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UNITED STATESSECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549

FORM
10-Q

x QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934  For
the quarterly period ended December 30, 2006


OR


o TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934 For
the transition period from ____ to ____


TrueYou.Com Inc.(Exact name of registrant as
specified in its charter)

|                                                              |                            |                                    
|------------------------------------------------------------- | -------------------------- | -----------------------------------
|Delaware                                                      | 000-51158                  | 13-4024017                         
|(State
  or other jurisdiction of incorporation)              | (Commission
  File Number) | (IRS
  Employer Identification No.)
|                                                              |                            |                                    
|Building No. 501, Fifth Floor
  7 Corporate Park, Norwalk, CT |                            | 06851                              
|(Address of principal
  executive offices)                    |                            | (Zip
  Code)                       

(203)295-2121(Registrants telephone number,
including area code)

Not Applicable(Former
name, former address and former fiscal year, if changed since last report)

|
|
|

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

Indicate by check mark
whether the registrant is a large accelerated filer, an accelerated filer, or a
non-accelerated filer. See definition of accelerated filer and large
accelerated filer in Rule 12b-2 of the Exchange Act. Large accelerated filer o Accelerated filer  o Non-accelerated
filer x

Indicate by check mark
whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes  o  No  x

APPLICABLE ONLY TO CORPORATE ISSUERS

The number of shares of
common stock, par value $0.001 per share, outstanding as of June 15, 2007 was
16,756,438.

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TABLE OF CONTENTS

|                |                                                                                                                                           |     
|--------------- | ----------------------------------------------------------------------------------------------------------------------------------------- | ----
|                |                                                                                                                                           | Page
|                |                                                                                                                                           |     
|PART I          | FINANCIAL INFORMATION                                                                                                                     |     
|                |                                                                                                                                           |     
|Item 1.         | Condensed
  Consolidated Financial Statements                                                                                             |     
|                |                                                                                                                                           |     
|                | Condensed
  Consolidated Balance Sheets as of December 30, 2006 (unaudited) and July 1,
  2006                                            | 1   
|                |                                                                                                                                           |     
|                | Condensed
  Consolidated Statements of Operations (unaudited) for the three and six
  monthsended December 30, 2006 and December 31, 2005 | 3   
|                |                                                                                                                                           |     
|                | Condensed
  Consolidated Statements of Cash Flows (unaudited) for the six
  months ended December 30, 2006 and December 31, 2005          | 4   
|                |                                                                                                                                           |     
|                | Notes to
  Condensed Consolidated Financial Statements                                                                                    | 5   
|                |                                                                                                                                           |     
|Item 2.         | Managements
  Discussion and Analysis of Financial Condition and Results of Operation                                                    | 30  
|                |                                                                                                                                           |     
|Item 3.         | Quantitative
  and Qualitative Disclosures about Market Risk                                                                              | 45  
|                |                                                                                                                                           |     
|Item 4.         | Controls
  and Procedures                                                                                                                 | 45  
|                |                                                                                                                                           |     
|                |                                                                                                                                           |     
|PART II         | OTHER INFORMATION                                                                                                                         |     
|                |                                                                                                                                           |     
|Item 1.         | Legal
  Proceedings                                                                                                                       | 46  
|                |                                                                                                                                           |     
|Item 6.         | Exhibits                                                                                                                                  | 46  
|                |                                                                                                                                           |     
|SIGNATURES      |                                                                                                                                           | 47  
|                |                                                                                                                                           |     
|EXHIBIT
  INDEX |                                                                                                                                           |     

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PART
I. FINANCIAL INFORMATION

Item 1. Financial Statements

TrueYou.Com Inc.
Condensed Consolidated Balance Sheets

|                                                                                                                                          |  |              |          |         |   |          |  
|----------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | -------- | ------- | - | -------- | -
|                                                                                                                                          |  | As of        |         
|                                                                                                                                         
|                                                                                                                                          |  | December 30, |          | July 1, |  
|                                                                                                                                          |  |             
|In
  thousands, except share and per share amounts                                                                                        |  | 2006         |          | 2006    |  
|                                                                                                                                         
|                                                                                                                                          |  | (Unaudited)  |          |         |   |         
|Assets:                                                                                                                                   |  |              |          |         |   |          |  
|Current assets:                                                                                                                           |  |              |          |         |   |          |  
|Cash and cash equivalents                                                                                                                 |  | $            | 2,814    |         | $ | 189      |  
|Restricted cash, current portion                                                                                                          |  |              | 1,616    |         |   | 1,602    |  
|Accounts receivable, net                                                                                                                  |  |              | 413      |         |   | 137      |  
|Inventories, net                                                                                                                          |  |              | 2,207    |         |   | 2,214    |  
|Prepaid Interest                                                                                                                          |  |              | 1,226    |         |   |         |  
|Other current assets                                                                                                                      |  |              | 1,485    |         |   | 1,009    |  
|                                                                                                                                          |  |              |          |         |   |          |  
|Total current assets                                                                                                                      |  |              | 9,761    |         |   | 5,151    |  
|                                                                                                                                          |  |              |          |         |   |          |  
|Property and equipment, net                                                                                                               |  |              | 12,748   |         |   | 12,981   |  
|Other assets                                                                                                                              |  |              | 899      |         |   | 855      |  
|Deferred financing costs, net                                                                                                             |  |              | 1,108    |         |   | 242      |  
|Restricted cash, non-current portion                                                                                                      |  |              | 786      |         |   | 845      |  
|Goodwill                                                                                                                                  |  |              | 18,072   |         |   | 18,072   |  
|Other intangibles, net                                                                                                                    |  |              | 4,137    |         |   | 5,025    |  
|                                                                                                                                          |  |              |          |         |   |          |  
|Total assets                                                                                                                              |  | $            | 47,511   |         | $ | 43,171   |  
|                                                                                                                                          |  |              |          |         |   |          |  
|                                                                                                                                          |  |              |          |         |   |          |  
|Liabilities and Shareholders deficit:                                                                                                    |  |              |          |         |   |          |  
|                                                                                                                                          |  |              |          |         |   |          |  
|Liabilities:                                                                                                                              |  |              |          |         |   |          |  
|Current liabilities:                                                                                                                      |  |              |          |         |   |          |  
|Accounts payable                                                                                                                          |  | $            | 7,225    |         | $ | 7,984    |  
|Accrued expenses and other current liabilities                                                                                            |  |              | 19,928   |         |   | 16,449   |  
|Deferred revenue                                                                                                                          |  |              | 9,418    |         |   | 8,273    |  
|Current portion of long term debt (net of debt discount of $18.0
  million and $0 as of December 30, 2006, and July 1, 2006 respectively) |  |              | 22,066   |         |   | 5,839    |  
|Senior Debt Current (net of debt discount of $0.9 million as of
July 1, 2006)                                                             |  |              |         |         |   | 9,146    |  
|                                                                                                                                          |  |              |          |         |   |          |  
|Total current liabilities                                                                                                                 |  |              | 58,637   |         |   | 47,691   |  
|Convertible securities                                                                                                                    |  |              | 122,826  |         |   | 197,565  |  
|Other long term liabilities                                                                                                               |  |              | 9,439    |         |   | 7,829    |  
|                                                                                                                                          |  |              |          |         |   |          |  
|Total liabilities                                                                                                                         |  |              | 190,902  |         |   | 253,085  |  
|                                                                                                                                          |  |              |          |         |   |          |  
|Commitments and contingencies                                                                                                             |  |              |          |         |   |          |  
|Shareholders deficit:                                                                                                                    |  |              |          |         |   |          |  
|Common stock, par value $0.001, authorized 20,000,000; issued and
  outstanding 14,995,513                                                |  |              | 15       |         |   | 15       |  
|                                                                                                                                          |  |              |          |         |   |          |  
|Additional paid-in capital                                                                                                                |  |              | 2,446    |         |   | 4,347    |  
|                                                                                                                                          |  |              |          |         |   |          |  
|Accumulated deficit                                                                                                                       |  |              | (145,852 | )       |   | (214,276 | )
|                                                                                                                                          |  |              |          |         |   |          |  

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1

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|                                                   |  |              |          |         |   |          |  
|-------------------------------------------------- |  | ------------ | -------- | ------- | - | -------- | -
|                                                   |  | As of        |         
|                                                   |  |              |         
|                                                   |  | December 30, |          | July 1, |  
|                                                   |  |             
|In
  thousands, except share and per share amounts |  | 2006         |          | 2006    |  
|                                                  
|                                                   |  |              |         
|                                                   |  |              |          |         |   |          |  
|Total shareholders deficit                        |  |              | (143,391 | )       |   | (209,914 | )
|                                                   |  |              |          |         |   |          |  
|                                                   |  |              |          |         |   |          |  
|Total liabilities and shareholders
deficit        |  | $            | 47,511   |         | $ | 43,171   |  
|                                                   |  |              |          |         |   |          |  

The accompanying notes are an integral part of the condensed
consolidated financial statements

2

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TrueYou.Com Inc.Condensed Consolidated Statements of Operations
(unaudited)

|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|------------------------------------------------------------- |  | ------------------- | ---------- | ------------------- | - | ------------------- | - | ------------------- | ---------- | - | - | ---------- | -
|                                                              |  | Three Months Ended  |            | Six Months Ended    |  
|                                                              |  |                     |            |                     |  
|In thousands, except share and per share amounts              |  | December 30,
  2006 |            | December 31,
  2005 |   | December 30,
  2006 |   | December 31,
  2005 |           
|                                                              |  |                     |            |                     |   |                     |   |                     |           
|Revenues:                                                     |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|Service                                                       |  | $                   | 5,176      |                     | $ | 6,091               |   | $                   | 9,824      |   | $ | 11,954     |  
|Retail and wholesale products                                 |  |                     | 2,001      |                     |   | 1,462               |   |                     | 4,615      |   |   | 3,364      |  
|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|Total
  Revenue                                               |  |                     | 7,177      |                     |   | 7,553               |   |                     | 14,439     |   |   | 15,318     |  
|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|Cost of
  Revenue:                                            |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|Service                                                       |  |                     | 3,638      |                     |   | 3,472               |   |                     | 6,557      |   |   | 6,860      |  
|Retail and wholesale products                                 |  |                     | 679        |                     |   | 572                 |   |                     | 1,743      |   |   | 1,360      |  
|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|Total
  Cost of Revenue                                       |  |                     | 4,317      |                     |   | 4,044               |   |                     | 8,300      |   |   | 8,220      |  
|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|Gross
  margin                                                |  |                     | 2,860      |                     |   | 3,509               |   |                     | 6,139      |   |   | 7,098      |  
|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|Stock based compensation
  (income) expense                   |  |                     | (3,169     | )                   |   | 150                 |   |                     | 1,012      |   |   | 150        |  
|Selling, general and
  administrative expenses                |  |                     | 10,733     |                     |   | 10,333              |   |                     | 21,700     |   |   | 18,305     |  
|Depreciation and
  amortization                               |  |                     | 1,135      |                     |   | 1,160               |   |                     | 2,301      |   |   | 2,269      |  
|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|Total
  operating expenses                                    |  |                     | 8,699      |                     |   | 11,643              |   |                     | 25,013     |   |   | 20,724     |  
|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|Operating loss                                                |  |                     | (5,839     | )                   |   | (8,134              | ) |                     | (18,874    | ) |   | (13,626    | )
|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|Interest expense, net                                         |  |                     | 1,706      |                     |   | 1,969               |   |                     | 4,384      |   |   | 3,070      |  
|Registration rights
  penalties                               |  |                     | 1,162      |                     |   |                    |   |                     | 2,324      |   |   |           |  
|Unrealized (gain) loss on
  convertible securities            |  |                     | (53,470    | )                   |   | 137,749             |   |                     | (94,006    | ) |   | 137,749    |  
|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|Income (loss) before
  income tax provision                   |  |                     | 44,763     |                     |   | (147,852            | ) |                     | 68,424     |   |   | (154,445   | )
|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|Income tax provision                                          |  |                     |           |                     |   |                    |   |                     |           |   |   |           |  
|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|Net income (loss)                                             |  |                     | 44,763     |                     |   | (147,852            | ) |                     | 68,424     |   |   | (154,445   | )
|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|Accrual / (forfeitures) of
  dividends on preferred stock     |  |                     | 383        |                     |   | (102                | ) |                     | 765        |   |   | 362        |  
|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|Net income (loss)
  applicable to common shareholders         |  | $                   | 44,380     |                     | $ | (147,750            | ) | $                   | 67,659     |   | $ | (154,807   | )
|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|Basic and diluted income
  (loss) per common share:           |  | $                   | 2.96       |                     | $ | (9.85               | ) | $                   | 4.51       |   | $ | (10.32     | )
|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  
|Weighted average common shares outstanding, basic and
diluted |  |                     | 14,995,513 |                     |   | 14,995,513          |   |                     | 14,995,513 |   |   | 14,995,513 |  
|                                                              |  |                     |            |                     |   |                     |   |                     |            |   |   |            |  

The accompanying notes are an integral part of the
condensed consolidated financial statements

3

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TrueYou.Com Inc.
Consolidated Statements of Cash Flows(Unaudited)

|                                                                                       |  |                     |         |                     |   |          |  
|-------------------------------------------------------------------------------------- |  | ------------------- | ------- | ------------------- | - | -------- | -
|                                                                                       |  | Six Months Ended    |        
|                                                                                      
|In
thousands                                                                           |  | December 30,
  2006 |         | December 31,
  2005 |  
|                                                                                      
|Cash flows from operating activities:                                                  |  |                     |         |                     |   |          |  
|Net income (loss)                                                                      |  | $                   | 68,424  |                     | $ | (154,445 | )
|Adjustments to reconcile net income (loss)
  to net cash used in operating activities: |  |                     |         |                     |   |          |  
|Depreciation and amortization                                                          |  |                     | 2,300   |                     |   | 2,268    |  
|Loss on disposals                                                                      |  |                     | 171     |                     |   | 35       |  
|Amortization of deferred financing costs                                               |  |                     | 153     |                     |   | 44       |  
|Amortization of debt discount                                                          |  |                     | 1,294   |                     |   |         |  
|Stock based compensation (income) expense                                              |  |                     | (1,012  | )                   |   | 150      |  
|Non-cash interest expense                                                              |  |                     | 1,753   |                     |   | 1,389    |  
|Unrealized (gain)
  loss on convertible securities                                     |  |                     | (94,006 | )                   |   | 137,749  |  
|Changes in operating assets and liabilities:                                           |  |                     |         |                     |   |          |  
|Inventories                                                                            |  |                     | 7       |                     |   | (555     | )
|Accounts receivable                                                                    |  |                     | (276    | )                   |   | 44       |  
|Other current assets                                                                   |  |                     | (1,983  | )                   |   | (335     | )
|Other assets                                                                           |  |                     | (44     | )                   |   | (33      | )
|Accounts payable                                                                       |  |                     | (759    | )                   |   | 282      |  
|Accrued expenses and other current
  liabilities                                       |  |                     | 2,057   |                     |   | 935      |  
|Deferred revenue                                                                       |  |                     | 1,145   |                     |   | 330      |  
|Other long term liabilities                                                            |  |                     | 1,486   |                     |   | (348     | )
|                                                                                       |  |                     |         |                     |   |          |  
|Net cash used in operating
activities                                                  |  |                     | (19,290 | )                   |   | (12,490  | )
|Cash flows from investing activities:                                                  |  |                     |         |                     |   |          |  
|Capital expenditures                                                                   |  |                     | (1,350  | )                   |   | (2,015   | )
|Purchase of intangible asset                                                           |  |                     |        |                     |   | (113     | )
|                                                                                       |  |                     |         |                     |   |          |  
|Net cash used in investing activities                                                  |  |                     | (1,350  | )                   |   | (2,128   | )
|Cash flows provided by financing activities:                                           |  |                     |         |                     |   |          |  
|Cash overdraft                                                                         |  |                     |        |                     |   | (163     | )
|Restricted cash                                                                        |  |                     | 45      |                     |   | (673     | )
|Proceeds of issuance of debt                                                           |  |                     | 32,450  |                     |   |         |  
|Repayment of long term debt                                                            |  |                     | (8,250  | )                   |   | (900     | )
|Loan fees                                                                              |  |                     | (980    | )                   |   |         |  
|Proceeds of issuance of TrueYou Series D
  Preferred stock                             |  |                     |        |                     |   | 14,942   |  
|Proceeds of issuance of KAAI Series G
  Preferred stock                                |  |                     |        |                     |   | 10,058   |  
|Proceeds of issuance of KAAI Series F
  Preferred stock                                |  |                     |        |                     |   | 4,754    |  
|                                                                                       |  |                     |         |                     |   |          |  
|Net cash provided by financing
activities                                              |  |                     | 23,265  |                     |   | 28,018   |  
|                                                                                       |  |                     |         |                     |   |          |  
|Net increase
  in cash and cash equivalents                                            |  |                     | 2,625   |                     |   | 13,400   |  
|Cash and
  cash equivalents - beginning of period                                      |  |                     | 189     |                     |   | 173      |  
|                                                                                       |  |                     |         |                     |   |          |  
|Cash and
  cash equivalents - end of period                                            |  | $                   | 2,814   |                     | $ | 13,573   |  
|                                                                                      
|Supplemental cash flow information                                                     |  |                     |         |                     |   |          |  
|Non-cash financing activities:                                                         |  |                     |         |                     |   |          |  
|Preferred
  stock dividends, net of preferred stock forfeitures                        |  | $                   | 765     |                     | $ | 362      |  
|Reclassification
  of preferred stock into convertible securities                      |  |                     |        |                     |   | 28,166   |  
|Beneficial
  conversion feature on preferred stock                                     |  |                     |        |                     |   | 2,830    |  
|Exchange of
  KAAI accrued dividends for TrueYou Series B Preferred Stock              |  |                     |        |                     |   | 464      |  
|Exchange of KAAI long term debt for TrueYou Series B Preferred Stock                   |  |                     |        |                     |   | 19,205   |  
|Exchange of KAAI accrued interest for TrueYou Series B Preferred Stock                 |  |                     |        |                     |   | 1,598    |  
|Classification of KAAI warrants issued with KAAI Preferred stock as liabilities        |  |                     |        |                     |   | 935      |  
|Exchange of senior debt for subordinated debt                                          |  |                     | 1,750   |                     |   |         |  
|Warrants issued with debt                                                              |  |                     | 19,267  |                     |   |         |  

The accompanying notes are an integral part of the condensed
consolidated financial statements

4

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Unless
otherwise indicated: references in these Notes to TrueYou refer to
TrueYou.Com Inc.; references to KAAI refer to Klinger Advanced Aesthetics,
Inc. and its consolidated subsidiaries; references to the Company, refer to
TrueYou.Com Inc. and its consolidated subsidiaries (including KAAI); and the
terms fiscal quarter and three months in this Quarterly Report on Form 10-Q
refer to the quarter ended December 30, 2006.

1. Basis of Presentation

On
May 7, 2007, the Company entered into a Purchase and Sale Agreement pursuant to
which it sold all of its spa/salons to GK Acquisition LLC, an unaffiliated
third party (see Subsequent Events Note 10).

The
Company adopted a plan to sell the spa/salons in May 2007 and, accordingly the
Company will present the operations of the stores as discontinued operations
beginning in the fourth quarter of the current fiscal year. The consolidated
financial statements presented herein include the results of operations for the
spas/salons in continuing operations for the periods presented.

The
Company offers both cosmetic services and medical procedures to customers under
one delivery system and combines them with salon and spa services together
under a single brand, giving clients access to top service providers, unique
treatments and predictable results in a state of the art environment. The
Company has developed a skin care line of products (Cosmedicine TM or
Cosmedicine) which is being distributed through Sephora USA, Inc. stores and
the Companys own facilities. The Company is the owner of the Cosmedicine
trademark. The Company co-brands its trade name with the trade names of the
salons and spas that it has acquired. The Companys salons and spas share
certain corporate resources such as senior management and administrative
services. As of May 31, 2007, and as a result of the sale of the spa/salons
described above, the Company had 29 employees. As of December 30, 2006 the
Company had 542 employees.

