ended July 2, 2006. Our retail segment grossprofit increased 17.4% to $80.8 million in the six months ended July 1, 2007from $68.9 million in the six months ended July 2, 2006, driven principally bygrowth in our infomercial and boutiques sales channels. Our wholesale segmentgross profit increased 35.0% to $87.9 million in the six months ended July 1,2007 from $65.1 million in the six months ended July 2, 2006, due to increasesin sales across all wholesale distribution channels.

Gross margindecreased approximately 1.6% to 70.4% in the six months ended July 1, 2007 from72.0% in the six months ended July 2, 2006. This overall decrease in the sixmonths ended July 1, 2007 is due both to a decrease in gross margins withinboth retail and wholesale segments as well as to wholesale sales comprising alarger percentage of total net sales compared to the six months ended July 2,2006, which have lower gross margins than retail segment sales.  Within the retail segment, gross margin decreasedto 78.9% in the six months ended July 1, 2007 from 79.5% in the six monthsended July 2, 2006, primarily due to increased royalty costs associated withsales of our products through the web. Within the wholesale segment, gross margin decreased to 64.0% in the sixmonths ended July 1, 2007 from 65.4% in the six months ended July 2, 2006,primarily as a result of a change in product mix and sales between channels andcustomers.

##### **Selling,general and administrative expenses**

Selling, generaland administrative expenses increased 31.6% to $82.7 million in the six monthsended July 1, 2007 from $62.9 million in the six months ended July 2, 2006. Theincrease was primarily due to a significant increase in investment in ourcorporate infrastructure of $11.0 million, including increased headcount costs,headquarters facilities costs, distribution center costs, other corporate costsand infrastructure costs relating to our UK acquisition, as well as increasedexpenses to support sales growth, including $3.6 million in increased storeoperating costs, $1.9 million in increased media spending and $1.4 million inpayroll expenses. As a percentage of net sales, selling, general andadministrative expenses increased 0.7% to 34.5% from 33.8%, primarily due tocorporate expenses increasing at a greater rate than net sales.

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##### **Depreciationand amortization**

Depreciation andamortization expenses increased 188.4% to $2.8 million in the six months endedJuly 1, 2007 from $1.0 million in the six months ended July 2, 2006. Thisincrease was primarily attributable to $0.8 million of amortization ofintangible assets from our recent acquisition and higher depreciation expenseas a result of an increase in depreciable assets as we continue to increase thenumber of company-owned boutiques and invest in our corporate infrastructure.

##### **Stock-based compensation**

Stock-basedcompensation expense increased 37.4% to $3.4 million in the six months endedJuly 1, 2007 from $2.5 million in the six months ended July 2, 2006. Thisincrease resulted primarily from the granting of additional stock options inthe last half of 2006 and the first half of 2007.

##### **Operating income**

Operating incomeincreased 17.9% to $79.8 million in the six months ended July 1, 2007 from$67.7 million in the six months ended July 2, 2006. This increase was largelydue to increases in operating income in both our retail and wholesale segments,reflecting growth across all sales channels, partially offset by an increasedoperating loss in our corporate segment.

 Our retail segment operating income increased16.9% to $35.1 million in the six months ended July 1, 2007 from $30.1 millionin the six months ended July 2, 2006, which was largely driven by growth in allof our retail sales channels with lower growth in our infomercial saleschannel. Our increased sales in the retail segment contributed to an increasein gross profit of $12.0 million which was partially offset by an increase inoperating expenses of $6.9 million. The increase in operating expenses waslargely due to increased store operating costs of $3.6 million as a result ofan increase in the number of boutiques open as of July, 2007, $1.9 million inincreased media spending and $0.4 million of increased fulfillment costs due toincreased sales.

Our wholesalesegment operating income increased 33.7% to $81.0 million in the six monthsended July 1, 2007 from $60.6 million in the six months ended July 2, 2006, dueto increased sales gains across all wholesale sales channels. Our increasedsales in the wholesale segment contributed to an increase in gross profit of$22.8 million which was partially offset by an increase in operating expense of$2.4 million.

Our corporatesegment operating loss increased 58.1% to $36.3 million in the six months endedJuly 1, 2007 from $23.0 million in the six months ended July 2, 2006. Thisincrease was largely due to an increase in corporate segment selling, generaland administrative expense of $11.0 million, an increase in depreciation andamortization of $1.8 million and stock-based compensation of $0.9 million.  The increase in corporate selling, generaland administrative expense was as a result of the increase in the investment inour corporate infrastructure to support sales growth and additional expensesassociated with being a public company.

##### **Interest expense**

Interest expensedecreased 40.2% to $13.1 million in the six months ended July 1, 2007 from$21.9 million in the six months ended July 2, 2006. The decrease was attributableto decreased debt balances in the six months ended July 1, 2007, primarilyassociated with repayment of outstanding indebtedness from proceeds of ourinitial public offering completed on October 4, 2006.

##### **Debt extinguishment costs**

Debt extinguishmentcosts decreased 100% to zero in the six months ended July 1, 2007 from $3.4million in the six months ended July 2, 2006. The charge for the six monthsended July 2, 2006 related to our June 2006 recapitalization.