The
consolidated financial statements presented herein pertain to the Company and
its subsidiaries on a consolidated basis. All significant intercompany accounts
and transactions have been eliminated in consolidation.The Company considers that it operates in one
segment for spa and salon domestic operations.

The
accompanying condensed consolidated financial statements included herein have
been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission for interim financial information. In the
opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Accordingly, they do not include all of the information and footnotes required
by accounting principles generally accepted in the United States of America for
complete financial statement presentation and should be read in conjunction
with the Companys audited consolidated financial statements and related
footnotes thereto for the fiscal year ended July 1, 2006 included in the
Companys Annual Report on Form 10-K filed with the Commission on February 6,
2007.

The
Companys quarterly results have included the operating results of the spa/salons
and the operating results for any quarter are therefore not necessarily
indicative of results that may be otherwise expected for the entire year.

Beginning
in fiscal year 2006, the Company began following the standard fiscal year of
the retail industry, which is a 52 or 53 week period, with the end of a period
being the closest Saturday to the end of a month.

5

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Going
Concern Disclosure:The
accompanying financial statements have been prepared on the going concern basis
which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. Since its inception, the Company
has experienced operating losses and negative cash flows from operations. As of
December 30, 2006, the Company had an accumulated deficit of $145.9 million and
a working capital deficiency of $48.9 million. Included in the Companys net
deficit at December 30, 2006 is the remeasurement of convertible securities.
Cumulative charges recorded through the remeasurement of this obligation
amounted to $38.7 million. These factors raise substantial doubt about the
Companys ability to continue as a going concern. The Companys ability to
continue as a going concern is ultimately dependent on its ability to increase
sales and reduce expenses to a level that will allow it to operate profitably
and sustain positive operating cash flows and raise additional capital. There
have been no adjustments to the financial statements to reflect the outcome of
this uncertainty. The Company has had several recent financings, with the most
recent being completed on May 7, 2007 (see Subsequent Events Note 10). There is
no assurance that the recent financings will be sufficient to fund operations
until sales and profitability improves such that the Company is able to operate
from internally generated cash flows.

2. Summary of Significant
Accounting Policies

Use of Estimates

In
preparing the consolidated financial statements, management is required to make
estimates and assumptions that affect the reported amounts in the consolidated
financial statements and accompanying notes. The more significant management
estimates are the valuation of goodwill and other intangibles, useful lives of
property and equipment and intangible assets, fair value of assets acquired in
business combinations, provisions for inventory obsolescence, deferred revenue
expirations and various contingencies. Actual results could differ from those
estimates. Changes in facts and circumstances may result in revised estimates,
which are recorded in the period in which they become known.

Revenue
Recognition

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | 
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
|  | The Company
  records revenue based on the following types of product and service
  offerings:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | 
| | Company run stores, medical, and internet
  sales - revenue is recognized for services rendered
  or products sold at the time when the service is performed or the item sold.
  When a gift card is purchased for a future service or product, the value of
  the card is recorded as a liability. In the past, we offered paper gift cards.
  For these paper cards, the entire
  liability remains on the balance sheet until the earlier of redemption or 36
  months, for non-escheatable states. It is our historical experience that the
  likelihood of redemption after 36 months is remote. After 36 months, 80% of
  the remaining liability is relieved and recorded as other income. After 48
  months, another 10% of the liability is relieved and recorded as other
  income. After 60 months, the last 10% of the remaining liability is relieved
  and recorded as other income. For escheatable states, the liability remains
  on the books until escheatment. Currently the only type of gift cards offered
  are electronic cards. For electronic cards, the entire liability remains on
  the books for the first year, less any redemptions. After the first year, the
  liability is reduced by five dollars per month as an inactivity fee and
  recorded to other income.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | 
| | Cosmedicine sales to Sephora  revenue is recognized as sales are made
  to Sephora. At the end of each quarter, an accrual is made for anticipated
  returns due to damages, store testers, and product with limited remaining
  code life.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

6

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Cash and Cash
Equivalents

Cash
and cash equivalents consist of cash and investments with maturities of ninety
days or less.

Restricted Cash

Restricted
cash represents an escrow account for prefunded interest on senior debt and
certificates of deposit to collateralize leases. The Company categorizes the
restricted cash as current or long term based on the date the restriction is
expected to lapse.

Inventories

Inventories
consist principally of hair care and skin care products held either for retail
sale or for use in salon, spa and medical services. Inventories are stated at
the lower of cost or market on a first-in, first-out basis.

Provisions
for Inventory Obsolescence

The
Company records provisions for estimated obsolescence of inventory. The
Companys estimates consider the cost of inventory, forecasted demand, the
shelf life of the inventory and our historical experience. If there are changes
to these estimates, additional provisions for inventory obsolescence may be
necessary.

Property and
Equipment

Property
and equipment are carried at cost, less accumulated depreciation and amortization.
Property, equipment and improvements to leased premises are depreciated using
the straight-line method over the estimated useful lives of the assets or when
applicable, the term of the lease, whichever is shorter. Estimated useful lives
generally range from 5 to 15 years for leasehold improvements and 3 to 7 years
for fixtures and equipment. Repair and maintenance expenses, which do not
improve or extend the life of the respective assets, are charged directly to
expense as incurred. The Company capitalizes all property and equipment
purchases in excess of $1,000. The assets and related depreciation and
amortization accounts are adjusted for property retirements and disposals with
the resulting gain or loss included in the Companys Consolidated Statements of
Operations. Fully depreciated assets remain in the accounts until retired from
service.

7

---



Goodwill

Goodwill
is tested for impairment annually or more frequently in accordance with the
provisions of Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets. Fair values are estimated based on the
Companys best estimate of the expected present value of future cash flows and
compared with the corresponding carrying value of the reporting unit, including
goodwill. The Company considers its consolidated operations to be a single
reporting unit when it tests for goodwill impairment due to the similar
customer base and use of the Klinger name for its products and services, and
the way in which management reviews the operations and allocates its resources.
The Company tested for goodwill at July 1, 2006 and determined that the
estimated fair value of the reporting unit exceeded its carrying amount,
indicating no impairment of goodwill. Subsequent to the end of the quarter
ended December 30, 2006, however, the Company believes that events have
occurred that have fully impaired its goodwill (see Subsequent Events Note 10).
As a result, the Company anticipates a charge of $18.1 million in its fiscal
quarter ended March 31, 2007 to write-off all of its goodwill.

The
Companys impairment review process is based on a discounted future cash flow
approach that uses estimates of revenues, driven by assumed growth rates,
estimated future gross margin and expense rates, as well as acquisition
integration and maturation, and appropriate discount rates. These estimates are
consistent with the plans and estimates that are used to manage the underlying
business.

Intangible
Assets

Certain
intangible asset amounts are based on purchase price allocations associated
with acquisitions and are based upon valuations conducted by independent
appraisers.

All
intangible assets, other than goodwill, have been assigned an estimated finite
useful life, and are amortized on a straight line basis over the number of
years that approximate their respective useful lives (ranging from two to six
years).

Measurement of
Impairment of Long-Lived Assets and Intangible Assets Subject to Amortization

When
events and circumstances indicate that assets might be impaired and the
undiscounted cash flows estimated to be generated by those assets are less than
the carrying amount of those assets, the Company records impairment losses with
respect to those assets.

The
impairment charge is determined based upon the amount by which the net book
value of the assets exceeds their estimated fair value. In determining the fair
value of the assets, the Company considers market trends, published values for
similar assets, recent transactions involving sales of similar assets or quotes
from third party appraisers. In making these determinations, the Company also
uses certain assumptions, including, but not limited to, the estimated
discounted future cash flows expected to be generated by these assets, which
are based on additional assumptions such as asset utilization, length of
service the asset will be used in the Companys operations and estimated
residual values.

Debt Issue Costs

Debt costs and transaction fees, which are
directly associated with the issuance of senior notes, are recorded on the
balance sheet as deferred financing costs and amortized (charged to interest
expense) using the straight line method over the term of the related notes. If
the senior notes are redeemed, the unamortized debt issuance costs and
transaction fees related to the senior notes being redeemed will be charged to
expense in that period.

8

---



Income Taxes

The
Company provides for federal and state income taxes currently payable, as well
as for those deferred due to temporary differences between reporting income and
expenses for financial statement purposes versus tax purposes. Deferred tax
assets and liabilities are recognized for the future tax consequences attributable
to differences between the carrying amount of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes.
Deferred tax assets and liabilities are measured using the enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recoverable or settled. Realization of deferred
tax assets is ultimately dependent upon future taxable income. The effect of a
change in tax rates is recognized as income or expense in the period of the
change.

Stock-Based
Compensation

In
December 2004, the FASB issued SFAS No. 123(R), Share Based Payment. This
statement establishes standards for the accounting for transactions in which an
entity exchanges its equity instruments for goods and services. It focuses
primarily on accounting for transactions in which an entity obtains employee
services in share-based payment transactions (employee stock options). The
statement requires the measurement of the cost of employee services received in
exchange for an award of equity instruments (such as employee stock options) at
fair value on the grant date. That cost will be recognized over the period
during which an employee is required to provide services in exchange for the award
(the requisite service period). The Company adopted FAS 123R, Share-Based
payment, effective for its year ended June 30, 2004, applying the modified
retrospective method. Inherent in that model are assumptions including the
volatility of our Common Stock, forfeiture rate, and the length of time which
we expect an option to remain outstanding.

Income (Loss) Per Share

Basic
income (loss) per share represents the net income (loss) applicable to Common
Shareholders divided by the weighted average number of common shares
outstanding during the measurement period. Diluted income (loss) per share
represents the net loss applicable to Common Shareholders divided by the
weighted average number of common shares outstanding during the measurement
period while also giving effect to all potentially dilutive securities that
were outstanding during the period. Potential dilutive common stock equivalents
for the three months ended December 30, 2006 consist of those related to:
convertible preferred stock of 448.2 million, warrants 164.5 million, stock
options 38.0 million, and registration rights 11.4 million. These common stock
equivalents were not considered to be dilutive as there were not sufficient
authorized shares to issue Common Stock. For the three months ended December
31, 2005, the impact of any convertible securities would be anti-dilutive due
to either losses incurred during the period or out-of-the-money options and are
not included in the diluted loss per share calculation.

Software Development Costs

The
Company incurs costs for the development of its Klinger 360° Best
Practices Aesthetics System 
(the
K360), which is a comprehensive software and hardware practice management
system that facilitates the delivery of evidenced based best practices
aesthetic services that is to be sold, leased, or licensed to third parties in
the future. All software development costs have been appropriately accounted
for in accordance with SFAS 86 Accounting for the Costs of Computer Software
to be Sold, Leased or Otherwise Marketed. All costs are expensed as incurred
as technological feasibility has not yet been established.

Disclosures about Fair Value of Financial
Instruments

The
following methods and assumptions were used to estimate the fair value of each
class of financial instrument for which it is practicable to estimate that
value:

9

---



Cash and
short-term investmentsFor
those short-term instruments, the carrying amount is a reasonable estimate of
fair value.

Convertible
SecuritiesThe Company remeasures its
convertible securities in compliance with EITF 00-19, based on the fair value
of its Common Stock into which they are convertible, since there are currently
insufficient shares authorized to allow conversion. The fair value of the Common
Stock is based on the price paid for a share of the stock closest to the
measurement date

Recently Issued
Accounting Standards

In
June 2006, FASB issued FIN 48, Accounting for Uncertainty in Income Taxes an
interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in an enterprises financial statements
in accordance with FASB Statement No. 109, Accounting
for Income Taxes. This Interpretation prescribes a recognition
threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return.
This Interpretation also provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure, and
transition. This guidance is effective for fiscal years beginning after
December 15, 2006. We believe the impact of the adoption of FIN 48 will not be
significant to the Companys consolidated financial statements.

In
September 2006, the FASB issued SFAS 157, Fair Value Measurements. SFAS 157
defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles (GAAP), and expands disclosures about
fair value measurements. This guidance becomes effective for the first
reporting period beginning after November 15, 2007. The Company is assessing the impact of the adoption of SFAS 157 on its
consolidated financial statements.

In
September 2006, the FASB issued SFAS 158, Employers Accounting for Defined
Benefit Pension and Other Postretirement Plansan amendment of FASB Statements
No. 87, 88, 106, and 132(R). SFAS 158 requires an employer to recognize the
overfunded or underfunded status of a defined benefit postretirement plan
(other than a multiemployer plan) as an asset or liability in its statement of
financial position and to recognize changes in that funded status in the year
in which the changes occur through comprehensive income. This guidance is effective
as of the end of the fiscal year for years ending after December 15, 2006. We
believe the impact of the adoption of SFAS 158 will not be significant to the
Companys consolidated financial statements.

3. Property and Equipment, net

Following
are the components of property and equipment included in the Consolidated
Balance Sheets as of December 30, 2006 and July 1, 2006:

|                                            |                      |        |                 |   |        |  
|------------------------------------------- | -------------------- | ------ | --------------- | - | ------ | -
|(Dollars
  in thousands)                    | December 30, 
  2006 |        | July 1, 
  2006 |  
|                                            |                      |        |                 |  
|                                            |                      |        |                 |   |        |  
|Furniture
  and fixtures                    | $                    | 2,914  |                 | $ | 2,337  |  
|Machinery
  and equipment                   |                      | 3,331  |                 |   | 3,078  |  
|Leasehold
  improvements                    |                      | 11,610 |                 |   | 11,261 |  
|Capital
  lease assets                      |                      | 439    |                 |   | 439    |  
|                                            |                      |        |                 |   |        |  
|                                            |                      |        |                 |   |        |  
|Total
  property and equipment              |                      | 18,294 |                 |   | 17,115 |  
|                                            |                      |        |                 |   |        |  
|Accumulated
  depreciation and amortization |                      | (5,546 | )               |   | (4,134 | )
|                                            |                      |        |                 |   |        |  
|                                            |                      |        |                 |   |        |  
|Total
  property and equipment, net         | $                    | 12,748 |                 | $ | 12,981 |  
|                                            |                      |        |                 |   |        |  

10

---



Depreciation
expense for the three months ended December 30, 2006 and
December 31, 2005 was $0.7 and $0.5 million, respectively, and for the six
months ended December 30, 2006 and December 31, 2005 was $1.4 and $1.0 million,
respectively.

4. Accrued Expenses and Other
Current Liabilities

The
table below sets forth the Companys accrued expenses and other current
liabilities as of December 30, 2006 and July 1, 2006.

|                                                     |  |                     |        |               |   |        | 
|---------------------------------------------------- |  | ------------------- | ------ | ------------- | - | ------ | 
|(Amounts in
  thousands)                             |  | December 31,
  2006 |        | July1,
  2006 |  
|                                                     |  |                     |        |               |   |        | 
|                                                     |  |                     |        |               |   |        | 
|Accrued interest                                     |  | $                   | 3,393  |               | $ | 2,735  | 
|Accrued dividends                                    |  |                     | 3,239  |               |   | 2,474  | 
|Accrued management Fees                              |  |                     | 1,714  |               |   | 1,714  | 
|Due to Johns Hopkins  consulting fees               |  |                     | 1,528  |               |   | 1,300  | 
|                                                     |  |                     |        |               |   |        | 
|Accrued
  registration penalties (a)                 |  |                     | 3,871  |               |   | 1,547  | 
|                                                     |  |                     |        |               |   |        | 
|Payroll, benefits and other                          |  |                     | 6,183  |               |   | 6,679  | 
|                                                     |  |                     |        |               |   |        | 
|Total Accrued Expenses and Other Current Liabilities |  | $                   | 19,928 |               | $ | 16,449 | 
|                                                     |  |                     |        |               |   |        | 

(a)  Registration Rights
Penalties

On
September 1, 2005, KAAI entered into an agreement with various stockholders
regarding the registration of the shares of common stock underlying the
securities they had purchased. The agreement, which was assumed by the Company
in connection with the Share Exchange Agreement, included an obligation to file
a resale registration statement covering the shares by February 18, 2006, which
was 60 days after the closing date of the Share Exchange Agreement (the Filing
Date). The Company did meet this requirement as it filed a Registration
Statement on Form S-1 on January 24, 2006. In addition, the agreement required
that the registration statement be declared effective by June 3, 2006 (105 days
after the Filing Date), which the Company did not meet. Failure under either of
the obligations under the original agreement required a cash payment. On
December 20, 2006, an amendment to the agreement was signed which required the
payment of damages through the issuance of warrants to purchase shares of
Company Common Stock, at an exercise price of $0.001 per share. The number of
Common Stock warrants to be issued for each period is calculated by dividing
the liquidated damages of 1% of the aggregate purchase price paid by such
stockholder for each 30-day period or pro rata portion, to the holders, by the
higher of (A) the average closing trading price of the Common Stock during the
30-day period immediately before the last day of the relevant period and (B)
$0.211254. The shareholders may also elect to receive a portion of the damages
in cash.

On
December 22, 2005, the Company entered into an agreement with certain
stockholders regarding the registration of the shares of common stock
underlying the securities they had acquired from the Company. The agreement
included an obligation to file a resale registration statement covering the
shares by January 21, 2006 which was 30 days after the December 22, 2005
closing date of the sale of securities to

11

---



such stockholders. Due to
the fact that the Company did not meet this requirement, it is subject to a
one-time penalty of 3% of the aggregate purchase price paid by such
stockholders. In addition, the agreement required the Company to put into
effect the planned authorized share increase, which would increase the number
of authorized shares of Common Stock that the Company is authorized to issue
from 20,000,000 to 60,000,000 (Authorized Share Increase) by May 1, 2006 which
was 130 days after the closing date of the sale of securities to such
stockholders. Due to the fact that the Company did not meet this requirement it
may be subject to a one time penalty of 3% of the aggregate purchase price paid
by such stockholders and ongoing monthly charges of 1.5% of the aggregate
purchase price paid by such stockholders for each 30-day period or pro rata
portion. Failure under either of the obligations requires a cash payment.

Due
to the fact that the Company did not meet the effective date requirement by
June 3, 2006 or the Authorized Share Increase requirement, a non-operating
charge has been recorded for the combined estimated penalties of $1.2 million
and $2.3 during the three months and six months ended December 30, 2006. This
includes charges of $0.4 million per month. There is no maximum included in the
agreement and penalties will continue to accrue for each agreement until the
Company is able to achieve compliance. The cumulative obligation of $3.9
million represents the aggregate registration penalties payable through
December 30, 2006 and is included in Accrued expenses and other current
liabilities on the Consolidated Balance Sheet.

Concurrent
with the May 7, 2007 financing (see Subsequent Events Note 10), holders of the
registration rights described above, agreed to waive any additional
registration rights penalties incurred by the Company after December 30, 2006.