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##### **Interestincome**

Interest incomeincreased 31.2% to $0.8 million in the six months ended July 1, 2007 from $0.6million in the six months ended July 2, 2006. The increase was primarily due to an increase in interest rates on ourcash balances and higher average cash balances compared to the six months endedJuly 2, 2006.

##### **Provisionfor income taxes**

The provision forincome taxes was $26.9 million, or 39.9% of income before provision for incometaxes, in the six months ended July 1, 2007 compared to $18.0 million, or 41.9%of income before provision for income taxes, in the six months ended July 2,2006. The increase resulted from higher income before provision for incometaxes offset by a lower effective rate in the six months ended July 1, 2007compared to the six months ended July 2, 2006. The decrease in the effectiverate is mainly due to the elimination of the non-deductible interest as aresult of our repayment in full of our aggregate principal amount outstandingof $125.0 million of our 15.0% subordinated notes on October 4, 2006.

# **Seasonality**

Because our products are largely purchased forindividual use and are consumable in nature, we are not subject to significantseasonal variances in sales. However, fluctuations in sales and operatingincome in any fiscal quarter may be affected by the timing of wholesaleshipments, home shopping television appearances and other promotional events.While we believe our overall business is not currently subject to significantseasonal fluctuations, we have experienced limited seasonality in our premium wholesaleand company-owned boutique channels as a result of increased demand forour products in anticipation of and during the holiday season. To the extentour sales to specialty beauty retailers and through our boutiques increase as apercentage of our net sales, we may experience increased seasonality.

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## **Liquidityand Capital Resources**

Our primary liquidity andcapital resource needs are to service our debt, finance working capital needsand fund ongoing capital expenditures. We have financed our operations through cash flows from operations,sales of common and preferred shares, borrowings under our credit facilitiesand issuances of senior subordinated notes.

Our operationsprovided us cash of $48.0 million in the six months ended July 1, 2007. At July1, 2007, we had working capital of $67.8 million, including cash and cashequivalents of $22.6 million, compared to working capital of $66.3 million,including $20.9 million in cash and cash equivalents, as of December 31, 2006.The $1.7 million increase in cash and cash equivalents resulted from cashprovided by operations of $48.0 million, as a result of net income for the sixmonths ended July 1, 2007 of $40.6 million, partially offset by cash used ininvestment activities of $30.9 million and cash used in financing activities of$15.6 million. The $1.5 million increase in working capital was primarilydriven by increases in cash and cash equivalents, accounts receivable, prepaidexpenses and other current assets and prepaid income tax, partially offset by adecrease in inventories and an increase in accounts payable and accruedliabilities.

Net cash used ininvesting activities was $30.9 million in the six months ended July 1, 2007,primarily attributable to our acquisition of U.K. based Cosmeceuticals, theopening of seven company-owned boutiques, and our continued investment in ourcorporate infrastructure. Our future capital expenditures will depend on thetiming and rate of expansion of our businesses, information technologyinvestments, new store openings, store renovations and international expansionopportunities.

Net cash used infinancing activities was $15.6 million in the six months ended July 1, 2007,which consisted of repayments of $39.3 million on our first-lien term loan,partially offset by proceeds, net of transaction costs, of $21.1 million fromour follow-on underwritten public offerings of common stock and an excess taxbenefit of $2.3 million relating to stock option exercises.

Our revolving creditfacility of $25.0 million, of which approximately $0.1 million in letters ofcredit is outstanding as of July 1, 2007 and our first-lien term loan of $300.0million, bear interest at a rate equal to, at our option, either LIBOR or thelender’s base rate, plus an applicable variable margin based on ourconsolidated total leverage ratio. The current applicable interest margin forthe revolving credit facility and first-lien term loan is 2.25% for LIBOR loansand 1.25% for base rate loans based on our current Moody’s rating. As of July1, 2007, interest on the first-lien term loan was accruing at 7.57%.

At all times afterOctober 2, 2007, we are required under our senior secured creditfacilities to enter into interest rate swap or similar agreements with respectto at least 40% of the outstanding principal amount of all loans under oursenior secured credit facilities, unless we satisfy specified coverage ratiotests. As of July 1, 2007, we satisfied these tests. If required, the interestrate protection must extend until February 2008. Currently, we do notengage in any hedging activities.

The terms of our seniorsecured credit facilities, require us to comply with financial covenants,including a maximum leverage ratio covenant. We are required to maintain amaximum leverage ratio (consolidated total debt to Adjusted EBITDA) of notgreater than 4.5 to 1.0. As of July 1, 2007, our leverage ratio was 1.70 to1.0. If we fail to comply with any of the financial covenants, the lenders maydeclare an event of default under the secured credit facility. An event ofdefault resulting from a breach of a financial covenant may result, at theoption of lenders holding a majority of the loans, in an acceleration ofrepayment of the principal and interest outstanding and a termination of therevolving credit facility. The secured credit facility also containsnon-financial covenants that restrict some of our activities, including ourability to dispose of assets, incur additional debt, pay dividends, createliens, make investments and engage in specified transactions with affiliates.The secured credit facility also contains customary events of default,including defaults based on events of bankruptcy and insolvency, nonpayment ofprincipal, interest or fees when due, subject to specified grace periods,breach of specified covenants, change in control and material inaccuracy ofrepresentations and warranties. We have been in compliance with all financialratio and other covenants under our credit facilities during all reportedperiods and we were in compliance with these covenants as July 1, 2007.

On March 23, 2007, weamended our senior secured credit facilities to permit acquisitions of up to$30.0 million in any one fiscal year and up to $60.0 million in the aggregateand investments in foreign subsidiaries to $25.0 million.

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Subject to specifiedexceptions, including for investment of proceeds in the case of asset saleproceeds and for permitted equity contributions for capital expenditures, weare required to prepay outstanding loans under our amended senior securedcredit facilities with the net proceeds of certain asset dispositions,condemnation settlements and insurance settlements from casualty losses,issuances of certain debt and, if our consolidated leverage ratio is 2.25 to1.0 or greater, a portion of excess cash flow.

On February 16, 2007, we filed a RegistrationStatement on Form S-1 (File No. 333-140763) with the Securities and ExchangeCommission for a follow-on underwritten public offering. As amended, theRegistration Statement provided for the sale of 12.0 million shares of ourcommon stock, consisting of 0.6 million shares sold by us and 11.4 millionshares by selling stockholders. In addition, the selling stockholders grantedthe underwriters the right to purchase up to an additional 1.8 million sharesto cover over-allotments. The over-allotment option was exercised on March 19,2007 by the underwriters. The follow-on underwritten public offering closed onMarch 19, 2007. We received approximately $18.1 million in net proceeds fromthis offering.

On May 14, 2007, we filed a Registration Statement onForm S-1 (File No. 333-142935) with the Securities and Exchange Commission fora follow-on underwritten public offering. As amended, the RegistrationStatement provided for the sale of 8.0 million shares of our common stock,consisting of 0.1 million shares sold by us and 7.9 million shares by sellingstockholders. The follow-on underwritten public offering closed on June 19,2007. We received approximately $3.0 million in net proceeds from this offering.

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# **Liquidity sources, requirementsand contractual cash requirement and commitments**

We believe thatcash flow from operations, cash on hand and amounts available under ourrevolving credit facility will provide adequate funds for our foreseeableworking capital needs and planned capital expenditures.  As part of our strategy, we intend to investin making significant improvements to our systems. We also intend to openapproximately nineteen new boutiques in 2007 (seven of which were open as of July 1, 2007) which will requireadditional capital expenditures. Finally, we also plan to continue to invest inour corporate infrastructure facilities. We anticipate that our capitalexpenditures in the year ending December 30, 2007 will be approximately$18.0 million. There can be no assurance that any such capital will beavailable on acceptable terms or at all. Our ability to fund our workingcapital needs, planned capital expenditures and scheduled debt payments, aswell as to comply with all of the financial covenants under our debtagreements, depends on our future operating performance and cash flow, which inturn are subject to prevailing economic conditions and to financial, businessand other factors, some of which are beyond our control.

# **Contractual commitments**

We lease retailstores, distribution facilities, and corporate offices under noncancelableoperating leases with various expiration dates through March 2018. Portions ofthese payments are denominated in foreign currencies and were translated in thetables below based on their respective U.S. dollar exchange rates at July 1,2007. These future payments are subject to foreign currency exchange raterisk.  As of July 1, 2007, the scheduledmaturities of our long-term contractual obligations were as follows:
| ** **                                                             | ** ** | **Remainder of  the year   ending  December 30,  2007** | ** ** | **1 - 3  Years** | ** ** | **4 - 5  Years** | ** ** | **After 5  Years** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|-------------------------|------------|-----------|------------|
| ** **                                                             | ** ** | **(amounts in millions )**                                   | ** ** |
| Operating leases, net  of sublease income                              |       | $                                                                           | 2.5        |                       | $          | 23.4                       |       | $                       | 14.7       |      | $          | 24.8 |   | $ | 65.4 |   |
| Principal payments on  long-term debt, including the current portion   |       | 8.8                                                                         |       | 52.9                       |       | 238.3                      |       | —                  |       | 300.0     |       |
| Interest payments on  long-term debt, including the current portion(1) |       | 11.1                                                                        |       | 59.6                       |       | 10.4                       |       | —                  |       | 81.1      |       |
| Minimum royalties under  licensing arrangements                        |       | 0.4                                                                         |       | 1.3                        |       | —                     |       | —                  |       | 1.7       |       |
| Total                                                                  |       | $                                                                           | 22.8       |                       | $          | 137.2                      |       | $                       | 263.4      |      | $          | 24.8 |   | $ | 448.2 |   |

 

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(1)             Theinterest payments on our long-term debt, including the current portion havebeen calculated using an estimated interest rate of 7.57% on the outstandingfirst-lien term loan, which were estimated based on the rate in effect as ofJuly 1, 2007. A 1% change in interest rates on our variable rate debtwould result in a change of $10.7 million in our total interest payments,of which $1.5 million would be in the remainder of the year endedDecember 30, 2007, $7.9 million would be in years 1-3 and$1.3 million would be in years 4-5.