5. Long-Term Debt and Other Long
Term Liabilities

The
Companys long-term debt and other long-term liabilities as of December 30,
2006 and July 1, 2006 consist of the following:

|                                                                         |  |                   |           |                    |  |                     |  |             |         |  |   |         | 
|------------------------------------------------------------------------ |  | ----------------- | --------- | ------------------ |  | ------------------- |  | ----------- | ------- |  | - | ------- | 
|                                                                         |  |                   |           |                    |  | Amounts Outstanding | 
|                                                                         |  |                   |           |                    |  |                     | 
|(Dollars in thousands)                                                   |  | Maturity 
  Dates |           | Interest Rate 
  % |  | December 30,2006    |  | July 1,2006 |        
|                                                                         |  |                   |           |                    |  |                     | 
|                                                                         |  |                   |           |                    |  |                     |  |             |         |  |   |         | 
|Senior debt (a)                                                          |  |                   | 3/31/2009 |                    |  | 12%                 |  | $           |        |  | $ | 9,146   | 
|                                                                         |  |                   |           |                    |  |                     |  |             |         |  |   |         | 
|Senior debt (b)                                                          |  |                   | 6/30/2010 |                    |  | Prime + 2%          |  |             | 15,860  |  |   |        | 
|                                                                        
|Subordinated debt (c)                                                    |  |                   | 7/1/2010  |                    |  | 12%                 |  |             | 5,206   |  |   | 4,839   | 
|                                                                        
|Other long term debt                                                     |  |                   |           |                    |  |                     |  |             |         |  |   |         | 
|Note payable                                                             |  |                   | Varies    |                    |  | 5%                  |  |             | 1,000   |  |   | 1,000   | 
|                                                                        
|Other long term liabilities                                              |  |                   |           |                    |  |                     |  |             |         |  |   |         | 
|Long term licensing obligation                                           |  |                   | 12/1/2008 |                    |  | 6%                  |  |             | 3,618   |  |   | 3,818   | 
|Deferred construction allowance                                          |  |                   |           |                    |  |                     |  |             | 120     |  |   | 130     | 
|Capital lease obligations                                                |  |                   | Varies    |                    |  | 6%                  |  |             | 298     |  |   | 393     | 
|                                                                         |  |                   |           |                    |  |                     |  |             |         |  |   |         | 
|Deferred Liability - Sephora                                             |  |                   |           |                    |  |                     |  |             | 5,000   |  |   | 5,000   | 
|                                                                         |  |                   |           |                    |  |                     |  |             |         |  |   |         | 
|Stock based awards                                                       |  |                   |           |                    |  |                     |  |             | 2,147   |  |   |        | 
|                                                                         |  |                   |           |                    |  |                     |  |             |         |  |   |         | 
|Convertible securities                                                   |  |                   |           |                    |  |                     |  |             | 122,826 |  |   | 197,565 | 
|                                                                         |  |                   |           |                    |  |                     |  |             |         |  |   |         | 
|                                                                         |  |                   |           |                    |  |                     |  |             |         |  |   |         | 
|Total                                                                    |  |                   |           |                    |  |                     |  |             | 156,075 |  |   | 221,891 | 
|                                                                         |  |                   |           |                    |  |                     |  |             |         |  |   |         | 
|Less current portion and amount included in
  other current liabilities* |  |                   |           |                    |  |                     |  |             | 23,810  |  |   | 16,497  | 
|                                                                         |  |                   |           |                    |  |                     |  |             |         |  |   |         | 
|                                                                         |  |                   |           |                    |  |                     |  |             |         |  |   |         | 
|Long-term portion                                                        |  |                   |           |                    |  |                     |  | $           | 132,265 |  | $ | 205,394 | 
|                                                                         |  |                   |           |                    |  |                     |  |             |         |  |   |         | 

---

*
Portion included in other current liabilities amounted to $1,744 and $1,512 at
December 30, 2006 and July 1, 2006, respectively.

12

---



(a) - Senior Debt - TICC

On
July 6, 2006 the Company repaid $8.3 million of the senior debt from Technology
Investment Capital Corp. (TICC) with proceeds from a financing it completed
with Laurus Master Fund, Ltd. (Laurus), and the remaining $1.7 million
outstanding was converted into the $5.2 million subordinated loan discussed
below. As a result of the early repayment of the debt, the unamortized discount
of $0.9 million and unamortized financing costs of $0.2 million were written
off and recorded as interest expense upon repayment in the six months ended
December 30, 2006.

(b) - Senior Debt - Laurus

On
July 6, 2006, the Company closed on a financing and issued to Laurus a Secured
Term Note in the aggregate principal amount of $25.0 million (the Laurus
Note) and issued to Laurus series A warrants, series B warrants and series C
warrants to purchase up to 37,351,824 shares, 6,839,394 shares and 6,693,875
shares, respectively, of its common stock.

The
Company placed $2.5 million (the Interest Amount) of the proceeds in a
restricted account to be utilized to pre-fund interest for the first year of
the Laurus Note. Closing costs of $0.9 million were incurred by the Company
relating to this debt. These costs were recorded as deferred financing costs
and will be amortized to interest expense over the term of the note using
straight-line amortization. The balance of $21.6 was placed into a restricted
cash account which was released on July 11, 2006 when the Company satisfied the
conditions associated with the Laurus Note. The Company used $8.3 million to
pay off the existing senior debt held by TICC and an additional $0.1 million
representing unpaid interest and other costs owed to TICC. Also in conjunction
with the payoff of the senior debt and all related interest and fees was the
release of $1.6 million of restricted cash previously held for interest
payments. The restriction on the funds was removed in January 2007.

The
Laurus Note matures on June 30, 2010 and interest accrues at a rate per annum
equal to the prime rate, plus two percent (2%) per annum, payable monthly, in
arrears, and commenced on August 1, 2006. These payments are approximately $0.2
million per month. Commencing on August 1, 2007, the Company will make monthly
principal payments to Laurus in an amount equal to $0.4 million together with
any accrued and unpaid interest on such portion of the outstanding principal amount
plus any and all other unpaid amounts which are then owing under the Note. The
Companys payment obligations are guaranteed by the Companys subsidiaries and
are secured by all of the Companys and such subsidiaries assets.

The
Company calculated a debt discount attributable to the value of these warrants
to be $10.3 million, which will be amortized over the term of the Note using
the effective interest method (see Note 8 for a discussion of assumptions used
to value the warrants). As of December 30, 2006, this Note carried a debt
discount of $9.1 million. For the three and six months ended December 30, 2006,
the Company recorded interest expense of $0.6 million and $1.2 million
respectively, related to the amortization of the debt

13

---



discount.  The warrants have a 10-year term and an
exercise price equal to $0.01 per share, or in certain circumstances, may be
exercised on a cashless basis.  If,
prior to the fourteenth month anniversary of June 30, 2006, (i) the Companys
obligations under the Note have been reduced to $12.5 million or less, then the
series B warrants will automatically be cancelled and terminated; and (ii) the
Companys obligations under the Note have been reduced to zero, then the
series C warrants will automatically be cancelled and terminated. The Company
is obligated to file a registration statement with the Securities and Exchange
Commission covering the resale of the shares underlying the warrants. As a result
of the May 7, 2007 refinancing discussed below, the Company will cancel the combined
13,533,269 warrants held by Laurus, due to the prepayment.

The
Company has also agreed to use its best efforts to amend its certificate of
incorporation to increase the number of authorized shares of its Common Stock
to such number as shall be sufficient to permit the exercise in full of the
warrants.  If Laurus notifies the Company
at any time prior to the effective date of such amendment that it desires to
exercise the warrants prior to such effective date, the Company will promptly
issue, in exchange for the warrants, substitute warrants exercisable to
purchase that number of shares of its series B convertible preferred stock that
are, upon effecting the Authorized Share Increase immediately convertible into
the number of shares of our Common Stock that would then have been issuable
upon exercise of the warrants in full if its certificate of incorporation had
then provided for sufficient authorized shares of its Common Stock to satisfy
such exercise, and otherwise containing substantially the same terms and
provisions as the warrants.

On
March 8, 2007, Laurus sent the Company a notice of default relating to the
$25.0 million Note and also the $1.0 million bridge loan obtained on December
    22, 2006 (see Subsequent Events Note 10).
As a result of this default, the Company has classified all its
remaining debt as current as of December 30, 2006, in its Consolidated Balance
Sheet.

On
May 7, 2007 the Company entered into an Amended and Restated Securities
Purchase Agreement with Laurus pursuant to which the Company sold to Laurus a
Secured Term Note in the aggregate principal amount of $54,650,000.  On the Closing Date, the 25.0 million
obligation of the Company to Laurus under the June 30, 2006 note and an
additional $3.8 million default penalty incurred in the fiscal quarter ended
March 31, 2007 was repaid (see Subsequent Events Note 10).

(c) - Subordinated
Debt

$4.8 Million Subordinated Loan

On
July 11, 2006, the Company entered into an amended and restated loan agreement
(the Amended Subordinated Loan Agreement) in order to amend and restate the
provisions of its $4.8 million loan (the Amended Subordinated Loan) that the
Company received from the Amended Subordinated Lenders on May 9, 2006 in order
to conform its terms to the terms of the $5.2 million Subordinated Loan
Agreement discussed below. Pursuant to a subordination agreement dated July 11,
2006, the Amended Subordinated Loan is subordinated to the Companys existing
senior indebtedness to Laurus under the Securities Purchase Agreement and the
Related Agreements

The
Amended Subordinated Loan is evidenced by an amended and restated subordinated
promissory note dated July 11, 2006 (the Amended Subordinated Promissory
Note). The terms of the Amended Subordinated Promissory Note are identical to
the terms of the Subordinated Promissory Note except that interest on the Amended
Subordinated Promissory Note accrues from May 9, 2006.

The
Amended Subordinated Promissory Note ranks pari
passu with the Subordinated Promissory Note.

Pursuant
to the Amended Subordinated Loan Agreement, the Company issued to the Amended
Subordinated Lenders warrants to purchase an aggregate of 30,658,597 shares of
Common Stock. These

14

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warrants have
the same terms and rights, including piggyback registration rights, as the
warrants that were issued pursuant to the Subordinated Loan Agreement described
below.  The Company calculated a debt
discount attributable to the value of these warrants of $3.2 million, which
will be amortized over the term of the note using the effective interest method
(see Note 8 for a discussion of assumptions used to value the warrants).  As of December 30, 2006, this note carried a
debt discount of $3.1 million.  For the
three and six months ended December 30, 2006, the Company recorded interest
expense of $0.03 million and $0.06 million respectively, related to the
amortization of the debt discount.

On
May 7, 2007, each of the holders of the $4.8 million Subordinated Loan
converted their indebtedness into shares of a newly created Series E
Convertible Preferred Stock of the Company (see Subsequent Events Note
10).

$5.2 Million Subordinated Loan:

On
July 11, 2006, the Company entered into a loan agreement (the Subordinated
Loan Agreement) with subordinated lenders for $5.2 million (the Subordinated
Loan) to be used by the Company for capital expenditures, general working
capital and to pay all costs and expenses in connection with the Subordinated
Loan. Pursuant to a subordination agreement dated July 11, 2006, between the
Subordinated Lenders and Laurus, the Subordinated Loan is subordinated to the
Companys existing senior indebtedness to Laurus.

The
Subordinated Loan bears interest at 12% per annum compounded annually;
provided, however, the interest rate will increase to 14% per annum upon: (i)
the Companys failure to pay in full, on or prior to July 1, 2010, the
principal amount of the Subordinated Loan, plus all accrued interest, and (ii)
certain other specified events that would be considered an event of default
under the Subordinated Promissory Note. The principal balance and accrued
interest on the Subordinated Promissory Note is due on the earliest of (i) July
1, 2010, and (ii) the first date on which any mandatory prepayment is payable
under the Subordinated Loan Agreement or the occurrence of any sale of all or
substantially all of the assets of the Company or its subsidiaries, or merger,
consolidation or other business combination involving the Company or its
subsidiaries if all senior indebtedness is first paid in full in cash in
connection with any such transaction (the Maturity Date).

Subject
to prior payment in full of all senior indebtedness, the Subordinated Loan is
subject to voluntary prepayment at any time and mandatory prepayment upon the
occurrence of a change in control of the Company.

In
the event that the Company consummates an equity financing at any time prior to
the Maturity Date, each Subordinated Lender may elect to convert the entire
principal amount due to such Subordinated Lender under the Promissory Note (along
with accrued interest thereon and all other amounts then due thereunder) into
such number of securities issued in the equity financing (in the event any
warrants or other property or rights are issued or granted in the financing,
together with the proportionate number of such warrants and other property or
rights) that is equal to (i) the principal amount of the Subordinated
Promissory Note (along with accrued interest thereon and all other amounts then
due) being converted divided by (ii) the lowest price per share of the
securities to be issued in the financing. However, if the securities and the
related warrants, if any, to be issued in the financing do not contain
provisions prohibiting the aggregate ownership percentage by the holder thereof
from exceeding 4.99% of the total number of shares of the Companys Common
Stock then issued and outstanding, then any Subordinated Lender may elect to
receive securities that are otherwise identical in all respects to those
purchased in the financing but that contain the foregoing restriction on
aggregate ownership.

Additionally,
the Company agreed that if it consummated one or more equity financings or
indebtedness junior to the Companys senior indebtedness after the date of such
financing with proceeds in

15

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excess of $10.0 million in the aggregate, then
two-thirds of all proceeds in excess of
$10.0 shall be proportionately applied to prepay pari passu, the Subordinated Loan and the obligations of
the Company under the Amended Subordinated Loan.  This
provision has been amended so that no such prepayment can be made until the
Senior Debt issued to Laurus on July 11, 2006 as well as the $4 million of
Senior Subordinated Debt issued on December 22, 2006 (including interest and
all other obligations due) have been paid.

The
obligations of the Company under the Subordinated Loan Agreement and
Subordinated Promissory Note are guaranteed by each of the Companys
subsidiaries.

The
Subordinated Promissory Note ranks pari
passu with the Amended Subordinated Promissory Note.

Pursuant
to the Subordinated Loan Agreement, the Company issued to the Subordinated
Lenders warrants to purchase an aggregate of 32,947,771 shares of Common Stock
at an exercise price of $0.001 per share, subject to certain adjustments set
forth therein. The warrants expire on June 30, 2013. The Subordinated Lenders
are not entitled to receive shares of Common Stock upon exercise of the
warrants if such receipt would cause such Subordinated Lender to be deemed to
beneficially own in excess of 4.99% of the outstanding shares of Common Stock
on the date of issuance of such shares. Such provision may by waived by any
Subordinated Lender upon 61 days prior written notice to the Company.  The Company recorded a debt discount in the
amount of $3.4 million which is attributable to the value of the warrants
issued.  The debt discount will be
amortized over the term of the loan using the effective interest method.  As of December 30, 2006, this note carried a
debt discount of $3.3 million.  For the
three and six months ended December 30, 2006, the Company recorded interest
expense of $0.04 million and $0.07 million respectively, related to the
amortization of the debt discount.

The
Company granted each Subordinated Lender piggyback registration rights with
respect to the shares of Common Stock issuable upon exercise of the warrants,
in accordance with the terms of a registration rights agreement. The Company
has agreed to use its best efforts to cause its certificate of incorporation to
be amended to increase the number of authorized shares of Common Stock to such
number as shall be sufficient to permit the exercise in full of the warrants.
If any Subordinated Lender notifies the Company at any time prior to the
effective date of such amendment that it desires to exercise its warrants prior
to such effective date, the Company will promptly issue to such Subordinated
Lender, in exchange for its warrants, substitute warrants exercisable to
purchase that number of shares of its Series B Convertible Preferred Stock that
are, upon authorization of the number as shall be sufficient to permit the
exercise in full of the warrants, immediately convertible into the number of
shares of Common Stock that would then have been issuable upon exercise of the
warrants in full if the certificate of incorporation of the Company had then
provided for sufficient authorized shares of Common Stock to satisfy such
exercise, and otherwise containing substantially the same terms and provisions
as the warrants.

On
May 7, 2007, each of the holders of the $5.2 million Subordinated Loan
converted their indebtedness into shares of a newly created Series E
Convertible Preferred Stock of the Company (see Subsequent Events Note
10).

$4.0 Million Senior Subordinated Loans:

(i) $1.0 Million Senior Subordinated Secured Loan

The Company
entered into a Subordinated Securities Purchase Agreement (the Laurus Purchase
Agreement) with Laurus dated as of December 22, 2006, pursuant to which the
Company issued to Laurus (i) a Subordinated Secured Term Note in the principal
amount of $1.0 million (the Subordinated Secured

16

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Note); and
(ii) warrants (the Laurus Warrants) to purchase up to 10,000,000
shares (the
Warrant Shares), of the Company Common Stock. In the event
the Subordinated Secured Note is not repaid by April 30, 2007, the Company has
agreed to issue Laurus warrants with like terms to purchase an additional 8,750,000
shares of Common Stock. Due to the fact that this debt was not repaid by April
30, 2007, the Company will issue the additional 8,750,000 warrants to Laurus.

The
Senior Subordinated Secured Note matures on December 22, 2009 or earlier upon a
change of control or other specified events. Interest will accrue on the unpaid
principal amount of the Note at a rate per annum equal to twelve percent (12%)
per annum. Interest in the amount of six percent (6 %) per annum shall accrue,
and subject to the provisions of the Subordination Agreement among the Company,
Laurus and Subordinated Lenders to the Company dated December 22, 2006
(Subordination Agreement), shall be payable monthly, in arrears, commencing
on February 1, 2007 and on the first day of each consecutive calendar month
thereafter. Interest in the amount of six percent (6 %) per annum shall accrue
but not be payable during the period commencing on the date of issuance and
ending on the maturity date of the Note (unless accelerated under certain
circumstances). The interest rate may be increased by 2% per annum in the event
that sufficient shares of the Common Stock are not authorized to allow Laurus
to exercise all of the Laurus Warrants by the six-month anniversary of the date
of the Laurus Purchase Agreement, and shall remain at such higher rate until
such time as a sufficient number of such shares are authorized.

The
Laurus Warrants have a 7-year term and an exercise price equal to $0.001 per
share. The Laurus Warrants also provide that if the fair market value of one
share of Common Stock is greater than the exercise price Laurus may choose to
exercise the warrant on a cashless exercise basis resulting in an issuance of
net shares with no cash payment.  The
Company recorded a debt discount in the amount of $0.7 million which is
attributable to the value of the warrants issued.  The debt discount will be amortized over the term of the loan
using the effective interest method.  As
of December 30, 2006, this note carried a debt discount of $0.7 million.

On
May 7, 2007, Laurus converted the $1.0 million loan into shares of a newly
created Series E Convertible Preferred Stock of the Company (see Subsequent
Events Note 10).

(ii) $3.0
Million Senior Subordinated Loan

The
Company entered into a loan agreement dated as of December 22, 2006 (the
Senior Subordinated Loan Agreement) with Senior Subordinated Lenders,
pursuant to which the Senior Subordinated Lenders loaned the Company $3.0
million (the Senior Subordinated Loan).
Pursuant to a Subordination Agreement dated as of December 22, 2006,
between such Subordinated Lenders, previous subordinated lenders to the Company
and Laurus, the Senior Subordinated Loan is subordinated to the Companys
existing  senior indebtedness to Laurus
under the Securities Purchase Agreement dated June 30, 2006 (the Securities
Purchase Agreement), and the Related Agreements referred to in the Securities
Purchase Agreement and ranks senior to the Companys $10.0 million of existing
subordinated indebtedness.

The
Senior Subordinated Loan is evidenced by a senior subordinated promissory note
dated December 22, 2006 (the Senior Subordinated Note) and bears interest at
annual rate equal to twelve percent (12%) per annum of which 6% shall be paid
in cash monthly, commencing 30 days from the closing (subject to the provisions
of the Subordination Agreement) and the balance of 6% paid in kind and paid on
the maturity date.  The principal
balance and remaining accrued interest on the Senior Subordinated Note is due
on December 31, 2009.

In
the event that the Company consummates an equity financing at any time prior to
the maturity date of the Senior Subordinated Note, each Senior Subordinated
Lender may elect to convert the entire principal amount and accrued interest
due to such Senior Subordinated Lender under the Senior Subordinated Note into
equity on
the same basis as in the equity offering.

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Pursuant
to the Senior Subordinated Loan Agreement, the Company issued to the Senior
Subordinated Lenders warrants to purchase an aggregate of 15,384,615 shares of
Common Stock at an exercise price of $0.001 per share.  The warrants expire on
    December 31, 2013. In the event the Laurus Note is not paid by April 30,
    2007, certain holders of such Warrants have agreed to contribute 8,750,000
    Warrants back to the Company and the Company has agreed to issue an additional
    8,750,000 Warrants to Laurus. As the debt was not repaid by April 30, 2007,
    certain holders will return 8,750,000 warrants to the Company which will
    then be issued to Laurus per the agreement. The Company recorded a debt
    discount in the amount of $1.7 million which is attributable to the value
    of the warrants issued. The debt discount will be amortized over the term
    of the loan using the effective interest method. As of December 30, 2006,
    this note carried a debt discount of $1.7 million.

On
May 7, 2007, each of the holders of the $3.0 million Senior Subordinated Loan
converted their indebtedness into shares of a newly created Series E
Convertible Preferred Stock of the Company (see Subsequent Events Note
10).

Accrued Interest and Maturities of Other Long
Term Debt

Accrued
interest of $3.4 million and $2.7 million is included in accrued expenses as of
December 30, 2006 and July 1, 2006, respectively.

Concurrent
with the May 7, 2007 financing, various debt holders agreed to waive $0.8
million in accrued interest that is included in the December 30, 2006 Condensed
Consolidated Balance Sheet.

6. Commitments and Contingencies

Litigation

UBS Lawsuit

UBS
Securities, LLC commenced a lawsuit against the Company in the Supreme Court
    of the State of New York, County of New York on September 18, 2006. The complaint
    alleges that UBS was engaged to provide investment banking services to the
    Company and that UBS is owed a fee of $1,750,000 with respect to a private
    placement that was consummated in June, 2006, and funded in July 2006. By
order entered on May 25, 2007, the court granted UBSs motion for summary
judgment.  On June 5, 2007 the court entered judgment against the Company
in the sum of $1,962,139.25, inclusive of interest and costs.  A hearing
on UBSs request for attorneys fees will be held on July 10, 2007.  
In the event the Company
is required to pay this judgment, it would materially and adversely affect
the Company. The Company does not believe a loss from an unfavorable outcome
will exceed the amount accrued.

Other Contingencies

Mandalay
Agreement

A vendor
asserted a claim relating to an October 1, 2005 agreement that was contested by
the Company.  An agreement between the
parties was reached on February 1, 2007 to settle the dispute by granting the
vendor 1,760,925 shares of Common Stock.
The Company has recorded a marketing charge of $0.4 million for the six
months ended December 30, 2006 for this claim and the $0.4
million is included in Accrued expenses and other current liabilities on the
Consolidated Balance Sheet.

General

The Company
is a party to a number of legal actions, proceedings or claims. While any
action, proceeding or claim contains an element of uncertainty, management
believes that the outcome of such

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actions, proceedings or claims will not have a material adverse effect
on the business, financial condition or results of operations.

Commitments

Acquisition of
Nouvisage Corp:

On
September 12, 2006, the Company entered into a letter of intent to acquire
Nouvisage Corp. (Nouvisage). Pursuant to the letter of intent, the
transaction was to be structured as an acquisition of all of the capital stock
of Nouvisage in exchange for newly issued shares of Series B Preferred Stock of
the Company, par value $0.001 per share (the Shares), each of which would be
convertible into 10,000 shares of Common Stock of the Company, par value $0.001
per share The acquisition was intended to qualify as a tax-free exchange under
the Internal Revenue Code of 1986.

The
purchase price for the Shares was to be $6.5 million, subject to adjustment
(the Purchase Price) and would be paid in Shares pro rata to the stockholders
of Nouvisage (the Sellers) at the closing of the acquisition (the Closing).

The
letter of intent was terminable by either party if the acquisition did not
close by January 10, 2007 (the Termination Date). Pursuant to the letter of
intent, the Sellers and Nouvisage had agreed not to solicit, initiate, or
encourage submission of or receive proposals or offers from another party until
the Termination Date.  The board of
directors of both the Company and Nouvisage agreed to extend the Termination
Date until March 1, 2007.   As of June
15, 2007, the Companies have not extended the Termination date further and the
exclusive period to negotiate has ended.
Due to the end of the exclusivity period and the recent sale of the
spa/salons (see Subsequent Events Note 10 for a discussion of the sale), it is
unlikely that the acquisition will occur.

The
obligations of the parties to close the acquisition are subject to certain
closing conditions, including (i) the satisfactory completion by the Company of
its legal and financial due diligence, (ii) the approval by the board of
directors of the Company, (iii) the closing of a financing of at least $19.0
million in gross proceeds to the Company, (iv) the execution of an employment agreement
between the Company and John Buckingham, the Chief Executive Officer of
Nouvisage (the Employment Agreement), and (v) the completion of an audit of
the financial statements of Nouvisage for the three years ended June 30, 2006
and a review of any interim financial statements. Pursuant to the letter of
intent, the parties agreed to negotiate in good faith a stock purchase
agreement, a registration rights agreement, the Employment Agreement and such
other agreements as may be appropriate or desirable to the parties. The parties
also agreed to negotiate a Strategic Alliance Agreement.

Upon
the signing of the letter of intent, the Company agreed to advance $300,000 to
Nouvisage. In accordance with this agreement, as of June 15, 2007 the Company
has advanced $300,000 to Nouvisage.  If
the Company does acquire Nouvisage, this advance will be applied to the
purchase price.  In addition, Nouvisage
agreed to provide security of its obligations through the issuance of
promissory notes which will allow the holder to convert such promissory notes
into an aggregate of 17% of Nouvisages common ownership if not repaid.
Pursuant to the letter of intent, if the acquisition does not close, Nouvisage
has agreed to refund to the Company all amounts paid to Nouvisage, except for
documented transaction costs of up to $75,000, in six equal monthly
installments.

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7. Related Party Transactions

L Capital Consulting
Services Agreement

On
November 25, 2003 KAAI entered into a Consulting Services Agreement with L
Capital pursuant to which L Capital performed consulting services for
KAAI.  Under the Agreement, KAAI was
required to pay L Capital an annual consulting fee, payable in quarterly
installments in arrears, equal to the higher of (a) $445,000 and (b) 1% of our
gross revenues plus $20,000 for such year.
As of December 30, 2006 and July 1, 2006, there were accrued and unpaid
consulting fees to L Capital of approximately $876,841.

On
December 20, 2005, the Company terminated the Consulting Agreement with L
Capital, and in accordance with this Agreement was obligated to pay all accrued
and unpaid consulting fees within one year of termination.  On December 19, 2006 a new agreement was
signed which deferred this payment until (a) the $25.0 million in principal,
along with the related interest of our senior debt issued on July 6, 2006 to
Laurus has been paid, (b) the $10.0 million in principal, along with the
related interest of our subordinated debt issued on July 11, 2006 has been paid
and (c) the $4.0 million in principal, along with the related interest of
senior subordinated debt issued on December 22, 2006.  Upon the occurrence of all of the preceding, all accrued
management fees will be due and payable.

Concurrent
with the May 7, 2007 financing, L Capital waived the $876,841 in accrued
management fees included in the December 30, 2006 Condensed Consolidated
Balance Sheet.

KCO Advisory Services
Agreement

On
November 25, 2003 KAAI entered into an Advisory Services Agreement with KCO
pursuant to which KCO performed advisory services for the Company.  Under the Agreement KAAI was required to pay
KCO an annual advisory fee, payable in quarterly installments in arrears, equal
to the higher of (a) $425,000 and (b) 1% of our gross revenues for such
year.  As of December 30, 2006 and July
1, 2006, there were accrued and unpaid consulting fees to KCO of approximately
$837,433.

On
December 20, 2005 the Company terminated the Advisory Agreement with KCO and in
accordance with this Agreement was obligated to pay all accrued and unpaid
advisory fees within one year of termination. On December 19, 2006 a new
agreement was signed which deferred this payment until (a) the $25.0 million in
principal, along with the related interest of our senior debt issued on July 6,
2006 to Laurus has been paid, (b) the $10.0 million in principal, along with
the related interest of our subordinated debt issued on July 11, 2006 has been
paid and (c) the $4.0 million in principal, along with the related interest of
senior subordinated debt issued on December 22, 2006.  Upon the occurrence of all of the preceding, all accrued
management fees will be due and payable.

Concurrent
with the May 7, 2007 financing, KCO waived the $837,433 in accrued management
fees included in the December 30, 2006 Condensed Consolidated Balance Sheet.

Loans by Affiliates of Pequot

Affiliates
of Pequot, who collectively are holders of more than 5% of the Common Stock of
the Company, hold 7 year warrants with an exercise price of $.001 per share, to
purchase an aggregate of 14,654,807 shares of the Common Stock of the Company
which warrants were received in connection with the $5.2 million Subordinated
Debt financing on July 11, 2006 and the $4.8 million Subordinated Debt
financing on May 9, 2006 in which such affiliates loaned the Company an
aggregate of $2,312,903.

On
May 7, 2007, affiliates of Pequot converted their indebtedness into shares of a
newly created Series E Convertible Preferred Stock of the Company (see
Subsequent Events Note 10).

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Loans by Klinger Investments

Klinger
Investments, LLC, an entity owned by William J. Kidd, the spouse of Carla G.
Kidd, the sole Manager of Seapine Investments, LLC, a holder of more than 5%
    of the Common Stock of the Company and a 50% owner of Kidd & Company,
    LLC, loaned the Company $2,275,269 as part of the July 11, 2006 $5.2 million
Subordinated Debt financing and May 9, 2006 $4.8 million Subordinated Debt
financing and $650,000 in the $4 million December 22, 2006 Senior Subordinated
financing and received 7 year warrants with an exercise price of $.001 per
share to purchase an aggregate of 14,416,354 shares of Common Stock and 7 year
warrants to purchase an aggregate of 2,904,762 shares of Common Stock.  In the
event the Laurus $1 million Senior Subordinated Loan is not repaid by April 30,
2007, warrants to purchase 2,708,374 shares will be returned by Klinger Investments
to the Company for cancellation. Due to the fact that this debt was not repaid
    by April 30, 2007, the Company will cancel the 2,708,374 warrants held by
    Klinger Investments.

On
May 7, 2007, Klinger Investments, LLC converted its indebtedness into shares of
a newly created Series E Convertible Preferred Stock of the Company (see
Subsequent Events Note 10).

Loans by Laurus Master Fund Ltd.

Laurus
has loaned the Company $25,000,000 as Senior Secured Debt and $1 million as
Senior Subordinated Secured Debt as described in this Report and received 10
year warrants with an exercise price of $.01 per share to purchase a total of
50,885,093 shares of Common Stock and 7 year warrants with an exercise price
    of $.001 per share to purchase a total of 10,000,000 shares of Common Stock.
    In addition Laurus is entitled to receive warrants to purchase an additional
    8,750,000 shares of Common Stock if the $1,000,000 Senior Subordinated Secured
    Debt is not repaid by April 30, 2007. Due to the fact that this debt
was not repaid by April 30, 2007, the Company will issue the additional
8,750,000 warrants to Laurus.  If prior
to the 14th month anniversary of June 30, 2006, the Companys
obligations to Laurus under the Senior Secured Debt have been reduced to
$12,500,000 or less, then warrants to purchase 6,839,394 shares of Common Stock
will be automatically cancelled and terminated and if at such time the
Companys obligations have been reduced to zero, then warrants to purchase
an additional 6,693,875 shares of Common Stock will also be cancelled. As a result
of the May 7, 2007 refinancing discussed below, the Company will cancel the combined
13,533,269 warrants held by Laurus, due to the prepayment.

On
May 7, 2007, the Company repaid the $25.0 million debt to Laurus as part of the
Senior Debt financing and an additional $3.8 million default penalty incurred
in the fiscal quarter ended March 31, 2007 (see Subsequent Events Note
10).

Loan by Richard Rakowski

Richard
Rakowski, the Chairman and former Chief Executive Officer of the Company,
loaned the Company $850,000 as part of the Senior Subordinated Debt financing
on December 22, 2006 and received 7 year warrants with an exercise price of
$.001 per share to purchase 3,798,534 shares of Common Stock.  In the event the
    Laurus $1 million Senior Subordinated Secured Loan is not repaid by April
    30, 2007, warrants to purchase 3,541,666 shares of Common Stock will be returned
    to the Company for cancellation by Mr. Rakowski. Due to
the fact that this debt was not repaid by April 30, 2007, the Company will
cancel the 3,541,666 warrants held by Mr. Rakowski.  Mr. Rakowski has also personally
guaranteed certain obligations of the Company.

On
May 7, 2007, Mr. Rakowski converted his indebtedness into shares of a newly
created Series E Convertible Preferred Stock of the Company (see Subsequent
Events Note 10).

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Loans by Andrew Lipman

Andrew
D. Lipman, a former Director, loaned the Company $150,000 in the July 11, 2006
$5.2 million Subordinated Debt Financing and received 7 year warrants with an
exercise price of $.001 per share to purchase 950,416 shares of Common Stock
and loaned the Company $200,000 in the December 22, 2006 Senior Subordinated
financing and received 7 year warrants with an exercise price of $.001 per
share to purchase 893,773 shares of Common Stock.  In the event the Laurus $1
    million Senior Subordinated Secured Loan is not repaid by April 30, 2007,
    warrants to purchase 833,334 shares of Common Stock will be returned to the
    Company for cancellation by Mr. Lipman. Due to the fact that this debt was
    not repaid by April 30, 2007, the Company will cancel the 833,334 warrants
    held by Mr. Lipman. Mr. Lipman loaned the
Company a combined $250,000 in the combined $4.0 million Secured Demand Note
financings completed on March 16, 2007 and March 27, 2007.

On
May 7, 2007, Mr. Lipman converted his indebtedness from the July 11, 2006 and
December 22, 2006 financings into shares of a newly created Series E
Convertible Preferred Stock of the Company (see Subsequent Events Note
10).

Sephora

Sephora,
with whom the Company has a strategic relationship, is a subsidiary of
LVMH.  L Capital Management SAS, which
manages and represents L Capital, is also a subsidiary of LVMH, and as a result
L Capital Management SAS and Sephora are affiliates.  The Companys decision to enter into a contract with Sephora was
made independent of its relationship with L Capital.  The Company has recorded $4.1 million in net revenues on a
cumulative basis as of December 30, 2006.
The Company recorded revenues of $0.5 million and $1.4 million for the
three and six months ended December 30, 2006.
At December 30, 2006, the Company had a $0.2 million payable balance to
Sephora which is included in Accounts receivable, net in the Condensed
Consolidated Balance Sheet.

8.  Stock-Based Compensation Plan and Warrants

Stock Options

In
December 2004, the FASB issued SFAS No. 123(R), Share Based Payment. This
statement establishes standards for the accounting for transactions in which an
entity exchanges its equity instruments for goods and services. It focuses
primarily on accounting for transactions in which an entity obtains employee
services in share-based payment transactions (employee stock options). The
statement requires the measurement of the cost of employee services received in
exchange for an award of equity instruments (such as employee stock options) at
fair value on the grant date. That cost will be recognized over the period
during which an employee is required to provide services in exchange for the
award (the requisite service period).
The Company adopted FAS 123R, Share-Based payment, applying the
modified retrospective method.

All
existing stock options as of July 1, 2006 had been issued under the subsidiary
(KAAI) 2003 stock option plan.
Management has developed a new stock option plan (The TrueYou.Com Inc.
2006 Stock Incentive Plan or the 2006 Plan) for the Company that was
approved by the Board of Directors (Board) of the Company in the first
quarter of fiscal year 2007.  At that
time, the Board also approved, subject to shareholder approval, the exchanging
of KAAI options for TrueYou options under the 2006 Plan.  The 2006 Plan must be submitted to the
stockholders of the Company for their approval within twelve months.  The Company believes that the approval of
the 2006 Plan by the stockholders is perfunctory, and as such has considered
all options approved by the Board as granted.
All options granted by the Board in the three months ended September 30,
2006 have been granted under the 2006 Plan.
No options were granted in the three months ended December 30,
2006.

22

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The
2006 Plan provides for awards of up to105 million shares of TrueYou Common
Stock to employees and outside contractors in various forms. These include
non-qualified options, incentive stock options, and stock appreciation rights.
The 2006 Plan is administered by the Board, which also establishes the terms of
the awards.  Non-qualified stock options
have been the only form of awards granted by the Board to date. A total of
27,698,738 shares of Common Stock remained available for future award grants as
of December 30, 2006.

Non-qualified
stock options granted under the 2006 Plan vest over a zero to four year period
and expire ten years from the date of grant. Options to acquire a total of
77,301,262 shares of Common Stock have been granted by the Board to employees
and contractors under the Plan. Non-qualified stock options may be granted at
any price but, in general, are not granted with an exercise price less than the
fair market value of the stock on the date of grant.

Since
the Company does not have sufficient shares authorized, it is required to treat
the options as liability awards and remeasure at each reporting period based
upon fair value, utilizing the Black-Scholes option pricing model.  The Company recognized compensation income
of approximately $3.2 million and compensation expense of $0.2 million for the
three months ended December 30, 2006 and December 31, 2005, respectively for
stock options granted and the subsequent remeasurement.  The Company recognized compensation expense
of approximately $1.0 and $0.2 million for the six months ended December 30,
2006 and December 31, 2005, respectively for stock options granted and the
subsequent remeasurement.  In addition,
as of December 30, 2006, there was approximately $1.4 million in unrecognized
stock based compensation expense related to non-vested stock options which is
expected to be recorded in future periods over a weighted average period of 1.9
years.

There were
new TrueYou options for the purchase of $55.1 million shares of Common Stock
granted during the six months ended December 30, 2006.  There were additional TrueYou options to
purchase $22.2 million shares of Common Stock issued as an exchange for
Advanced Aesthetics, Inc. options.
There were no options granted during the six months ended December 31,
2005.

The
weighted average fair value of the new employee options granted during the six
months ended December 30, 2006 was $0.08.
The fair value was estimated using the Black-Scholes option pricing
model with the following weighted average assumptions for the six months ended
December 30, 2006 and December 31, 2005:

|                               |  |                     |      |                     |  |     | 
|------------------------------ |  | ------------------- | ---- | ------------------- |  | --- | 
|                               |  | Six Months Ended    |     
|                               |  |                     |     
|Assumptions                    |  | December 30,
  2006 |      | December 31,
  2005 | 
|                               |  |                     |      |                     | 
|                               |  |                     |      |                     |  |     | 
|Expected dividend yield        |  |                     | None |                     |  | N/A | 
|Risk-free interest rate        |  |                     | 4.6  |                     |  | N/A | 
|Expected life of option grants |  |                     | 3.0  |                     |  | N/A | 
|Forfeiture rate                |  |                     | 2.5% |                     |  | N/A | 
|Expected volatility            |  |                     | 50%  |                     |  | N/A | 

The
Company also provides stock options to some of its outside contractors.  These options are subject to the provisions
of EITF 96-8, which requires remeasurement of the awards until performance is
complete.  As a result, these awards
were also revalued as of December 30, 2006.
As of December 30, 2006 the weighted average fair value was $0.06, the weighted
average interest rate was 4.8%, the forfeiture rate was 2.5%, and weighted
average expected life was 3.1 years for these stock options.

A summary of the Companys
stock option activity during the six
months ended September 30, 2006 is follows:

23

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|                                 |  |                     |             |                                   |   |      | 
|-------------------------------- |  | ------------------- | ----------- | --------------------------------- | - | ---- | 
|                                 |  | Options Outstanding |            
|                                 |  |                     |            
|                                 |  | Shares              |             | Weighted Average
  Exercise Price |  
|                                 |  |                     |             |                                   |  
|                                
|Outstanding,
  July 1, 2006 (1)  |  |                     | 22,220,942  |                                   | $ | 0.34 | 
|                                 |  |                     |             |                                   |   |      | 
|Granted                          |  |                     | 77,301,262  |                                   |   | 0.28 | 
|Cancelled                        |  |                     | (22,220,942 | )                                 |   | 0.34 | 
|Exercised                        |  |                     |            |                                   |   |     | 
|                                 |  |                     |             |                                   |   |      | 
|                                 |  |                     |             |                                   |   |      | 
|Outstanding,
  December 30, 2006 |  |                     | 77,301,262  |                                   | $ | 0.28 | 
|                                 |  |                     |             |                                   |   |      | 

|    |                                                                                                
|--- | -----------------------------------------------------------------------------------------------
|(1) | 1,892,850 KAAI options were exchanged for TrueYou options at an
  exchange rate of 11.73940981.