We are also partyto a sublicense agreement for use of certain patents associated with certain ofour mineral-based skin care products. The agreement requires that we paya quarterly royalty of 4.0% of the net sales of these skin care products up tothe date of the last to expire licensed patent rights. This sublicense alsorequires minimum annual royalty payments of approximately $0.6 million for2007 and thereafter. The minimum annual royalty payments have not been includedin the schedule of long-term contractual obligations above as we can terminatethe agreement at any time with six months written notice.

We adopted FASBInterpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”)on January 1, 2007. As of July 1, 2007, we had approximately $4.1 million oftotal unrecognized tax benefits, including related interest, of which $2.2million, if recognized, would affect the effective income tax rate in futureperiods. However, as we are unable to determine the timing of the potentialrealization of our unrecognized tax benefits, we have excluded the totalunrecognized tax benefits in the schedule of long-term contractual commitmentsabove.

**Off-balance-sheet arrangements**

We do not have anyoff-balance-sheet financing or unconsolidated special purpose entities.

**Effects of inflation**

Our monetaryassets, consisting primarily of cash and receivables, are not significantlyaffected by inflation because they are short-term in nature. Our non-monetary assets,consisting primarily of inventory, intangible assets, goodwill and prepaidexpenses and other assets, are not currently affected significantly byinflation. We believe that replacement costs of equipment, furniture andleasehold improvements will not materially affect our operations. However, therate of inflation affects our cost of goods sold and expenses, such as thosefor employee compensation, which may not be readily recoverable in the price ofthe products offered by us. In addition, an inflationary environment couldmaterially increase the interest rates on our debt.

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**Non-GAAP Measures**

In evaluating ourbusiness, we consider and use Adjusted EBITDA as a supplemental measure of ouroperating performance. We use EBITDA only to assist in reconciliation toAdjusted EBITDA.  We define EBITDA as netincome before net interest expense, provision for income taxes, depreciationand amortization. We define Adjusted EBITDA as EBITDA plus expenses (minusgains) that we do not consider reflective of our ongoing operations. We useAdjusted EBITDA as a supplemental measure to review and assess our operatingperformance and also as a key profitability measure for covenant complianceunder our senior secured credit facilities. If we fail to maintain required levelsof Adjusted EBITDA, we could have a default under our senior secured creditfacilities, potentially resulting in an acceleration of all of our outstandingindebtedness.  All of the adjustmentsmade in our calculation of Adjusted EBITDA, as described below, are adjustmentsthat would be made in calculating our performance for purposes of coverageratios under our senior secured credit facilities. In prior periods, we used anadjusted EBITDA calculation for internal purposes and for calculation of compliancewith coverage ratios that incorporated additional adjustments not included inour calculation of Adjusted EBITDA. We also believe use of Adjusted EBITDAfacilitates investors’ use of operating performance comparisons from period toperiod and company to company by backing out potential differences caused byvariations in capital structures (affecting relative interest expense,including the impact of write-offs of deferred financing costs when companiesrefinance their indebtedness), the book amortization of intangibles (affectingrelative amortization expense) and the age and book value of facilities andequipment (affecting relative depreciation expense). We also present AdjustedEBITDA because we believe it is frequently used by securities analysts, investorsand other interested parties as a measure of financial performance. The termsEBITDA and Adjusted EBITDA are not defined under U.S. generally acceptedaccounting principles, or U.S. GAAP, and are not measures of operating income,operating performance or liquidity presented in accordance with U.S. GAAP. OurEBITDA and Adjusted EBITDA have limitations as analytical tools, and whenassessing our operating performance, you should not consider EBITDA andAdjusted EBITDA in isolation, or as a substitute for net income****(loss) or other consolidated incomestatement data prepared in accordance with U.S. GAAP. Some of these limitationsinclude, but are not limited to:

·                  EBITDAand Adjusted EBITDA do not reflect our cash expenditures or future requirementsfor capital expenditures or contractual commitments;

·                  theydo not reflect changes in, or cash requirements for, our working capital needs;

·                  theydo not reflect the significant interest expense, or the cash requirementsnecessary to service interest or principal payments, on our debt;

·                  theydo not reflect income taxes or the cash requirements for any tax payments;

·                  althoughdepreciation and amortization are non-cash charges, the assets beingdepreciated and amortized often will have to be replaced in the future, andEBITDA and Adjusted EBITDA do not reflect any cash requirements for suchreplacements; and