As
of December 30, 2006, the weighted average exercise prices and remaining
contractual lives of stock options are as follows:

|                                       |  |                                                    |  |                                                              |  |                                     |  |                                       |  |                          |  |  |  |  |  | 
|-------------------------------------- |  | -------------------------------------------------- |  | ------------------------------------------------------------ |  | ----------------------------------- |  | ------------------------------------- |  | ------------------------ |  |  |  |  |  | 
|                                       |  | Options outstanding                                |  | Options exercisable                                          | 
|                                       |  |                                                    |  |                                                              | 
|Range of exercise prices               |  | Number of
  options
  outstanding
  as of 12/30/06 |  | Weighted average
  remaining
  contractual life (in
  years) |  | Weighted
  average
  exercise price |  | Number
  exercisable as
  of 12/30/06 |  | Weighted
  average price | 
|                                       |  |                                                    |  |                                                              |  |                                     |  |                                       |  |                          | 
|                                      
|Stock
  options issued @$0.19 to $0.34 |  | 77,301,262                                         |  | 9.3                                                          |  | $0.28                               |  | 53,873,479                            |  | $0.28                    | 

Warrants

The
Company issued 139,876,075, warrants during the six months ended December 30,
2006 which were valued using the Black-Scholes option pricing model using the
following weighted average assumptions: risk-free rate of return  5.08%; term
 8.1 years; volatility  50%; dividend yield  0.0%. The warrants were
recorded as a discount to debt.

Warrants outstanding as of
December 30, 2006 are as follows:

|                                 |  |                      |             |                                   |   |       | 
|-------------------------------- |  | -------------------- | ----------- | --------------------------------- | - | ----- | 
|                                 |  | Warrants Outstanding |            
|                                 |  |                      |            
|                                 |  | Shares               |             | Weighted Average
  Exercise Price |  
|                                 |  |                      |             |                                   |  
|                                
|Outstanding,
  July 1, 2006      |  |                      | 63,638,769  |                                   | $ | 0.166 | 
|                                 |  |                      |             |                                   |   |       | 
|Granted                          |  |                      | 139,876,075 |                                   |   | 0.004 | 
|Cancelled                        |  |                      |            |                                   |   |      | 
|Exercised                        |  |                      |            |                                   |   |      | 
|                                 |  |                      |             |                                   |   |       | 
|                                 |  |                      |             |                                   |   |       | 
|Outstanding,
  December 30, 2006 |  |                      | 203,514,844 |                                   | $ | 0.055 | 
|                                 |  |                      |             |                                   |   |       | 

At
December 30, 2006, the exercise prices and remaining contractual lives of
warrants are as follows:

24

---



|                                   |  |                                                     |             |                                                                |  |                                       |  |                                       |        |                            |  |             |  |  |        | 
|---------------------------------- |  | --------------------------------------------------- | ----------- | -------------------------------------------------------------- |  | ------------------------------------- |  | ------------------------------------- | ------ | -------------------------- |  | ----------- |  |  | ------ | 
|                                   |  | Warrants outstanding                                |             | Warrants exercisable                                           | 
|                                   |  |                                                     |             |                                                                | 
|Range of exercise prices           |  | Number of
  warrants
  outstanding
  as of 12/30/06 |             | Weighted
  average
  remaining
  contractual life
  (in years) |  | Weighted
  average
  exercise
  price |  | Number
  exercisable
  as of 12/30/06 |        | Weighted
  average
  price | 
|                                   |  |                                                     |             |                                                                |  |                                       |  |                                       |        |                            | 
|                                  
|Warrants
  issued @ $.001 to $.230 |  |                                                     | 203,514,844 |                                                                |  | 6.8                                   |  |                                       | varies |                            |  | 203,514,844 |  |  | varies | 
|                                  
|                                   |  |                                                     |             |                                                                |  |                                       |  |                                       |        |                            |  |             |  |  |        | 

9. Convertible Securities

The
Company has insufficient shares of Common Stock authorized to allow for the
exercise of stock options or warrants, or allow the conversion of preferred
stock. As a result, under EITF 00-19, the Company is required to classify these
instruments as liabilities and remeasure the convertible securities at each
reporting period end based on fair value. The Company determines the fair value
of the convertible securities based on the number of shares common stock into
which they are convertible and the current fair value of the common stock on
the remeasurement date. Fair value of the Common Stock is determined based on
actual amounts paid for a share of Common Stock in a transaction closest to the
remeasurement date. The fair values of the Common Stock as of December 30, 2006
and July 1, 2006 were $0.19 and $0.39, respectively. The number of common
shares into which the convertible securities are convertible was 646,452,766
and 506,576,690 as of December 30, 2006 and July 1, 2006, respectively. As of
December 30, 2006, the Company remeasured the convertible securities based on
an estimated fair value of approximately $122.8 million and recorded an
unrealized gain of approximately $53.5 and $94.0 million for the three and six
months ended December 30, 2006. As of December 31, 2005, the Company remeasured
the convertible securities based on an estimated fair value of approximately
$197.6 million and recorded an unrealized loss of approximately $137.7 for the
three and six months ended December 31, 2005.

10. Subsequent Events

Bridge financings

(a)
$2,000,000 Senior Secured Loans

On
March 16, 2007, the Company executed four Senior Secured Notes in the aggregate
amount of $2,000,000 (North Sound Legacy International Ltd. $1,125,000, North
Sound Legacy Institutional Fund LLC $375,000, and, Seapine Investments, LLC
$375,000, each of whom is an existing stockholder of the Company, and Andrew D.
Lipman, a former director and existing stockholder $125,000). The Notes are due
on demand and bear interest at the prime rate in effect from time to time as
reported in the Wall Street Journal plus 2% and rank pari passu in payment
and security with the $25,000,000 of senior indebtedness of the Company issued
to Laurus made as of June 30, 2006.

The Company,
    Laurus, and bridge lenders are negotiating to implement the integration of
    these loans into an agreement consistent with that of the May 2007 loan document
    discussed below.

(b)
$2,000,000 Senior Secured Loans

On
March 27, 2007, the Company executed four additional Senior Secured Notes in
the aggregate amount of $2,000,000 (North Sound Legacy International Ltd.
$1,125,000, North Sound Legacy Institutional Fund LLC $375,000, and, Seapine
Investments, LLC $375,000, each of whom is an existing stockholder of the
Company, and Andrew D. Lipman, a former director and existing stockholder
$125,000). The Notes are due on demand and bear interest at the prime rate in
effect from time to time as reported in the Wall Street

25

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Journal plus
2% and also rank pari passu in payment and security
with the $25,000,000 of senior indebtedness of the Company issued to Laurus
made as of June 30, 2006.

The Company,
    Laurus, and bridge lenders are negotiating to implement the integration of
    these loans into an agreement consistent with that of the May 2007 loan document
discussed below.

Default on Senior Secured Debt

On
March 8, 2007, Laurus, the holder of the Companys $25.0 million in principal
amount of Senior Secured Debt and also the holder of $1.0 million in principal
amount of Senior Subordinated Secured Debt, sent the Company a Notice of
Default and Acceleration accelerating the obligations due to Laurus under the
Secured Term Note issued as of June 30, 2006 and the Senior Subordinated
Secured Term Note issued as of December 22, 2006. As a result of this default,
the Company has classified all the debt discussed above as current as of
December 30, 2006, in its Consolidated Balance Sheet. The Company incurred a
$3.8 million penalty in May 2007 as a result of this default.

Impairment of Goodwill

As
a result of the notice of default received on the Senior Secured Debt on March
8, 2007 and the drop in the Company traded share price, the Company believes
that there has been an impairment to its goodwill. As of May 30, 2007, the
closing price of its Common Stock was $0.04. The default and the limited
capital options determined after the event left the Company with no capacity to
invest to maintain any remaining goodwill. Planned spending was curtailed
relating to any non-essential activities or operations. This reduction in
planned spending significantly reduced the projected cash flows of the
stores/salons and the Company overall. As a result, the Company anticipates a
charge of $18.1 million in its fiscal quarter ended March 31, 2007 to write-off
all of its goodwill.

Closing of Beverly Hills

On
February 8, 2007, the Company reached an agreement with the landlord at Beverly
Hills to surrender the leased property. Due to the limited capital and a
revised business plan, the Company is unable to complete the remodeling and
re-open the store. As a result of this agreement, the Company anticipates a charge
of $0.6 million in the third quarter to write-off all of the net assets of the
Beverly Hills facility.

Refinancing  Senior Debt

On
May 7, 2007 (the Closing Date), the Company entered into an Amended and
Restated Securities Purchase Agreement with Laurus (Purchaser) pursuant to
which (i) the Company sold to the Purchaser a Secured Term Note in the
aggregate principal amount of $54,650,000 (the Note); and (ii) the Company
issued to the Purchaser Series D Warrants (the Series D Warrants) and Series
E Warrants (the Series E Warrants) collectively the Warrants) to purchase
up to 29,276,583,452 shares and 9,245,236,880 shares, respectively
(collectively, the Warrant Shares), of the Company Common Stock, par value
$0.001 per share (the Common Stock).

On
the Closing Date, the obligations of the Company to Laurus under the June 30,
2006 note were repaid and the Company received $25,900,000 in new cash proceeds
from the Note and placed $8,069,243 in a restricted account to be utilized to
prefund interest of the Note. Other disbursements include a closing payment of
$906,500 to Laurus Capital Management, LLC, an affiliate of Laurus, Laurus due
diligence and structuring expenses of $10,000 and escrow agent fees of $2,000.
The sum of $4,000,000 was wired to a Company account and an additional
$12,912,256 was deposited to a restricted account to be disbursed to the
Company in accordance with the Restricted Account Letter Agreement dated May 4,
2007, which provides that the Company must meet certain financial conditions
including reaching settlements with creditors before further money is released.

26

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The
Note matures on May 4, 2010. Interest accrues on the unpaid principal amount of
the Note at a rate per annum equal to the prime rate published in The Wall
Street Journal (the Prime Rate), plus two percent (2%) per annum (such sum
being referred to as the Contract Rate). Interest is (i) calculated on the
basis of a 360 day year on the unpaid principal amount of the Note outstanding
from time to time during the applicable period; and (ii) payable monthly, in
arrears, commencing on May 1, 2007, on the first business day of each
consecutive calendar month thereafter through and including the Maturity Date,
and on the Maturity Date, whether by acceleration or otherwise. The Contract
Rate may be increased by 2% per annum in the event that sufficient shares of
the Common Stock are not authorized to allow the Purchaser to exercise all of
the Warrants by December 31, 2007, as described in the Purchase Agreement, and
shall remain at such higher rate until such time as a sufficient number of such
shares are authorized.

The
Company may prepay the Note by paying to the Purchaser a sum of money equal to
(i) one hundred percent (100%) of the principal amount outstanding at such time
together with accrued but unpaid interest thereon and any and all other sums
due, accrued or payable to Purchaser arising under the Note, the Purchase
Agreement or any other Related Agreement.

In
connection with the issuance of the Warrants, the Company entered into a
Registration Rights Agreement dated May 4, 2007 with the Purchaser, pursuant to
which the Company agreed to file a registration statement with the Securities
and Exchange Commission covering the resale of the Warrant Shares within one
year and to cause the registration statement to become effective within 90 days
following the filing of such registration statement.

The
Warrants issued to the Purchaser have a 10-year term and an exercise price
equal to $.001 per share. The Company will calculate a debt discount attributable
to the value of these warrants which will be amortized over
the term of the Note using the effective interest method. As the determination of the
fair value of the warrants is finalized by the Company, an expense and
corresponding liability will be recorded, as required by EITF 00-19 due to the
insufficient number of shares authorized. The liability to be recorded for the
securities will be adjusted to fair value at each reporting period until the number
of authorized shares is increased to permit the exercise of these securities. Under the Purchase
Agreement, if the conditions set forth in the Purchase Agreement are met within
three years, then the Series E Warrant will be returned to the Company. The
Company has agreed to issue a like warrant to Richard Rakowski, Chairman of the
Company if the Series E warrants are returned to the Company. The conditions
include that all of the Companys obligations to Purchaser have been repaid and
that the Companys Total Debt (as defined) divided by the aggregate amount of
EBITDA (as defined) for a 12 month period has not exceeded 4.0 for four
consecutive months.

If
exercised in full, the Warrants issued to Laurus would constitute approximately
75% of the issued and outstanding Common Stock of the Company on a fully
diluted basis provided however that such Warrants contain a blocker provision
pursuant to which Laurus cannot exercise such Warrants to acquire more than
9.99% of the then outstanding shares of Common Stock of the Company provided
further that such limitation may be waived by the Holder on not less than 61
days prior notice to the Company. The Warrants further provide that such
limitation is automatically null and void following notice to the Company upon
the occurrence and during the continuance of an Event of Default (as defined in
the Purchase Agreement).

The
Company has agreed to use its best efforts to cause its certificate of
incorporation to be amended to increase the number of authorized shares of
Common Stock to such number as shall be sufficient to permit the exercise in
full of the Warrants (such amount, the Share Amount). If the Purchaser
notifies the Company at any time prior to the effective date of such amendment
that it desires to exercise the Warrants prior to such effective date, the
Company will promptly issue to the Purchaser, in exchange for the Warrants,
substitute warrants exercisable to purchase that number of shares of its Series
B Convertible Preferred Stock that are, upon authorization of the Share Amount,
immediately convertible into the number of shares of Common Stock that would
then have been issuable upon exercise of the Warrants in full if the
certificate of incorporation of the Company had then provided for sufficient
authorized shares of Common Stock to satisfy such exercise, and otherwise containing
substantially the same terms and provisions as the Warrants. In the event that
effective date of the amendment authorizing the Share Amount does not occur by
December 31,

27

---



2007 as
described in the Purchase Agreement, the Contract Rate of the Note may be
increased by 2% per annum and shall remain at such higher rate until such time
as the Share Amount is authorized.

Sale of Company Stores/salons

On
May 7, 2007, the Company entered into a Purchase and Sale Agreement pursuant to
which it sold all of its spa/salons to GK Acquisition LLC, an unaffiliated
third party (Purchaser). The agreement provides that the sale transaction is
effective for accounting and profit/loss purposes as of April 1, 2007. The sale
was implemented by the sale of the equity interests of various subsidiary
entities of the Company as well as an assignment of leases. The sale includes
all of the inventory, furniture, fixtures and equipment in the spa/salons and
business and includes all rights in and to the name Georgette Klinger and
various related intellectual property.

In
consideration for the sale, the Purchaser assumed $1,450,000 of accounts
payable relating to the business as well as all outstanding gift card liability
of the spa/salons. In addition the Purchaser issued a note to the Company in
the amount of $150,000 due in 60 days.

The
parties also entered into various agreements in connection with the sale
including a transition services agreement pursuant to which the Company will
provide transitional services to the Purchaser as well as a Cosmedicine supply
agreement pursuant to which the Company will supply the Purchaser with
Cosmedicine products. Pursuant to the transaction, the Company agreed not to
compete with the business sold for a period of three years.

In
connection with the sale, on May 7, 2007 the Company and Laurus entered into a
Waiver and Consent Agreement whereby Laurus released its security interest in
the assets sold in connection with the Purchase and Sale Agreement. As the
Company could not sell the stores without approval from Laurus, the Company
will record discontinued operations in the fourth quarter. The Company was not
committed to a plan to sell the stores until the forth quarter as the required
approval from Laurus occurred at that time. As a result of this sale, the
Company anticipates a loss on sale of $2.5 million in the fourth quarter.

Conversion of Debt and Equity

On
May 7, 2007, each of the holders of the Companys Series C Preferred Stock,
Series D Preferred Stock and the holders of its Senior Subordinated
Indebtedness and Subordinated Indebtedness aggregating an original principal
amount of $14,038,710 and issued on May 9, 2006, July 11, 2006, and December
22, 2006 converted their shares of Preferred Stock and indebtedness,
respectively, into shares of a newly created Series E Convertible Preferred
Stock of the Company. The conversion was in connection with and as a condition
to the Laurus financing and the issuance of Warrants by the Company to Laurus.
An additional $1,000,000 of Subordinated Debt was also converted into Series E
Convertible Preferred Stock of the Company.

To
implement the conversion, on May 7, 2007, the Company created a new Series E
Convertible Preferred Stock. The Series E Preferred Stock is being utilized
because the Company does not have sufficient authorized shares of Common Stock
and ranks pari passu with the existing Common Stock and Series B
Preferred Stock of the Company. Holders of Series E Preferred Stock shall have
full voting rights and powers and equal to that of holders of Common Stock and
Preferred B holders. The Series E Preferred Stock shall be initially convertible
into Common Stock at the rate of one million shares of Common Stock per Preferred
Share. These shareholders will also be entitled to dividends on a pari passu basis
with that of the Common Stock holders.

28

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Consulting Agreement  Richard Rakowski

On
May 7, 2007, the Company entered into a Consulting Agreement with Richard
Rakowski, Chairman of the Company, pursuant to which Mr. Rakowski will provide
consulting services for the Company. He will receive a fee at the annual rate
of $295,000 from May 1, 2007, to August 31, 2007. From September 1, 2007, to December
31, 2007, the equivalent annual fee will decrease to $175,000 and from January
1, 2008 and thereafter, the equivalent rate will decrease to $125,000. In
addition the Agreement provides that in the event that Mr. Rakowski is
successful in specified transactions involving the Company, he is entitled to a
success fee of 2.5% of the actual cash provided to the Company in such
transactions. The agreement may be terminated at any time by either party.

Termination of Agreements  Johns Hopkins

On
May 7, 2007, the Company entered into an agreement with Johns Hopkins Medicine,
Johns Hopkins University and Johns Hopkins Health Systems Corporation, pursuant
to which the Consulting and Services Agreement between Advanced Aesthetics,
Inc. and Johns Hopkins Medicine dated November 23, 2003, as amended was
terminated effective April 13, 2007. Under the Agreement, KAA is required to
pay Johns Hopkins $369,565 by July 31, 2007, and as of the effective date,
Johns Hopkins will no longer provide services to the Company. As a result of
this agreement, the Company will record a derecognition of the intangible asset
of approximately $3.7 million and liability of approximately $3.3 million in
the fourth quarter.

The
May 7, 2007 agreement also provides that the License and Management Agreement
between Johns Hopkins University and the Company relating to the Companys
Chevy Chase, Maryland facility is terminated effective May 13, 2007, and that
the Company shall pay Johns Hopkins all amounts due under that agreement by May
21, 2007. The Company paid $0.2 million as part of this agreement.

29

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ITEM 2. MANAGEMENTS DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

The
following discussion and analysis should be read in conjunction with our
attached unaudited condensed consolidated financial statements and notes
thereto included in this Report and our audited consolidated financial
statements and notes thereto for the fiscal year ended July 1, 2006, included
in our 2006 Annual Report on Form 10-K filed with the Securities and Exchange
Commission on February 6, 2007.

Unless
otherwise indicated in this Item 2, references to TrueYou refer to
TrueYou.Com Inc.; references to KAAI refer to Klinger Advanced Aesthetics,
Inc. and its consolidated subsidiaries; references to the we, our,,
Company, and us refer to TrueYou.Com Inc. and its consolidated subsidiaries
(including KAAI), as applicable; and the terms fiscal quarter and three
months in this Quarterly Report on Form 10-Q refer to the quarter ended
December 30, 2006.

Forward-Looking Statements

Certain
of the statements set forth in this Form 10-Q constitutes Forward Looking
Statements. Forward-looking statements include, without limitation, any statement
that may predict, forecast, indicate, or imply future results, performance or
achievements, and may contain the words estimate, project, intend,
forecast, anticipate, plan, planning, expect, believe,
will,
will likely, should, could, would, may or words or expressions of
similar meaning. Therefore, readers are cautioned that there also can be no
assurance that the forward-looking statements included in this Form 10-Q will
prove to be accurate and results may differ materially. In light of the
significant uncertainties inherent to the forward-looking statements included
herein, the inclusion of such information should not be regarded as a
representation or warranty by us or any other person that our objectives and
plans will be achieved in any specified time frame, if at all. Thus, we cannot
guarantee future results, levels of activity, performance or achievements.
Moreover, except to the extent required by applicable laws or rules, we do not
undertake any obligation to update any forward-looking statements or to
announce revisions to any of the forward-looking statements after the date of
this Form 10-Q.

Business Overview

On
May 7, 2007, the Company entered into a Purchase and Sale Agreement pursuant to
which it sold all of its spa/salons to GK Acquisition LLC, an unaffiliated
third party (see Subsequent Events Note 10).

The
Company adopted a plan to sell the spa/salons in May 2007 and, accordingly the
Company will present the operations of the stores as discontinued operations
beginning in the fourth quarter. The consolidated financial statements
presented herein include the results of operations for the spas/salons in
continuing operations for the periods presented.

We
offer both medical and non-medical services and products to customers. We
co-brand our trade name with the trade names of the salons and spas that we
acquired. We offer our Cosmedicine skin care products at retail through our own
location and at wholesale through Sephora stores and the internet. We are
developing and testing the Klinger 360°
Best Practices Aesthetics System  (the K360), which to our knowledge is the
first comprehensive software and hardware practice management system that
facilitates the delivery of evidenced based best practices aesthetic
services. Our salons and spas share certain corporate resources such as senior
management and administrative services. As of
    May 31, 2007, and as a result of the sale of the spa/salons described above,
    we had 29 employees. As of December 30, 2006 we had 542 employees.

30

---



KAAI
commenced business operations on June 29, 2003 when it acquired Dischino
Corporation. Dischino Corporation operated an established beauty salon and spa
in West Palm Beach, Florida. In December 2003, KAAI acquired three additional
facilities in the State of Florida. The first facility was a spa located in
Palm Beach Gardens, the second and third facilities were spas located in Boca
Raton. In April 2004, KAAI expanded operations by acquiring assets of the
Georgette Klinger Corporation which owned and operated nine salons throughout
the United States that offer spa and salon services.

In
2006, we opened our two new flagship locations, the NorthPark flagship in
Dallas Texas, and the Chevy Chase flagship in Chevy Chase, Maryland. These
locations are the models that showcase our business strategy and are used to
advertise all our products and services. They have been developed as fully
integrated properties, in a new format which offers cosmetic dermatology, spa
and salon services, retail products, and the K360 system in a luxurious upscale
setting (the KAAI Model). These locations are located in key markets. The
complete listing of our store locations is as follows:

| |   |                                  
| | - | ---------------------------------
| |  | Dallas,
  Texas                  
| |  | Chevy Chase,
  Maryland          
| |  | Manhattan,
  New York,           
| |  | Manhasset
  Long Island, New York
| |  | Costa Mesa,
  California         
| |  | Boca Raton,
  Florida            
| |  | Palm Beach,
  Florida (A)        
| |  | Chicago,
  Illinois              
| |  | Short Hills,
  New Jersey        

(A) 
There are currently three stores in Palm Beach

These
fully-integrated facilities feature cosmetic dermatology, skin care, cosmetic
medical consultations, hair care, spa and salon services, and retail products
on site, and cosmetic medical services provided by medical offices operated by
Johns Hopkins and UT Southwestern. We also participate in the Johns Hopkins
Cosmetic Safety Program in locations where they have visited the site and
confirmed that we are in compliance with their specifications. Johns Hopkins
Medicine provides clinical and safety oversight for our medical services. We
have rights to use the Johns Hopkins Medicine name in this regard and approved
language is used in our facilities and diagnostic software.

We
have developed an over-the-counter skin care line of products called
Cosmedicine. Johns Hopkins consulted on the design and information analysis of
tests performed on Cosmedicine products. In return for its consulting services,
Johns Hopkins receives fees from KAAI. We launched the products in February
2006 for exclusive retail distribution at Sephora stores, KAAI locations and on
our respective websites. All Cosmedicine products are being developed and
formulated for us by Atlantis Laboratories. Atlantis Laboratories is an
independent developer and manufacturer of bulk skin care products. We believe
that going forward, revenues generated from sales of our Cosmedicine products
will be a significant percentage of our aggregate revenues.

In
addition, we have developed a beta version of the K360 system, a practice
management system for medical offices that perform aesthetic procedures. The
K360 system has been designed to provide a series of unique tools that we
believe will improve the quality, safety and predictability of aesthetic
services performed in a medical setting. The K360 system has a series of
functions, each of which is guided by standardized protocols to optimize
standardization. Beginning in July 2006, we began licensing the software to a
small number of clients. Our goal is to begin generating a small amount of
revenue on this software in 2007.

31

---



Our
financial statements have been prepared on the going concern basis, which
contemplates the realization of assets and the satisfaction of liabilities in
the normal course of business. Since our inception, we have experienced
substantial operating losses and negative cash flow from operations. As of
December 30, 2006, we have an accumulated deficit of $145.9 million and a
working capital deficit of $48.9 million. Included in our net deficit at December
30, 2006 is the remeasurement of convertible securities. Cumulative charges
recorded through the remeasurement of this obligation amounted to $38.7
million. These factors raise substantial doubt about our ability to continue as
a going concern. Also, as a result of our losses, the opinion of our
Independent Registered Public Accountants on our audited financial statements
for fiscal year 2006 included an explanatory paragraph relating to going
concern. A going concern explanatory paragraph indicates that our auditors
believe there is substantial doubt about our ability to continue as a going
concern for at least a reasonable period of time. Our ability to continue as a
going concern ultimately depends on our ability to increase sales and reduce expenses
to a level that will allow us to operate profitably and sustain positive
operating cash flows.

On
May 7, 2007 we entered into an Amended and Restated Securities Purchase
Agreement with Laurus pursuant to which we sold to Laurus a Secured Term Note
in the aggregate principal amount of $54,650,000. On the Closing Date, our 25.0
million obligation to Laurus under the June 30, 2006 note was repaid.

There
is no assurance that this recently completed financing will be sufficient to fund
operations until sales and profitability improve to the point that KAAI is able
to operate from internally generated cash flows.

Current Trends and
Outlook

We
have recently completed some key initiatives that we believe will result in
improved operating performance and profitability. On May 7, 2007, we sold all
our stores/salons in an effort to improve profitability and cash flow. This
will also allow management to focus on our Cosmedicine skin care line. In April
2007, we entered into a marketing agreement with Home Shopping Network (HSN)
to promote and sell Cosmedicine products. Commencing in August of 2007, the
Company, expects to sell selected products of its Cosmedicine skin care line
through direct to consumer television programming on HSN. Cosmedicine is
currently available in the United States at Sephora stores, Sephoras website,
Cosmedicine.com and spa locations formerly operated by the Company and which
have been sold to GK Acquisitions LLC. We believe that these markets will provide
excellent growth opportunities for our products.

As
discussed above, concurrent with the stores sale on May 7th, we
completed a refinancing with Laurus. This capital was critical to the
operations and will be a key to growing the Cosmedicine business.

Earlier
in the year, we had experienced significant challenges to raise sufficient
capital to service our ongoing debt obligations and continue our operations as
presently conducted. As discussed below (see Future Liquidity and Capital Needs),
on March 8, 2007 Laurus sent a notice of default relating to its $25.0 million
Secured Term Note and its $1.0 million Senior Subordinated Secured Term Note.
This default was one of the factors that ultimately led to the selling of the
stores. As a result of the this notice of default on the Senior Secured Debt
and the drop in the Company traded share price, we believe that there has been
an impairment to goodwill in our fiscal quarter ended March 31, 2007. As of May
30, 2007, the closing price of the Companys Common Stock was $0.04. The
default and the limited capital options determined after the event left the
Company with no capacity to invest to maintain any remaining goodwill. Planned
spending was curtailed relating to any non-essential activities or operations.
This reduction in planned spending significantly reduced the projected cash
flows of the stores/salons and the Company overall. As a result, we intend to
record an $18.1 million expense in our fiscal quarter ended March 31, 2007 to
write-off all of our goodwill.

32

---



On
February 8, 2007, we reached an agreement with the landlord at our Beverly
Hills store to surrender the leased property. Due to our limited capital and
revised business plan, we are unable to complete the remodeling and re-open the
store. As a result of this agreement, we anticipate a net write-off of $0.6
million of net assets in the third quarter.

We
have had a small net decline in revenues for the three and six months ended
December 30, 2006 versus the three and six months ended December 31, 2005 due
primarily to some facilities experiencing lost revenue. We believe the reasons
behind this trend include our facility in Boca Raton that has not fully
recovered from hurricane damage that was sustained in October, 2005. This
includes significant employee turnover at this facility as a result of the
damage sustained. We permanently closed our Beverly Hills location, that had
been temporarily closed for renovations, due to the ongoing rent expense and
the significant capital investment it would have required to re-open it. We are
also experienced declining revenues in some of our legacy stores, due to
limited capital. These losses were partially offset in the quarter and six
months ended December 30, 2006 with the continued success of our Cosmedicine
products. We also plan to optimize the K360 system. The plan is to license the
software to clients for a modest fee and to have it serve as the catalyst for
the sale of our products and licensed services.

Revenue Sources

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We derived
  revenue from the following sources during the periods:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | Spa and Salon Services
   Our salon offerings include services such as hair styling, coloring,
  texturizing, treatments, extensions, make-up artistry and manicure/pedicures.
  Our spa services include treatments such as facials, body treatments
  (exfoliation, wraps, cellulite treatments), waxing and massage therapy. Spa
  and salon service revenue represented 66% and 71% of our total operating
  revenues for the three months ended December 30, 2006 and December 31, 2005,
  respectively and 62% and 69% of our total operating revenues for the six
  months ended December 30, 2006 and December 31, 2005, respectively.                                                                                                                                                                                                                                                                               
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | Spa and
  salon services are provided at all our operating stores.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | Medical Services 
  Our medical offerings include injection services (Botox and Restylane),
  sclerotherapy (vein treatments), peels, microdermabrasion, permanent make-up,
  laser resurfacing and laser hair removal. Medical service revenue represented
  6% and 9% of our total operating revenues for the three months ended December
  30, 2006 and December 31, 2005, respectively and 6% and 9% of our total
  operating revenues for the six months ended December 30, 2006 and December
  31, 2005, respectively.                                                                                                                                                                                                                                                                                                                                                                                                 
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | Historically
  we have offered on-site and off-site medical services. All dermatology
  related procedures are performed on-site. For the on-site procedures, medical
  providers utilize space in our stores, having been provided a separate
  medical area with its own entrance and medical accessories. Prior to August
  2006, we also offered off-site medical services. These services consisted of
  cosmetic surgeries that were performed by the medical practitioners at a
  third party participating hospital. The on-site medical facility would provide
  the initial consultation, with the surgery performed off-site by the medical
  practitioner. We bill and collect all revenues and pay all expenses related
  to the medical services and pay the medical practitioners for their services.
  We no longer offer any off-site medical services as we have discontinued
  offering cosmetic surgeries.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | To generate
  our revenues for our medical segment, we enter into medical practitioner fee
  contracts with our medical practitioners where they receive a percentage of the
  revenue generated from the performance of their services. Depending upon the
  medical provider and the type of service that is delivered, the percentage
  varies from 30-70% for medical revenues.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

33

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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In all
  cases, physicians are contracted as consultants and not as employees. In most
  cases, the nurse practitioners are hired as employees. We do not generate any
  revenues from referring individuals to medical providers.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | Retail Product Sales
   Include sales of third party products and our Cosmedicine products through
  our own locations. Retail product sales revenue represented 21% and 19% of
  our total operating revenues for the three months ended December 30, 2006 and
  December 31, 2005, respectively and 22% of our total operating revenues for
  the six months ended December 30, 2006 and December 31, 2005.                                                                                                                                                                                                                                                                                                                                                               
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | Our
  locations offer a variety of retail products including products for hair
  care, skin care, and make-up. Hair care product offerings include such brands
  as LOreal, Kerastase, and Bumble & Bumble. Skin care product offerings
  include such brands as DDF, Obagi, IS Clinical, MD Skincare, and La Therapie.
  Our make-up product offering consists of the brand NARS. Additionally many of
  our locations offer our private label skin care brands, Georgette Klinger and
  Cosmedicine. In general, different combinations of the products are offered
  at different locations. Our Cosmedicine products are sold at all our
  locations, however, and have become our largest retail brand, beginning in
  fiscal 2006.                                    
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | Wholesale Product Sales  Include sales of our
  Cosmedicine products at Sephora stores and through the internet. These
  products were launched in fiscal 2006 and represented 7% and 10% of our total
  operating revenues for the three and six months ended December 30, 2006,
  respectively. Sephora, with whom we have a strategic relationship, is a
  subsidiary of LVMH, SA and L Capital is a private equity fund sponsored by
  LVMH, SA and, as a result, Sephora and L Capital are affiliates. Net revenue
  recognized on sales to Sephora was $0.5 million and $1.4 million for the
  three and six months ended December 30, 2006. Our decision to enter into a
  strategic alliance with Sephora was made independent of our relationship with
  L Capital.

We
manage our business by evaluating net revenue, gross margin, and liquidity.
There is a close review of performance by location in these key areas to
determine if resources need to be added or shifted to improve performance. We
benchmark the facilities against each other to utilize data from high
performing locations to assist those that are under performing. Key personnel
are often deployed to the locations that show negative trends in these
statistics. A close review of the operations is also performed to determine
current cash position and future capital needs. Capital is tightly managed and
utilized in those operations that will provide the greatest return.

We
encounter a variety of challenges that may affect our business. These factors
include weather, including hurricanes which have adversely impacted our
facilities in Florida, and our dependence on individuals to provide services to
our clients who leave the Company and take clients with them.

Beginning
in fiscal year 2006, the Company began following the standard fiscal year of
the retail industry, which is a 52 or 53 week period, with the end of a period
being the closest Saturday to the end of a month.

34

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Critical Accounting Estimates

Accounting
estimates and assumptions discussed in this section are those that we consider
to be the most critical to an understanding of our financial statements because
they inherently involve significant judgments and uncertainties. For all of
these estimates, we caution that future events rarely develop exactly as forecast,
and the best estimates routinely require adjustment.

Revenue
Recognition: We record revenue based on the following
types of product and service offerings:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Company run stores, medical, and internet
  sales - revenue is recognized for services rendered
  or product sold at the time when the service is performed or the item sold.
  When a gift card is purchased for a future service or product, the value of
  the card is recorded as a liability. In the past, we offered paper gift
  cards. For these paper cards, the entire liability remains on the balance
  sheet until the earlier of redemption or 36 months, for non-escheatable
  states. It is our historical experience that the likelihood of redemption
  after 36 months is remote. After 36 months, 80% of the remaining liability is
  relieved and recorded as other income. After 48 months, another 10% of the
  liability is relieved and recorded as other income. After 60 months, the last
  10% of the remaining liability is relieved and recorded as other income. For
  escheatable states, the liability remains on the books until escheatment.
  Currently the only type of gift cards offered are electronic cards. The
  recording of the sale is the same as paper gift cards. But for electronic
  cards, the entire liability remains on the books for the first year, less any
  redemptions. After the first year, the liability is reduced by five dollars
  per month as an inactivity fee and recorded to other income.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |  | Cosmedicine
  sales to Sephora  revenue is recognized as sales are made to Sephora. At the
  end of each quarter, an accrual is made for anticipated returns due to
  damages, store testers, and product with limited remaining code life.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

Impairment
of Goodwill:We review long-lived assets to be held
and used whenever events or changes in circumstances indicate that the carrying
amount of such assets may not be fully recoverable. In addition, we review
goodwill for impairment at least on an annual basis. Measurement of an
impairment loss is based on the fair value of the asset compared to its
carrying value. As discussed above, as a result of the this notice of default
on the Senior Secured Debt and the drop in the Company traded share price, we
believe that there has been an impairment to goodwill in our fiscal quarter ended
March 31, 2007. As of May 30, 2007, the closing price of the Companys Common
Stock was $0.04. As a result, we intend to record an $18.1 million expense in
our fiscal quarter ended March 31, 2006 to write-off all of our goodwill.

Inventories:
Inventories consist principally of hair care and skin care products held either
for retail sale or for use in salon, spa and medical services. Inventories are
stated at the lower of cost or market on a first-in, first-out basis. Further,
on a quarterly basis, we estimate losses from shrinkage due to lost or stolen
inventory based on historical experience and reduce the inventory value by that
estimate.

Provisions
for Inventory Obsolescence:We record provisions for estimated obsolescence of inventory.
Our estimates consider the cost of inventory, forecasted demand, the shelf life
of the inventory and our historical experience. If there are changes to these
estimates, additional provisions for inventory obsolescence may be necessary.

Stock
Based Compensation: We estimate the cost of stock
based compensation using the Black-Scholes Option Pricing Model. Inherent in
that model are assumptions including the volatility of our Common Stock,
forfeiture rate, and the length of time which we expect an option to remain
outstanding.

35

---



Deferred
Income Taxes: We review our provision for income taxes
at least quarterly and make a determination as to the likelihood of our ability
to use the income tax benefit of our net operating losses. We then make a
determination as to an appropriate allowance to reduce the value of this asset.

Convertible
Securities:We remeasured our convertible securities
in compliance with EITF 00-19, based on the fair value of our Common Stock into
which they are convertible, since there are currently insufficient shares
authorized to allow conversion. The fair value of the Common Stock is based in
the price paid for a share of the stock closest to the measurement date. As of
December 30, 2006 the closing price for our Common Stock was $0.19. Changes in
the price paid for a share of our Common Stock can have a significant impact on
the amount recorded for the convertible securities. For example, the movement
up or down in the price of our Common Stock by $0.10 will cause the balance of
convertible securities to fluctuate by approximately $65 million. This
fluctuation would result in an impact to our net loss. As of May 30, 2007, the
closing price of our Common Stock was $0.04. Convertible securities will convert
back to equity when there are a sufficient number of shares of Common Stock
authorized.

New Accounting Pronouncements

In
June 2006, FASB issued FIN 48, Accounting for Uncertainty in Income Taxes an
interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in an enterprises financial statements
in accordance with FASB Statement No. 109, Accounting
for Income Taxes. This Interpretation prescribes a recognition
threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return.
This Interpretation also provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure, and
transition. This guidance is effective for fiscal years beginning after
December 15, 2006. We believe the impact of the adoption of FIN 48 will not be
significant to the Companys consolidated financial statements.

In
September 2006, the FASB issued SFAS 157, Fair Value Measurements. SFAS 157
defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles (GAAP), and expands disclosures about
fair value measurements. This guidance becomes effective for the first
reporting period beginning after November 15, 2007. We are assessing the impact of the
adoption of SFAS 157 on the Companys consolidated financial statements.

In
September 2006, the FASB issued SFAS 158, Employers Accounting for Defined
Benefit Pension and Other Postretirement Plansan amendment of FASB Statements
No. 87, 88, 106, and 132(R). SFAS 158 requires an employer to recognize the
overfunded or underfunded status of a defined benefit postretirement plan
(other than a multiemployer plan) as an asset or liability in its statement of
financial position and to recognize changes in that funded status in the year
in which the changes occur through comprehensive income. This guidance is
effective as of the end of the fiscal year for years ending after December 15,
2006. We believe the impact of the adoption of SFAS 158 will not be significant
to the Companys consolidated financial statements.