·                  other companiesmay calculate EBITDA and Adjusted EBITDA differently than we do, limiting theirusefulness as comparative measures. We compensate for these limitations byrelying primarily on our GAAP results and using Adjusted EBITDA onlysupplementally. EBITDA and Adjusted EBITDA are calculated as follows for theperiods presented:
|                                     | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | **July 1, 2007**       | ** ** | **July 2, 2006**     | ** ** | **July 1, 2007** | ** ** | **July 2, 2006** | ** ** |
| ** **                          | ** ** | **(in thousands)**          | ** ** |
| **Net  income**                     |       | $                                | 20,215     |                           | $          | 10,474 |   | $ | 40,620 |   | $ | 25,008 |   |
| Plus: interest expense              |       | 6,274                            |       | 12,887                         |       | 13,085 |   | 21,870 |   |
| Less: interest income               |       | (487                             | )          | (345                           | )          | (828 | ) | (631 | ) |
| Plus: depreciation and amortization |       | 1,860                            |       | 506                            |       | 2,800 |   | 971 |   |
| Plus: provision for income taxes    |       | 13,389                           |       | 7,640                          |       | 26,941 |   | 18,035 |   |
| **EBITDA**                          |       | 41,251                           |       | 31,162                         |       | 82,618 |   | 65,253 |   |
| Plus: debt extinguishment costs(1)  |       | —                           |       | 3,391                          |       | — |   | 3,391 |   |
| Plus: management fees(2)            |       | —                           |       | 150                            |       | — |   | 300 |   |
| Plus: stock-based compensation(3)   |       | 1,779                            |       | 1,523                          |       | 3,390 |   | 2,467 |   |
| **Adjusted EBITDA**                 |       | $                                | 43,030     |                           | $          | 36,226 |   | $ | 86,008 |   | $ | 71,411 |   |

 

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(1)            During the six monthsended July 2, 2006, we incurred debt extinguishment costs of $3.4 millionrelated to the early extinguishment of our previously outstanding debt inconnection with our June 2006 recapitalization.

(2)            We paid transactionfees and monthly management fees to Berkshire Partners LLC and JH Partners, LLCunder management agreements each in an amount of $300,000 per annum.  These management agreements were terminatedupon completion of our initial public offering on October 4, 2006.  We paid an aggregate of $1.8 million toBerkshire Partners LLC and JH Partners, LLC as consideration for termination ofthese agreements.

(3)            The stock-basedcompensation charges primarily resulted from our adoption of the fair valuerecognition and measurement provisions of Statement of Financial AccountingStandards No. 123(R), or SFAS 123(R), effective January 3, 2005.

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**Critical Accounting Policies andEstimates**

The preparation offinancial statements in conformity with U.S. generally accepted accountingprinciples requires management to make estimates and assumptions. Predictingfuture events is inherently an imprecise activity and, as such, requires theuse of judgment. Actual results may vary from estimates in amounts that may bematerial to the financial statements. An accounting policy is deemed to becritical if it requires an accounting estimate to be made based on assumptionsabout matters that are highly uncertain at the time the estimate is made, andif different estimates that reasonably could have been used, or changes in theaccounting estimates that are reasonably likely to occur periodically, couldmaterially impact our consolidated financial statements.  Our critical accounting policies andestimates are discussed in our recently filed Annual Report on Form 10-K forthe fiscal year ended December 31, 2006, which was filed with the SEC on March 30,2007.  We believe that there have been noother significant changes during the six months ended July 1, 2007 to the itemsthat we disclosed in our critical accounting policies and estimates with theexception of the adoption of FIN 48 as noted below.

We adoptedFinancial Accounting Standards Board (“FASB”) Interpretation No. 48, *Accounting for Uncertainty in Income Taxes*,(“FIN 48”) on January 1, 2007.  FIN48 prescribes a comprehensive model for how a company should recognize,measure, present and disclose in its financial statements uncertain taxpositions that the company has taken or expects to take on a tax return.  In connection with the adoption of FIN 48, wechanged our accounting policy and now recognize accrued interest and penaltiesrelated to income tax matters in income tax expense.  These amounts were previously classified inselling, general and administrative expenses.

**New Accounting Standards**

InSeptember 2006, the FASB issued SFAS No. 157*, Fair Value Measurements*. Statement 157defines fair value, establishes a framework for measuring fair value, andexpands disclosures about fair value measurements. Statement 157 also appliesunder other accounting pronouncements that require or permit fair valuemeasurements, but does not require any new fair value measurements. The provisionsof Statement 157 are effective for fiscal years beginning afterNovember 15, 2007. We will adopt Statement 157 during our fiscal yearending December 28, 2008. We are currently in the process of determiningthe impact, if any, of adopting the provisions of Statement 157 but it is notexpected to have a material impact on our financial position or results ofoperations.

In February 2007,the FASB issued SFAS No. 159, *Fair Value Option forFinancial Assets and Financial Liabilities. *Statement 159 permits entities to choose to measure manyfinancial instruments, and certain other items, at fair value. Statement 159also establishes presentation and disclosure requirements designed tofacilitate comparisons between entities that choose different measurement attributesfor similar types of assets and liabilities. The provisions of Statement 159are effective for fiscal years beginning after November 15, 2007.  We will adopt Statement 159 during our fiscalyear ending December 28, 2008. We are currently in the process ofdetermining the impact, if any, of adopting the provisions of Statement 159 butit is not expected to have a material impact on our financial position orresults of operations.

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**ITEM3.****   QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

***Interest ratesensitivity***

We are exposed tointerest rate risks primarily through borrowings under our creditfacilities.  Interest on all of ourborrowings under our senior secured credit facilities is based upon variableinterest rates. Our weighted average borrowings outstanding during the sixmonths ended July 1, 2007 were $322.5 million and the annual effective interestrate for the period was 8.0%. Presently, we do not hedge against interest raterisks. Based on the foregoing, a hypothetical 1% increase or decrease ininterest rates would have resulted in a $1.6 million change to our interestexpense in the six months ended July 1, 2007 and $3.2 million on anannualized basis.