Results of Operations

The
following discussion should be read in conjunction with our Financial
Statements and the Notes thereto.

Three Months
Ended December 30, 2006 and December 31, 2005

The
following table sets forth our operating revenues and cost of revenue data as
    a percentage of net sales for the three months ended December 30, 2006 and
December 31, 2005:

36

---



|                        |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |        |   |  |     |   
|----------------------- |  | ------------------- | ----- | ------------------- |  | ----------------------- | - | ---------------- | ----- |  |  | --- | - | - | ------ | - |  | --- | --
|                        |  | Three Months Ended  |       |                     |  |                         |   |                  |      
|                        |  |                     |       |                     |  |                         |   |                  |      
|In thousands            |  | December 30,
  2006 |       | December 31,
  2005 |  | Increase /
  (Decrease) |   | Percent
  Change |      
|                        |  |                     |       |                     |  |                         |   |                  |      
|Operating
  Revenues    |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |        |   |  |     |   
|Services                |  | $                   | 5,176 |                     |  | 72                      | % | $                | 6,091 |  |  | 81  | % | $ | (915   | ) |  | (15 | %)
|Retail and wholesale    |  |                     | 2,001 |                     |  | 28                      | % |                  | 1,462 |  |  | 19  | % |   | 539    |   |  | 37  | % 
|                        |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |        |   |  |     |   
|                        |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |        |   |  |     |   
|Total Operating Revenue |  | $                   | 7,177 |                     |  | 100                     | % | $                | 7,553 |  |  | 100 | % | $ | (376   | ) |  | (5  | %)
|                        |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |        |   |  |     |   
|                        |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |        |   |  |     |   
|                        |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |        |   |  |     |   
|Cost of
  Revenue       |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |        |   |  |     |   
|Services                |  | $                   | 3,638 |                     |  | 51                      | % | $                | 3,472 |  |  | 46  | % | $ | 166    |   |  | 5   | % 
|Retail and wholesale    |  |                     | 679   |                     |  | 9                       | % |                  | 572   |  |  | 8   | % |   | 107    |   |  | 19  | % 
|                        |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |        |   |  |     |   
|                        |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |        |   |  |     |   
|Total Cost of Revenue   |  | $                   | 4,317 |                     |  | 60                      | % | $                | 4,044 |  |  | 54  | % | $ | 273    |   |  | 7   | % 
|                        |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |        |   |  |     |   
|                        |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |        |   |  |     |   
|                        |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |        |   |  |     |   
|Gross
  Margin          |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |        |   |  |     |   
|Services                |  | $                   | 1,538 |                     |  | 21                      | % | $                | 2,619 |  |  | 35  | % | $ | (1,081 | ) |  | (41 | %)
|Retail and wholesale    |  |                     | 1,322 |                     |  | 18                      | % |                  | 890   |  |  | 12  | % |   | 432    |   |  | 49  | % 
|                        |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |        |   |  |     |   
|                        |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |        |   |  |     |   
|Total Gross Margin      |  | $                   | 2,860 |                     |  | 40                      | % | $                | 3,509 |  |  | 46  | % | $ | (649   | ) |  | (18 | %)
|                        |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |        |   |  |     |   

Revenue

The
results of such sources for the three months ended December 30, 2006 and December
31, 2005 are as follows:

|                        |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |      |   |  |     |   
|----------------------- |  | ------------------- | ----- | ------------------- |  | ----------------------- | - | ---------------- | ----- |  |  | --- | - | - | ---- | - |  | --- | --
|In
thousands            |  | Three Months Ended  |       |                     |  |                         |   |                  |      
|                        |  |                     |       |                     |  |                         |   |                  |      
|                        |  | December 30,
  2006 |       | December 31,
  2005 |  | Increase /
  (Decrease) |   | Percent
  Change |      
|                        |  |                     |       |                     |  |                         |   |                  |      
|Operating
  Revenues    |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |      |   |  |     |   
|Spa and salon services  |  | $                   | 4,711 |                     |  | 66                      | % | $                | 5,394 |  |  | 71  | % | $ | (683 | ) |  | (13 | %)
|Retail products         |  |                     | 1,481 |                     |  | 21                      | % |                  | 1,462 |  |  | 19  | % |   | 19   |   |  | 1   | % 
|Wholesale products      |  |                     | 520   |                     |  | 7                       | % |                  | 0     |  |  |    |   |   | 520  |   |  |    |   
|Medical services        |  |                     | 465   |                     |  | 6                       | % |                  | 697   |  |  | 9   | % |   | (232 | ) |  | (33 | %)
|                        |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |      |   |  |     |   
|                        |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |      |   |  |     |   
|Total Operating Revenue |  | $                   | 7,177 |                     |  | 100                     | % | $                | 7,553 |  |  | 100 | % | $ | (376 | ) |  | (5  | %)
|                        |  |                     |       |                     |  |                         |   |                  |       |  |  |     |   |   |      |   |  |     |   

Revenue
for the three months ended December 30, 2006 was $7.2 million compared to $7.6
million for the three months ended December 31, 2005, a decrease of $0.4
million. All revenues during the two quarters were derived from the U.S. The
slight decrease in revenue was primarily due to a $0.7 million decrease in
service revenue, comprised of spa and salon services, and the decrease of medical
services of $0.2 million. The decrease was primarily due to the Boca Raton
location which has not fully recovered from the major hurricane which hit in
October 2005. Employees initially stayed with the Company as they anticipated
capital spending to restore the spa to pre-hurricane conditions. But due to
limited capital, we were not able to make the required repairs. While some of
the damages were ultimately recovered from insurance, the proceeds were needed
for operations and could not be used for capital improvements. The

37

---



combination of damages and
employee turnover led to a significant loss of the pre-existing customer base.
Customers often follow long-term service providers to their new location. The
decrease in spa and service revenue was $0.8 million for this location versus
the three months ended December 31, 2005. In addition, we have decided to
permanently close the Beverly Hills location that had been temporarily closed
for remodeling. There were no revenues from this location in the three months
ended December 30, 2006 versus $0.1 million for the three months ended December
31, 2005. We have also experienced a slight decline in several of our other
legacy stores due to the limited capital available to maintain or increase the
revenue base. These decreases were partially offset by wholesale product sales
of $0.5 million for the three months ended December 30, 2006, from the
Cosmedicine products sold to Sephora.

Cost of Revenue

Cost
of revenue increased to $4.3 million for the three months ended December 30,
2006 from $4.0 million for the three months ended December 31, 2005, an
increase of $0.3 million. Cost of revenue represented 60% and 54% of operating
revenues for the three months ended December 30, 2006 and December 31, 2005, respectively.
The increase was primarily due to the higher cost of backbar usage in the
salons for the quarter ended December 30, 2006. These are products used only
for services provided at the salons and not sold at retail. In an effort to
expand our Cosmedicine line, we began increasing the use of these products for
backbar usage in our salons and reducing the usage of the Georgette Klinger
backbar products and those of third party vendors. While we believe the
Cosmedicine products provide additional benefits to customers, the cost of the
Cosmedicine backbar products is higher than Georgette Klinger or those
purchased from third party vendors.

Gross Margin

Gross
margin was 40% and 46% for the three months ended December 30, 2006 and
December 31, 2005, respectively. The decline in gross margin was primarily due
to the higher cost of backbar usage discussed above and higher payroll and
commission structures which were partially offset by the launch of our
Cosmedicine product line.

Operating Expenses

The
following table compares our operating expenses for the three months ended
December 30, 2006 and December 31, 2005:

|                                 |  |                     |        |                     |   |                         |  |                  |        |   |  |       |   
|-------------------------------- |  | ------------------- | ------ | ------------------- | - | ----------------------- |  | ---------------- | ------ | - |  | ----- | --
|                                 |  | Three Months Ended  |        |                     |   |                         |  |                  |       
|                                 |  |                     |        |                     |   |                         |  |                  |       
|In thousands                     |  | December 30,
  2006 |        | December 31,
  2005 |   | Increase /
  (Decrease) |  | Percent
  Change |       
|                                 |  |                     |        |                     |   |                         |  |                  |       
|Operating
  Expenses             |  |                     |        |                     |   |                         |  |                  |        |   |  |       |   
|Share based compensation expense |  | $                   | (3,169 | )                   | $ | 150                     |  | $                | (3,319 | ) |  | (2213 | %)
|Payroll                          |  |                     | 3,118  |                     |   | 3,535                   |  |                  | (417   | ) |  | (12   | %)
|Depreciation and amortization    |  |                     | 1,134  |                     |   | 1,159                   |  |                  | (25    | ) |  | (2    | %)
|                                
|Loss on disposal of fixed assets |  |                     |       |                     |   | 35                      |  |                  | (35    | ) |  |      |   
|Occupancy                        |  |                     | 1,691  |                     |   | 1,288                   |  |                  | 403    |   |  | 31    | % 
|Insurance                        |  |                     | 1,114  |                     |   | 588                     |  |                  | 526    |   |  | 89    | % 
|Equipment leasing                |  |                     | 57     |                     |   | 49                      |  |                  | 8      |   |  | 16    | % 
|Travel and entertainment         |  |                     | 557    |                     |   | 395                     |  |                  | 162    |   |  | 41    | % 
|Professional fees                |  |                     | 2,834  |                     |   | 2,445                   |  |                  | 389    |   |  | 16    | % 
|Office Expenses                  |  |                     | 272    |                     |   | 144                     |  |                  | 128    |   |  | 89    | % 
|Advertising and marketing        |  |                     | 292    |                     |   | 656                     |  |                  | (364   | ) |  | (55   | %)
|Credit card fees                 |  |                     | 198    |                     |   | 83                      |  |                  | 115    |   |  | 139   | % 
|Postage and delivery             |  |                     | 170    |                     |   | 118                     |  |                  | 52     |   |  | 44    | % 
|Telephone                        |  |                     | 169    |                     |   | 109                     |  |                  | 60     |   |  | 55    | % 
|Training and education           |  |                     | 46     |                     |   | 101                     |  |                  | (55    | ) |  | (54   | %)
|Management fees                  |  |                     |       |                     |   | 190                     |  |                  | (190   | ) |  | (100  | %)
|Other                            |  |                     | 216    |                     |   | 598                     |  |                  | (382   | ) |  | (64   | %)
|                                 |  |                     |        |                     |   |                         |  |                  |        |   |  |       |   
|                                 |  |                     |        |                     |   |                         |  |                  |        |   |  |       |   
|Total Operating Expenses         |  | $                   | 8,699  |                     | $ | 11,643                  |  | $                | (2,944 | ) |  | (25   | %)
|                                 |  |                     |        |                     |   |                         |  |                  |        |   |  |       |   

38

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Operating
expenses were $8.7 million for the three months ended December 30, 2006
compared to $11.6 million for the three months ended December 31, 2005, a
decrease of $2.9 million. The decrease of 25.0% was primarily due to due to a
$3.3 million decrease in stock option expense under SFAS No. 123R related
primarily to the remeasurement at December 30, 2006.

Non-operating Expenses

The
following table compares our non-operating expenses for the three months ended
December 30, 2006 and December 31, 2005:

|                                            |  |                     |         |                     |   |                         |  |                  |          |   |  |      |   
|------------------------------------------- |  | ------------------- | ------- | ------------------- | - | ----------------------- |  | ---------------- | -------- | - |  | ---- | --
|                                            |  | Three Months Ended  |         |                     |   |                         |  |                  |         
|In thousands                                |  | December 30,
  2006 |         | December 31,
  2005 |   | Increase /
  (Decrease) |  | Percent
  Change |         
|                                            |  |                     |         |                     |   |                         |  |                  |         
|Non-operating
  (Income) Expenses           |  |                     |         |                     |   |                         |  |                  |          |   |  |      |   
|Interest expense, net                       |  | $                   | 1,706   |                     | $ | 1,969                   |  | $                | (263     | ) |  | (13  | %)
|Unrealized (gain) on convertible
securities |  |                     | (53,470 | )                   |   | 137,749                 |  |                  | (191,219 | ) |  | (139 | %)
|Registration rights penalties               |  |                     | 1,162   |                     |   |                        |  |                  | 1,162    |   |  |     |   
|                                            |  |                     |         |                     |   |                         |  |                  |          |   |  |      |   
|Total Non-operating (Income) Expense        |  | $                   | (50,602 | )                   | $ | 139,718                 |  | $                | (190,320 | ) |  | (136 | %)
|                                            |  |                     |         |                     |   |                         |  |                  |          |   |  |      |   

Interest Expense,
net

Interest
expense was $1.7 million for the three months ended December 30, 2006 compared
to $2.0 million for the three months ended December 31, 2005, a decrease of
$0.3 million.

Unrealized Loss on
Convertible Securities

On
December 20, 2005, as a result of the Share Exchange Agreement, the Company
recorded the convertible securities at $65 million, which represented the
carrying amount of the convertible securities issued under the arrangement.
Since the securities issued are convertible into common shares and the Company
did not have sufficient authorized shares to allow for that conversion, under
EITF 00-19 the Company was required to reclassify these amounts as liabilities
and remeasure them to fair value at each reporting period end. The Company
remeasures the convertible securities at the end of each reporting period based
on the share price of the True You Common Stock closest to the period end. At
July 1, 2006 the share price was multiplied by the number of common shares into
which the convertible securities were convertible, which was 506,576,690 as of
that date. The per share trading value as of July 1, 2006 was $0.39, which
resulted in an estimated fair value of the convertible securities of $197.6
million. During the three months ended December 30, 2006, the Company added
25,384,615 warrants issued with debt. As of December 30, 2006, the number of
common shares into which the convertible securities were convertible was
646,452,766 as of that date. The per share trading value as of December 30,
2006 was $0.19, that resulted in an estimated fair value of the convertible
securities of $122.8 million. The Company recorded an unrealized gain of
approximately $53.5 million for the three months ended December 30, 2006.

39

---



Registration Rights
Penalties

The
Company incurred penalties of $1.2 million for the three months ended December
30, 2006. The penalties are due to failure to meet conditions included in
registration rights agreements with various stockholders.

Concurrent
with the May 7, 2007 financing, holders of the registration rights waived any
additional registration rights penalties incurred by the Company after December
30, 2006.

Dividends Accrued on Preferred Stock

Dividends
accrued on preferred stock were $0.4 million for the three months ended
December 30, 2006 as compared to net forfeitures of dividends of $0.1 million
for the three months ended December 31, 2005. The increase was due to the
forfeiture of dividends accrued on preferred stock which was converted into
KAAIs common stock and subsequently exchanged for TrueYou Series B Preferred
Stock in the quarter ended December 31, 2005.

Concurrent
with the May 7, 2007 financing, preferred shareholders waived $3.2 million in
accrued dividends fees included in the December 30, 2006 Condensed Consolidated
Balance Sheet.

Six Months Ended
December 30, 2006 and December 31, 2005

The
following table sets forth our operating revenues and cost of revenue data as a
percentage of net sales for the six months ended December 30, 2006 and December
1, 2005:

|                        |  |                     |        |                     |  |                         |   |                  |        |  |  |     |   |   |        |   |  |     |   
|----------------------- |  | ------------------- | ------ | ------------------- |  | ----------------------- | - | ---------------- | ------ |  |  | --- | - | - | ------ | - |  | --- | --
|                        |  | Six Months Ended    |        |                     |  |                         |   |                  |       
|                        |  |                     |        |                     |  |                         |   |                  |       
|In thousands            |  | December 30,
  2006 |        | December 31,
  2005 |  | Increase /
  (Decrease) |   | Percent
  Change |       
|                        |  |                     |        |                     |  |                         |   |                  |       
|Operating
  Revenues    |  |                     |        |                     |  |                         |   |                  |        |  |  |     |   |   |        |   |  |     |   
|Services                |  | $                   | 9,824  |                     |  | 68                      | % | $                | 11,954 |  |  | 78  | % | $ | (2,130 | ) |  | (18 | %)
|Retail and wholesale    |  |                     | 4,615  |                     |  | 32                      | % |                  | 3,364  |  |  | 22  | % |   | 1,251  |   |  | 37  | % 
|                        |  |                     |        |                     |  |                         |   |                  |        |  |  |     |   |   |        |   |  |     |   
|Total Operating Revenue |  | $                   | 14,439 |                     |  | 100                     | % | $                | 15,318 |  |  | 100 | % | $ | (879   | ) |  | (6  | %)
|                        |  |                     |        |                     |  |                         |   |                  |        |  |  |     |   |   |        |   |  |     |   
|                        |  |                     |        |                     |  |                         |   |                  |        |  |  |     |   |   |        |   |  |     |   
|Cost of
  Revenue       |  |                     |        |                     |  |                         |   |                  |        |  |  |     |   |   |        |   |  |     |   
|Services                |  | $                   | 6,557  |                     |  | 45                      | % | $                | 6,860  |  |  | 45  | % | $ | (303   | ) |  | (4  | %)
|Retail and wholesale    |  |                     | 1,743  |                     |  | 12                      | % |                  | 1,360  |  |  | 9   | % |   | 383    |   |  | 28  | % 
|                        |  |                     |        |                     |  |                         |   |                  |        |  |  |     |   |   |        |   |  |     |   
|Total Cost of Revenue   |  | $                   | 8,300  |                     |  | 57                      | % | $                | 8,220  |  |  | 54  | % | $ | 80     |   |  | 1   | % 
|                        |  |                     |        |                     |  |                         |   |                  |        |  |  |     |   |   |        |   |  |     |   
|                        |  |                     |        |                     |  |                         |   |                  |        |  |  |     |   |   |        |   |  |     |   
|Gross
  Margin          |  |                     |        |                     |  |                         |   |                  |        |  |  |     |   |   |        |   |  |     |   
|Services                |  | $                   | 3,267  |                     |  | 23                      | % | $                | 5,094  |  |  | 33  | % | $ | (1,827 | ) |  | (36 | %)
|Retail and wholesale    |  |                     | 2,872  |                     |  | 20                      | % |                  | 2,004  |  |  | 13  | % |   | 868    |   |  | 43  | % 
|                        |  |                     |        |                     |  |                         |   |                  |        |  |  |     |   |   |        |   |  |     |   
|Total Gross Margin      |  | $                   | 6,139  |                     |  | 43                      | % | $                | 7,098  |  |  | 46  | % | $ | (959   | ) |  | (14 | %)

40

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The
results of such sources for the six months ended December 30, 2006 and December
31, 2005 are as follows:

|                        |  |                     |        |                     |  |                         |   |   |                  |  |  |     |   |   |        |   |  |     |   
|----------------------- |  | ------------------- | ------ | ------------------- |  | ----------------------- | - | - | ---------------- |  |  | --- | - | - | ------ | - |  | --- | --
|                        |  | Six Months Ended    |        |                     |  |                         |   |   |                 
|                        |  |                     |        |                     |  |                         |   |   |                 
|In thousands            |  | December 30,
  2006 |        | December 31,
  2005 |  | Increase /
  (Decrease) |   |   | Percent
  Change | 
|                        |  |                     |        |                     |  |                         |   |   |                  | 
|Operating
  Revenues    |  |                     |        |                     |  |                         |   |   |                  |  |  |     |   |   |        |   |  |     |   
|Spa and salon services  |  | $                   | 9,007  |                     |  | 62                      | % | $ | 10,603           |  |  | 69  | % | $ | (1,596 | ) |  | (15 | %)
|Retail products         |  |                     | 3,191  |                     |  | 22                      | % |   | 3,364            |  |  | 22  | % |   | (173   | ) |  | (5  | %)
|Wholesale products      |  |                     | 1,424  |                     |  | 10                      | % |   |                 |  |  |    |   |   | 1,424  |   |  |    |   
|Medical services        |  |                     | 817    |                     |  | 6                       | % |   | 1,351            |  |  | 9   | % |   | (534   | ) |  | (40 | %)
|                        |  |                     |        |                     |  |                         |   |   |                  |  |  |     |   |   |        |   |  |     |   
|                       
|Total Operating Revenue |  | $                   | 14,439 |                     |  | 100                     | % | $ | 15,318           |  |  | 100 | % | $ | (879   | ) |  | (6  | %)
|                        |  |                     |        |                     |  |                         |   |   |                  |  |  |     |   |   |        |   |  |     |   

Revenue
for the six months ended December 30, 2006 was $14.4 million compared to $15.3
million for the six months ended December 31, 2005, a decrease of $0.9 million.
All revenues during the periods were derived from the U.S. The decrease in
revenue was primarily due to a $1.6 million decrease in service revenue,
comprised of spa and salon services, and the decrease of medical services of
$0.5 million. The decrease was primarily due to the Boca Raton location which
has not fully recovered from the major hurricane which hit in October 2005. The
combination of damages and employee turnover led to a significant loss of the
pre-existing customer base. The decrease in spa and service revenue was $1.4
million for this location versus the six months ended December 31, 2005. In
addition, we have decided to permanently close the Beverly Hills location that
had been temporarily closed for remodeling. There were no revenues from this
location in the six months ended December 30, 2006 versus $0.3 million for the
six months ended December 31, 2005. We have also experienced a slight decline
in several of our other legacy stores due to the limited capital available to
maintain or increase the revenue base. These decreases were partially offset by
wholesale product sales of $1.4 million for the six months ended December 30, 2006,
from the Cosmedicine products sold to Sephora.