***Foreigncurrency risk***

Most of our sales,expenses, assets, liabilities and cash holdings are currently denominated inU.S. dollars but a portion of the net revenues we receive from such sales isdenominated in currencies other than the U.S. dollar. Additionally,portions of our costs of net revenues and our other operating expenses areincurred by our U.K. operations and denominated in local currencies. Whilefluctuations in the value of these net revenues, costs and expenses as measuredin U.S. dollars have not materially affected our results of operationshistorically, we cannot assure you that adverse currency exchange ratefluctuations will not have a material impact in the future. In addition, ourbalance sheet reflects non-U.S. dollar denominated assets and liabilitieswhich can be adversely affected by fluctuations in currency exchangerates.  We do not hedge against foreigncurrency risks and we believe that our foreign currency exchange risk isimmaterial.

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**ITEM4.****   CONTROLSAND PROCEDURES**

The Companymaintains disclosure controls and procedures that are designed to ensure thatinformation required to be disclosed in its reports pursuant to the SecuritiesExchange Act of 1934, as amended, is recorded, processed, summarized andreported within the time periods specified in the SEC’s rules, and that suchinformation is accumulated and communicated to the Company’s management,including its Chief Executive Officer and Chief Financial Officer, asappropriate, to allow timely decisions regarding required disclosure.Management is responsible for establishing and maintaining adequate internalcontrol over financial reporting. In designing and evaluating the disclosurecontrols and procedures, management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, andmanagement necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.

As required by SECRule 13a-15(b), the Company carried out an evaluation, under the supervisionand with the participation of its management, including the Chief ExecutiveOfficer and the Chief Financial Officer, of the effectiveness of the design andoperation of the Company’s disclosure controls and procedures as of the end ofthe quarter covered by this report. Based on the foregoing, its Chief ExecutiveOfficer and Chief Financial Officer determined that disclosure controls andprocedures were effective at a reasonable assurance level.

There has been nochange in internal controls over financial reporting during the most recentfiscal quarter that has materially affected, or is reasonably likely tomaterially affect, internal controls over financial reporting.

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**PART II—OTHER INFORMATION**

**ITEM1.****   LEGALPROCEEDINGS**

In the ordinarycourse of our business, we are subject to periodic lawsuits, investigations andclaims. Although we cannot predict with certainty the ultimate resolution oflawsuits, investigations and claims asserted against us, we do not believe thatany currently pending legal proceeding to which we are a party is likely tohave a material adverse effect on our business, results of operations, cashflows or financial condition.

**ITEM1A.****   RISKFACTORS**

*An investment in our common stock involves a highdegree of risk.  Our Annual Reporton Form 10-K for the year ended December 31, 2006 includes a detaileddiscussion of our risk factors under the heading “Part I,Item 1A—Risk Factors.” Set forth below are certain changes from the riskfactors previously disclosed in our Annual Report on Form 10-K. You shouldcarefully consider the risk factors discussed in this report and our AnnualReport on Form 10-K as well as the other information in this report, beforemaking an investment decision. If any of the following risks or the risksdiscussed in the Annual Report on Form 10-K occur, our business, financial condition, results of operations orfuture growth could suffer.*

***The beauty industry is highly competitive, and if we areunable to compete effectively it could significantly harm our business,prospects, financial condition and results of operations.***

The beauty industry is highly competitive and at times changes rapidlydue to consumer preferences and industry trends. Our products face, and willcontinue to face, competition for consumer recognition and market share withproducts that have achieved significant national and international brand namerecognition and consumer loyalty, such as those offered by global prestigebeauty companies Avon Products, Inc., Elizabeth Arden, Inc., The Estée LauderCompanies, Inc. And L’Oréal S.A. Avon and Neutrogena, of which Avon, L’Oréaland Neutrogena have recently launched mineral-based makeup. These companieshave significantly greater resources than we have and are less leveraged thanwe are. These competitors typically devote substantial resources to promotingtheir brands through traditional forms of advertising, such as print media andtelevision commercials. Because of such mass marketing methods, thesecompetitors’ products may achieve higher visibility and recognition than ourproducts. In addition, these competitors may duplicate our marketing strategyand distribution model to increase the breadth of their product sales. We alsoface competition from other companies that recently have launched, or may inthe future launch, mineral-based cosmetics. Some of these competitors havesignificant experience using infomercials to market and sell cosmetics and skincare products and have employed marketing strategies and distribution modelssimilar to ours.

The total market for prestige cosmetics is not growing rapidly. As aresult, competition for market share in this cosmetics category is especiallyintense. In order to succeed, we must continue to take market share from ourcompetitors across all of our sales channels. We compete with prestigecosmetics companies primarily in department store and specialty beauty retailchannels, but prestige cosmetics companies also recently have increased theirsales through informercial and home shopping television channels. Masscosmetics brands are sold primarily though channels in which we do not sell ourproducts, such as mass merchants and catalogs, but mass cosmetics companies areincreasingly making efforts to acquire market share in the higher-marginprestige cosmetics category by introducing brands and products that addressthis market. If we are unable to maintain or improve the inventory levels andin-store positioning of our products in third-party retailers or maintain andincrease sales of our products through our other distribution channels,including informercials, home shopping television and other direct-to-consumermethods, our ability to achieve and maintain significant market acceptance forour products could be severly impaired.

Our *i.d. bareMinerals*foundation products face competition from liquid- or cream-based foundationand, to a lesser extent, mineral-based foundation products, sold by ourcompetitors. Because the process for production of mineral-based cosmetics isnot subject to patent protection, there is a low barrier to entry into themarket for such products as evidenced by the number of smaller companiesrecently entering the market for such products. If these smaller companies’products prove successful or if global prestige beauty companies were tosignificantly increase production and marketing of mineral-based cosmetics, ournet sales could suffer. If consumers prefer our competitors’ products overours, we will lose market share and our net sales will decline. New productsthat we develop might not generate sufficient consumer interest and sales tobecome profitable or to cover the costs of their development.

Advertising,promotion, merchandising and packaging, and the timing of new productintroductions and line extensions have a significant impact on consumers’buying decisions and, as a result, our net sales. These factors, as well asdemographic trends, economic conditions and discount pricing strategies bycompetitors, could result in increased competition and could harm our net salesand profitability.

***We do not currently own any patents on our products. If weare unable to protect our intellectual property rights, our ability to competecould be harmed.***

We regard our trademarks,trade dress, copyrights, trade secrets, know-how and similar intellectualproperty as critical to our success. Our principal intellectual property rightsinclude registered trademarks on our name, “Bare Escentuals,” as well asour brands “*i.d. bareMinerals*,” “*i.d.*,” “*mdformulations*,” “*Bare Escentuals*”and “*RareMinerals*,” copyrights inour infomercial broadcasts and website content, rights to our domain names *www.bareescentuals.com*, *www.bareminerals.com*and *www.mdformulations.com*, and tradesecrets and know-how with respect to product formulations, product sourcing,sales and marketing and other aspects of our business. As such, we rely ontrademark and copyright law, trade secret protection and confidentialityagreements with our employees, consultants, suppliers, and others to protectour proprietary rights. We have not received patent protection on any of ourproducts, though we have licenses for the proprietary formulations andingredients used in some of our *mdformulations* and *RareMinerals*products. If we are unable to protect or preserve the value of our trademarks,copyrights, trade secrets or other proprietary rights for any reason, our brandand reputation could be impaired and we could lose customers.

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Although most of ourbrand names are registered in the United States and in certain foreigncountries in which we operate, we may not be successful in asserting trademarkor trade name protection. In addition, the laws of certain foreign countriesmay not protect our intellectual property rights to the same extent as the lawsof the United States. The costs required to protect our trademarks and tradenames may be substantial. In addition, the relationship between regulationsgoverning domain names and laws protecting trademarks and similar proprietaryrights is unclear. Therefore, we may be unable to prevent third parties fromacquiring domain names that are similar to, infringe upon or otherwise decreasethe value of our trademarks and other proprietary rights.

Other parties mayinfringe on our intellectual property rights and may thereby dilute our brandsin the marketplace. Any such infringement of our intellectual property rightswould also likely result in a commitment of our time and resources to protectthese rights through litigation or otherwise. For example, we currently are pursuingclaims in litigation against M/D Skin Care LLC and its founderDr. Dennis Gross regarding their use of the trademark “MD Skincare.”  M/D Skin Care LLC has also filed claimsagainst us in the case. In each case, we believe the competing marks infringeour trademark rights and create confusion in the marketplace. We are alsopursuing claims in litigation against L’Oréal USA, Inc. and L’Oréal S.A.regarding their use of the trademark “Bare Naturale” and for false advertisingof this brand. We have incurred and expect to incur significant legal fees andother expenses in pursuing these claims. If we receive an adverse judgment ineither of these matters or in any other cases we may bring in the future todefend our intellectual property rights, we may suffer further dilution of ourtrademarks and other rights, which could harm our ability to compete as well asour business, prospects, financial condition and results of operations.

***Wemay make acquisitions and strategic investments, which will involve numerousrisks. We may not be able to address these risks without substantial expense,delay or other operational or financial problems.***

Although we have alimited history of making acquisitions or strategic investments, we may acquireor make investments in related businesses or products in the future.Acquisitions or investments involve various risks, such as:

·                  higher thanexpected acquisition and integration costs;

·                  the difficultyof integrating the operations and personnel of the acquired business;

·                  the potentialdisruption of our ongoing business, including the diversion of management timeand attention;

·                  the possibleinability to obtain the desired financial and strategic benefits from theacquisition or investment;

·                  assumption ofunanticipated liabilities;

·                  incurrenceof substantial debt or dilutive issuances of securities to pay foracquisitions;

·                  impairment inrelationships with key suppliers and personnel of any acquired businesses dueto changes in management and ownership;

·                  the loss of keyemployees of an acquired business; and

·                  the possibilityof our entering markets in which we have limited prior experience.