Cost of Revenue

Cost
of revenue increased to $8.3 million for the six months ended December 30, 2006
from $8.2 million for the six months ended December 31, 2005, an increase of
$0.1 million. Cost of revenue increased from period to period as it represented
57% and 54% of operating revenues for the six months ended December 30, 2006
and December 31, 2005, respectively. The primary cause of the increase was an
increase in the cost of backbar usage in the salons for the six months ended
December 30, 2006.

Gross Margin

Gross
margin was 43% and 46% for the six months ended December 30, 2006 and December
31, 2005, respectively. The decline in gross margin was due primarily to the
higher cost of backbar usage and higher payroll and commission structures which
were partially offset by the launch of our Cosmedicine product line.

Operating Expenses

The following table compares our operating expenses for the six months
ended December 30, 2006 and December 31, 2005:

41

---



|                                 |  |                     |        |                     |   |                         |  |                  |       |   |  |      |   
|-------------------------------- |  | ------------------- | ------ | ------------------- | - | ----------------------- |  | ---------------- | ----- | - |  | ---- | --
|                                 |  | Six Months Ended    |        |                     |   |                         |  |                  |      
|                                 |  |                     |        |                     |   |                         |  |                  |      
|In thousands                     |  | December 30,
  2006 |        | December 31,
  2005 |   | Increase /
  (Decrease) |  | Percent
  Change |      
|                                 |  |                     |        |                     |   |                         |  |                  |       |   |  |      |   
|Operating
  Expenses             |  |                     |        |                     |   |                         |  |                  |       |   |  |      |   
|Share based compensation expense |  | $                   | 1,012  |                     | $ | 150                     |  | $                | 862   |   |  | 575  | % 
|Payroll                          |  |                     | 6,512  |                     |   | 5,667                   |  |                  | 845   |   |  | 15   | % 
|Depreciation and amortization    |  |                     | 2,300  |                     |   | 2,268                   |  |                  | 32    |   |  | 1    | % 
|Loss on disposal of fixed assets |  |                     | 171    |                     |   | 35                      |  |                  | 136   |   |  | 389  | % 
|Occupancy                        |  |                     | 3,326  |                     |   | 2,572                   |  |                  | 754   |   |  | 29   | % 
|Insurance                        |  |                     | 2,006  |                     |   | 1,147                   |  |                  | 859   |   |  | 75   | % 
|Equipment leasing                |  |                     | 166    |                     |   | 100                     |  |                  | 66    |   |  | 66   | % 
|Travel and entertainment         |  |                     | 1,041  |                     |   | 711                     |  |                  | 330   |   |  | 46   | % 
|Professional fees                |  |                     | 5,274  |                     |   | 4,170                   |  |                  | 1,104 |   |  | 26   | % 
|Office Expenses                  |  |                     | 575    |                     |   | 293                     |  |                  | 282   |   |  | 96   | % 
|Advertising and marketing        |  |                     | 1,075  |                     |   | 1,123                   |  |                  | (48   | ) |  | (4   | %)
|Credit card fees                 |  |                     | 358    |                     |   | 286                     |  |                  | 72    |   |  | 25   | % 
|Postage and delivery             |  |                     | 309    |                     |   | 185                     |  |                  | 124   |   |  | 67   | % 
|Telephone                        |  |                     | 275    |                     |   | 202                     |  |                  | 73    |   |  | 36   | % 
|Training and education           |  |                     | 190    |                     |   | 176                     |  |                  | 14    |   |  | 8    | % 
|Management fees                  |  |                     |       |                     |   | 420                     |  |                  | (420  | ) |  | (100 | %)
|Other                            |  |                     | 423    |                     |   | 1,219                   |  |                  | (796  | ) |  | (65  | %)
|                                 |  |                     |        |                     |   |                         |  |                  |       |   |  |      |   
|                                
|Total Operating Expenses         |  | $                   | 25,013 |                     | $ | 20,724                  |  | $                | 4,289 |   |  | 21   | % 
|                                 |  |                     |        |                     |   |                         |  |                  |       |   |  |      |   

Operating
expenses were $25.0 million for the six months ended December 30, 2006 compared
to $20.7 million for the six months ended December 31, 2005, an increase of
$4.3 million. The increase of 21.0% was primarily due to due to a $0.9 million
increase in stock option expense under SFAS No. 123R related primarily to new
options granted during the six months ended December 30, 2006 and the remeasurement
at December 30, 2006, an increase of $1.1 million in professional fees for
accounting, legal, information technology, inventory management services,
software development, and public relations; a $.9 million increase in payroll
due to a $0.5 increase in severance expense, and the addition of several senior
management level officers; a $0.8 million increase in occupancy expenses due to
the new leases on the flagship stores and headquarters versus the prior leases
on the old locations, and $0.3 million increase in advertising and marketing
due primarily to an agreement made after the end of the quarter to provide
1,760,925 shares of Common stock to a vendor in settlement of a prior
unfulfilled contract.

Non-operating Expenses

The following table
compares our non-operating expenses for the six months ended December 30, 2006
and December 31, 2005:

|                                          |  |                     |         |                     |   |                         |  |                  |          |   |  |      |   
|----------------------------------------- |  | ------------------- | ------- | ------------------- | - | ----------------------- |  | ---------------- | -------- | - |  | ---- | --
|                                          |  | Six Months Ended    |         |                     |   |                         |  |                  |         
|                                          |  |                     |         |                     |   |                         |  |                  |         
|In
thousands                              |  | December 30,
  2006 |         | December 31,
  2005 |   | Increase /
  (Decrease) |  | Percent
  Change |         
|                                          |  |                     |         |                     |   |                         |  |                  |         
|                                          |  |                     |         |                     |   |                         |  |                  |          |   |  |      |   
|Non-operating
  (Income) Expenses         |  |                     |         |                     |   |                         |  |                  |          |   |  |      |   
|Interest expense, net                     |  | $                   | 4,384   |                     | $ | 3,070                   |  | $                | 1,314    |   |  | 43   | % 
|Unrealized gain on convertible securities |  |                     | (94,006 | )                   |   | 137,749                 |  |                  | (231,755 | ) |  | (168 | %)
|Registration rights penalties             |  |                     | 2,324   |                     |   |                        |  |                  | 2,324    |   |  |     |   
|                                          |  |                     |         |                     |   |                         |  |                  |          |   |  |      |   
|                                         
|Total Non-operating (Income) Expense      |  | $                   | (87,298 | )                   | $ | 140,819                 |  | $                | (228,117 | ) |  | (162 | %)
|                                          |  |                     |         |                     |   |                         |  |                  |          |   |  |      |   

42

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Interest Expense, net

Interest
expense was $4.4 million for the six months ended December 30, 2006 compared to
$3.1 million for the six months ended December 31, 2005. The increase of $1.3
million was caused primarily by the write-off the unamortized discount and
financing costs on the loan with Technology Investment Capital Corp of $0.9 million and $0.2 million,
respectively, upon the early repayment. Interest expense also increased
due to the increase in debt levels in the six months ended December 30, 2006
versus December 31, 2005, due to the new financing.

Unrealized Loss on Convertible Securities

During
the six months ended December 30, 2006, the Company added 139,876,075 warrants
issued with debt. As of December 30, 2006, the number of common shares into
which the convertible securities were convertible was 646,452,766 as of that
date. The per share trading value as of December 30, 2006 was $0.19, which
resulted in an estimated fair value of the convertible securities of $122.8 million.
The Company recorded an unrealized gain of approximately $94.0 million for the
six months ended December 30, 2006.

Registration Rights Penalties

The
Company incurred penalties of $2.3 million for the six months ended December
30, 2006. The penalties are due to failure to meet conditions included in
registration rights agreements with various stockholders.

Dividends Accrued on Preferred Stock

Dividends
accrued on preferred stock were $0.8 million for the six months ended December
30, 2006 as compared to $0.4 million for the six months ended December 31,
2005. The increase was due to the forfeiture of dividends accrued on preferred
stock which were converted into KAAIs common stock and subsequently exchanged
for TrueYou Series B Preferred Stock in the quarter ended December 31, 2005.

Financial Condition, Liquidity and Capital
Resources

Net
cash used in operating activities was $19.3 million and $12.5 million for the
six months ended December 30, 2006 and December 31, 2005, respectively. This
deterioration of cash flows resulted primarily from an operating loss of $18.9
million for the six months ended December 30, 2006 versus an operating loss of
$13.6 million for six months ended December 31, 2005.

Net
cash used in investing activities was $1.4 million and $2.1 million for the six
months ended December 30, 2006 and December 31, 2005, respectively. The
decrease is primarily due to capital expenditures.

Cash
flows provided by financing activities were $23.3 million and $28.0 million for
the six months ended December 30, 2006 and December 31, 2005, respectively. For
the six months ended December 30, 2006, financing activities were primarily the
$24.2 net increase in debt due to the new financing, offset by the $0.9 million
debt closing costs. For the six months ended December 31, 2005, cash flows from
financing activities were primarily the result of the $14.9 million gross
issuance of TrueYou Series D Preferred Stock, $10.1 million gross issuance of
KAAI Series G Preferred Stock and $4.8 million gross from issuance of KAAI
Series F Preferred Stock, which was subsequently exchanged for Series H
Preferred Stock.

43

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Future Liquidity and Capital Needs

Since
its inception, the Company has experienced operating losses and negative cash
flow from operations. As of December 30, 2006, we had a cumulative deficit of
$145.9 million and a working capital deficiency of $48.9 million. Included in
our net deficit at December 30, 2006 is the remeasurement of convertible
securities. Cumulative charges recorded through the remeasurement of this
obligation amounted to $38.7 million. These factors raise substantial doubt
about our ability to continue as a going concern. Our ability to continue as a
going concern is ultimately dependent on our ability to increase sales and
reduce expenses to a level that will allow us to operate profitably and sustain
positive operating cash flows and raise additional capital. The
financial statements do not include any adjustments to reflect the outcome of
this uncertainty. We have had
several recent financings as described in this Report, with the most recent completed on May 7,
2007. There is no assurance that the recent refinancing will be sufficient to
fund operations until sales and profitability improve to the point that the
Company is able to operate from internally generated cash flows.

On
March 8, 2007, Laurus sent the Company a Notice of Default and Acceleration
accelerating the obligations due to Laurus under the $25.0 million Secured Term
Note issued as of June 30, 2006 and the $1.0 million Senior Subordinated
Secured Term Note issued as of December 22, 2006. The Company incurred a $3.8
penalty in May 2007 as a result of this default.

Our
principal future uses of funds are for debt service, working capital
requirements, and capital spending to execute our strategy. It is expected that
our net losses will continue at least through the end of fiscal year 2008.

Financings Subsequent to End of Fiscal
Quarter

On
March 16, 2007, we executed four Senior Secured Notes with existing
stockholders in the aggregate amount of $2.0 million and on March 27, 2007, we
executed four additional Senior Secured Notes with existing stockholders in the
aggregate amount of $2.0 million.

On
May 7, 2007 the Company entered into an Amended and Restated Securities
Purchase Agreement with Laurus pursuant to which the Company sold to Laurus a
Secured Term Note in the aggregate principal amount of $54,650,000. On the Closing
Date, the 25.0 million obligation of the Company to Laurus under the June 30,
2006 note and an additional $3.8 million default penalty incurred in the fiscal
quarter ended March 31, 2007 was repaid

Contractual Obligations

As
of December 30, 2006, our contractual obligations were as follows:

|                          |  |       |        |                    |  |             |  |                          |       |                     |  |       |  |  |       | 
|------------------------- |  | ----- | ------ | ------------------ |  | ----------- |  | ------------------------ | ----- | ------------------- |  | ----- |  |  | ----- | 
|                          |  |       |        |                    |  |             |  | Payments
  Due by Period |       |                     |  |      
|                         
|Contractual
  Obligations |  | Total |        | Less
  than 1 Year |  | 1-3
  Years |  | 3-5
  Years              |       | More
  than 5 Years | 
|                         
|                         
|Operating leases          |  |       | 23,581 |                    |  | 3,801       |  |                          | 8,908 |                     |  | 6,572 |  |  | 4,300 | 
|Capitalized leases        |  |       | 311    |                    |  | 207         |  |                          | 104   |                     |  |      |  |  |      | 
|Long-term debt (1)        |  |       | 40,039 |                    |  | 40,039      |  |                          |      |                     |  |      |  |  |      | 
|Consulting obligation (2) |  |       | 1,052  |                    |  | 379         |  |                          | 621   |                     |  | 52    |  |  |      | 
|                         
|Totals                    |  |       | 64,983 |                    |  | 44,426      |  |                          | 9,633 |                     |  | 6,624 |  |  | 4,300 | 
|                         

| |     |                                                                                                                                                
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | Does not include letters
  of credit securing lease obligations.                                                                               
| |     |                                                                                                                                                
| | (2) | Includes contracted
  services with our Formulator for Cosmedicine, and consulting agreements with
  accounting, packaging, and IT consultants.

44

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Off Balance Sheet
Arrangements

We
do not have any off balance sheet arrangements.

ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market
risk represents the risk of loss that may impact our consolidated financial
position, results of operations or cash flows. We are exposed to market risk
associated with changes in interest rates. Our cash resources earned interest
at variable rates and, therefore, our return on these funds is affected by
fluctuations in interest rates. There have been no changes in interest rates
that would have a material impact on our consolidated financial position,
results of operations or cash flows for the three and six months ended
December 30, 2006.

Convertible
Securities: We remeasured our convertible securities in compliance with EITF
00-19, based on the fair value of our Common Stock into which they are
convertible, since there are currently insufficient shares authorized to allow
conversion. The fair value of the Common Stock is based on the price paid for a
share of the stock closest to the measurement date. As of December 30, 2006 the
closing price for our Common Stock was $0.19. Changes in the price paid for a
share of our Common Stock can have a significant impact on the amount recorded
for the convertible securities. For example, the movement up or down in the
price of our Common Stock by $0.10 will cause the balance of convertible
securities to fluctuate by approximately $65 million. This fluctuation would
result in an impact to our net loss. As of May 30, 2007, the closing price of our
Common Stock was $0.04. Convertible securities will convert back to equity when
there are a sufficient number of shares of Common Stock authorized.

ITEM 4.
CONTROLS AND PROCEDURES

Disclosure
Controls and Internal Controls

Our
management, with the participation of our principal executive officer and
principal financial officer, have evaluated the effectiveness of our disclosure
controls and procedures (as such term is defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange
Act) as of the end of the period covered by this report. Based on such
evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that the disclosure controls and procedures are not effective for the
reasons specified below.

Material Weaknesses

On
January 25, 2007, our independent registered public accounting firm, Amper,
Politziner, and Mattia, P.C. (Amper) noted in a letter to management, a copy
of which was presented to our Board, certain matters involving internal
controls that they consider to be material weaknesses and significant
deficiencies. However, Amper was not engaged to perform an audit of our
internal controls over financial reporting. Accordingly, Amper has not
expressed an opinion on the effectiveness of our internal controls over
financial reporting.

The
material weaknesses identified by Amper were (A) inadequate resources in the
accounting functions; (B) inadequate controls over cash management; (C)
inadequate controls over computer information; and (D) inadequate anti-fraud
program. More specifically, Amper identified among other things, material
weaknesses in the processes and procedures associated with our preparation and review of account
reconciliations, monitoring of financial results, application of accounting
principles, control over cash management, communication between departments, inventory management and valuation, vendor
management and segregation of duties, and anti-fraud program. Examples
of the issues identified include,

45

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among many others,
inadequate segregation of duties, insufficient staffing in the accounting
department, failure to reconcile or analyze accounts, lack of effective review
of the reconciliations and analysis that are prepared and, in some instances,
poor design of controls and poor compliance with existing policies and
procedures, and no whistle blower hotline.

Remediation of Material Weaknesses

In
order to remediate these weaknesses, we have retained another accounting firm
in which members of that firms accounting staff have worked under the
supervision of our Chief Financial Officer. The Company has also retained an
information technology firm to upgrade operating, financial and accounting
systems which is expected to further improve the control environment. In
addition, On May 1, 2006, we appointed a new Chief Financial Officer and in
August 2006 we hired a Controller. We are also working to integrate our
inventory system to improve our controls over inventory and related areas. We
have made progress to remediate identified internal control deficiencies and to
establish adequate internal controls over financial reporting during the six
months ended December 30, 2006. The above remedial actions have not been in place
long enough to have been tested and will be assessed for their adequacy on a
continuous basis.

Except
as described above, there have not been any changes in our internal control
over financial reporting (as such term is defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act) since the fiscal year ended July 1, 2006 that
have materially affected, or are reasonable likely to materially affect, our
internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

UBS Lawsuit

UBS
Securities, LLC commenced a lawsuit against the Company in the Supreme Court
    of the State of New York, County of New York on September 18, 2006. The complaint
alleges that UBS was engaged to provide investment banking services to the
Company and that UBS is owed a fee of $1,750,000 with respect to a private
placement that was consummated in June, 2006 and funded in July 2006.  By order
    entered on May 25, 2007, the court granted UBSs
motion for
summary judgment. On June 5, 2007 the court entered judgment against the
Company in the sum of $1,962,139.25, inclusive of interest and costs. A hearing
on UBSs request for attorneys fees will be held on July 10, 2007.
In the event the Company is required to pay this judgment, it would materially
and adversely affect the Company. The Company does not believe a loss from an
unfavorable outcome will exceed the amount accrued.

Item 6. Exhibits

| |    |                                                                                                                                              
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------
| | 1. | Exhibits:
  (see accompanying Exhibit Index included after the signature page of this
  Report for a list of  exhibits filed in this Report).

46

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SIGNATURES

Pursuant to
the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.

|                     |                    |                                                      
|-------------------- | ------------------ | -----------------------------------------------------
|                     | TRUEYOU.COM
  INC.
|                     |                    |                                                      
|Date:
  July 3, 2007 | By:                | /s/
  Matthew Burris                                 
|                     |                    |                                                      
|                     |                    | Matthew
  Burris                                     
|                     |                    | Chief
  Operating Officer and Chief Financial Officer

47

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EXHIBIT INDEX

Description

|     |                                                                         
|---- | ------------------------------------------------------------------------
|10.1 | James O'Crowley separation agreement.                                   
|     |                                                                         
|31.1 | Rule 13a-14(a)/15d-14(a)
  Certification of Principal Financial Officer.
|     |                                                                         
|32.1 | Section 1350 Certification
  of Principal Financial Officer.            

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