Future acquisitions andinvestments could also result in substantial cash expenditures, potentiallydilutive issuance of our equity securities, our incurring of additional debtand contingent liabilities, and amortization expenses related to otherintangible assets that could adversely affect our business, operating resultsand financial condition.

***If we fail to maintain proper andeffective internal controls, our ability to produce accurate financialstatements could be impaired, which could adversely affect our operatingresults, our ability to operate our business and investors’ views of us.***

We must ensure that wehave adequate internal financial and accounting controls and procedures inplace so that we can produce accurate financial statements on a timely basis.We will be required to spend considerable effort on establishing andmaintaining our internal controls, which will be costly and time-consuming andwill need to be re-evaluated frequently. We have very limited experience indesigning and testing our internal controls. We are in the process ofdocumenting, reviewing and, if appropriate, improving our internal controls andprocedures, in accordance with Section 404 of the Sarbanes-Oxley Act of 2002,which will require annual management assessments of the effectiveness of ourinternal control over financial reporting. In addition, we will be required tofile a report by our independent registered public accounting firm addressingthese assessments beginning with our Annual Report on Form 10-K for the yearending December 30, 2007. Both we and our independent auditors will be testingour internal controls in anticipation of being subject to Section 404requirements and, as part of that documentation and testing, may identify areasfor further attention and improvement. Implementing any appropriate changes toour internal controls may entail substantial costs to modify our existing financialand accounting systems, take a significant period of time to complete, anddistract our officers, directors and employees from the operation of ourbusiness. These changes may not, however, be effective in maintaining theadequacy of our internal controls, and any failure to maintain that adequacy,or a consequent inability to produce accurate financial statements on a timelybasis, could increase our operating costs and could materially impair ourability to operate our business. In addition, investors’ perceptions that ourinternal controls are inadequate or that we are unable to produce accuratefinancial statements may seriously affect our stock price.

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**ITEM2.****   UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

None.

**ITEM3.****   DEFAULTSUPON SENIOR SECURITIES**

None.

**ITEM4.****   SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

The following is atabulation of the votes on proposals considered at our annual meeting ofstockholders held on June 4, 2007:

1.    To elect two directors to serve on our board of directors for a three-yearterm.
|               | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|---------------|------------|------------|------------|--------------|------------|
| Ross M. Jones |       | 54,761,434 |       | 6,693,957    |       |
| Glen T. Senk  |       | 59,796,501 |       | 1,658,890    |       |

 

In addition to theelection of Mr. Jones and Mr. Senk to an additional three-year term,the following directors’ terms of office as directors continued after themeeting: Bradley M. Bloom, Michael J. John, Lea Anne S. Ottinger,Leslie A. Blodgett, John C. Hansen and Karen M. Rose.

2.    To ratify the selection of Ernst & Young LLP as our independentregistered public accounting firm for the fiscal year ending December 30,2007.
| For     |   | 61,409,073 |   |
|---------|--------|------------|--------|
| Against |   | 42,711     |   |
| Abstain |   | 3,607      |   |

 

**ITEM5.****   OTHERINFORMATION**

None.

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**ITEM6.****   EXHIBITS**

Exhibits

The followingdocuments are filed as Exhibits to this report: 
| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                |
|-----------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                                           |
| 3.2 (1)         |       | Amended and Restated Certificate of Incorporation.                                                                                                                                             |
|            |       |                                                                                                                                                                                           |
| 3.4 (1)         |       | Amended and Restated Bylaws.                                                                                                                                                                   |
|            |       |                                                                                                                                                                                           |
| 10.50 (2)       |       | First Amendment to the Amended and Restated Credit  Agreement among Bare Escentuals Beauty, Inc., Bare Escentuals, Inc.,  BNP Paribas and the lenders party thereto dated March 23, 2007. |
|            |       |                                                                                                                                                                                           |
| 31.1            |       | Certification of the Chief Executive Officer, as  required by Section 302 of the Sarbanes-Oxley Act of 2002.                                                                              |
|            |       |                                                                                                                                                                                           |
| 31.2            |       | Certification of the Chief Financial Officer, as  required by Section 302 of the Sarbanes-Oxley Act of 2002.                                                                              |
|            |       |                                                                                                                                                                                           |
| 32.1            |       | Certification of the Chief Executive Officer and the  Chief Financial Officer as required by  Section 906 of the  Sarbanes-Oxley Act of 2002.                                        |

 

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(1)             Incorporatedby reference from our Quarterly Report on Form 10-Q for the period endedOctober 1, 2006 filed on November 11, 2007.

(2)             Incorporatedby reference from our Current Report on Form  8-K filed on April 2, 2007.

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, as amended, the registranthas duly caused this report to be signed on its behalf by the undersignedthereunto duly authorized.
|                       | BARE ESCENTUALS, INC. |
|-----------------------|-----------------------|
| Date: August 14, 2007 | By:                   | /s/ LESLIE A. BLODGETT |   |
|                  |                  | Leslie A. Blodgett |
|                  |                  | Chief Executive Officer and Director |
|                  | By:                   | /s/ MYLES B. MCCORMICK |   |
|                  |                  | Myles B. McCormick |
|                  |                  | Senior Vice President, Chief Financial Officer and  Chief Operations Officer |
|                       |                       |  |  |  |

 

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