General

This discussion should be read in conjunction with the Notes to Condensed Consolidated Financial Statements included herein and the Notes to Consolidated Financial Statements and Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K, as amended on form 10-K/A for, the year ended December 31, 2011.

Overview of the Business

We specialize in developing and marketing innovative, premium-priced products for the mass market channel. Our products focus on addressing skin imperfections through a problem-solution approach, unlike competitors whose products focus primarily on changing fashion trends. Our cosmetic products address specific, everyday cosmetics needs and include face powders, bronzers, concealers, blushes, foundations, eye shadows, eyeliners, mascaras and brow makeup. Our skin care products include cleansers, moisturizers and treatments.

We sell our products to mass market retailers such as Wal-Mart, Target, CVS and Rite Aid. Our products provide above-average profitability for retailers due to their higher price points. Our products are currently sold in over 25,000 of the 45,500 stores in which we estimate our masstige competitors' products are sold. We seek to be first-to-market with new products within this channel, and are able to take new products from concept development to shipment in less than 12 months. New products are a very important part of our business and have contributed, on average, approximately 33.9% of our gross sales from 2010 to 2011.

On September 26, 2012, we entered into an agreement and plan of merger (the "Merger Agreement") with Markwins International Corporation ("Markwins") and Markwins Merger Sub, Inc. ("MergerSub"), a wholly owned subsidiary of Markwins. Pursuant to the Merger Agreement, Markwins agreed to acquire us in an all cash merger for $4.90 per share, representing approximately $74.9 million in equity value (the "Merger"). See Note 10, Merger Agreement, for a detailed discussion.

Our stockholders adopted the Merger Agreement on November 8, 2012, and as a result, the closing of the Merger was to occur no later than November 14, 2012. Markwins subsequently informed us that although the equity and debt commitment letters Markwins received in connection with the signing of the Merger Agreement remain in full force and effect, notwithstanding the availability of the financing represented by such commitment letters, Markwins is pursuing alternative financing with more favorable terms and that Markwins intends to close the Merger no later than December 13, 2012. See Item 1A. Risk Factors of Part II of this quarterly report on Form 10-Q.

Overview of U.S. Market Share Data

Based on retail sales data provided by ACNielsen, our approximate dollar share of the masstige cosmetics market, as defined below, was 6.2% for the 52 weeks ended September 29, 2012 compared to 6.2% for the same period in the prior year. The overall dollar sales for the masstige cosmetics market increased 7% during this period.

We define the masstige cosmetics market as products sold in the mass market channel under the following premium-priced brands: Physicians Formula, Almay, L'Oreal, Neutrogena, Revlon, Olay, OPI, Borghese, Iman, Essie and Orly. ACNielsen is an independent research entity. In addition, ACNielsen's data is based on sampling methodology, and extrapolation from those samples, which means that estimates based on that data may not be precise. Our estimates have been based on information obtained from our customers, trade and business organizations and other contacts in the market in which we operate, as well as management's knowledge and experience in the market in which we operate.

Seasonality

Our business, similar to others in the cosmetic industry, is subject to seasonal variation due to the annual "sell-in" period when retailers decide how much retail space will be allotted to each supplier and the number of new and existing products to be offered in their stores. For us, this period has historically been from December through April. Sales during these months are typically greater due to the shipments required to fill the inventory at retail stores and retailers' warehouses. Retailers typically reset their retail selling space during these months to accommodate changes in space allocation to each supplier and to incorporate the addition of new products and the deletion of slow-selling items. For example, as a result of this seasonality, our net sales for the second and third quarters are generally lower than our net sales for the first and fourth quarters of the years. Our quarterly results of operations may fluctuate as a result of a variety of reasons, including the timing of new product introductions, product discontinuances, general

economic conditions or consumer buyer behavior. In addition, results for any one quarter may not be indicative of results for the same quarter in subsequent years.

Critical Accounting Policies and Estimates

Our condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S., which require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure as of the date of our financial statements. On an ongoing basis, we evaluate our estimates and judgments, including those related to revenue, returns, trade allowances, inventories, goodwill and other intangible assets, share-based compensation and income taxes. We base our estimates and judgments on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis of our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results or changes in the estimates or other judgments of matters inherently uncertain that are included within these accounting policies could result in a significant change to the information presented in the condensed consolidated financial statements. We believe that the estimates and assumptions that are among those most important to an understanding of our condensed consolidated financial statements are contained in our Annual Report on Form 10-K, as amended on Form 10-K/A, for the year ended December 31, 2011. There have been no material changes to these policies as of this Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2012.

Results of Operations

The table below sets forth certain operating data expressed as a percentage of
net sales for the periods indicated:

                                                   Three Months Ended        Nine Months Ended
                                                      September 30,            September 30,
                                                    2012         2011         2012        2011
Net sales                                         100.0  %      100.0  %     100.0 %     100.0  %
Cost of sales                                      49.7          50.3         48.5        51.2
Gross profit                                       50.3          49.7         51.5        48.8
Selling, general and administrative expenses       53.8          52.3         42.7        46.9
(Loss) income from operations                      (3.5 )        (2.6 )        8.8         1.9
Interest expense, net                               0.6           3.8          0.6         3.2
Other (income) expense                             (0.1 )         0.3            -         0.1
(Loss) income before provision (benefit) for
income taxes                                       (4.0 )        (6.7 )        8.2        (1.4 )
Provision (benefit) for income taxes                3.0          (3.3 )        4.1        (0.6 )

Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011

Net Sales. Net sales includes revenue recognized from product sales, less estimates for returns and trade allowances. Net sales increased $3.2 million, or 20.4%, to $19.1 million for the three months ended September 30, 2012 from $15.9 million for the three months ended September 30, 2011. These results were driven by an increase in gross sales of $3.6 million, or 13.0%, and a decrease in our returns provision of $3.1 million, which was partially offset by an increase in trade spending of $3.4 million. The increase in gross sales was due to higher sales of color cosmetics and the new and expanded distribution of the skin care line.

Our provision for trade allowances with retailers increased $3.4 million, or 65.4%, to $8.7 million for the three months ended September 30, 2012 from $5.3 million for the three months ended September 30, 2011. The increase was primarily due to a $2.4 million increase in retail marketing and a $1.1 million increase in cooperative advertising, which resulted from our efforts to increase brand awareness and trial of our 2012 new products. Also contributing to the increase was a $542,000 increase in markdowns, partially offset by a $499,000 decrease in coupon expense and a $35,000 decrease in cash discounts and miscellaneous allowances.

Our provision for returns decreased $3.1 million, or 47.3%, to $3.4 million for the three months ended September 30, 2012 from $6.5 million for the three months ended September 30, 2011, primarily due to lower expected returns from retailers. Provision for returns as a percentage of net sales was 18.0% for the three months ended September 30, 2012 compared to 41.1% for the three months ended September 30, 2011.

During the three months ended September 30, 2012, our results included net sales of $2.3 million to our international customers compared to $2.0 million for the three months ended September 30, 2011. The increase in sales to international customers resulted primarily from our Australian and Canadian businesses.

Cost of Sales. Cost of sales increased $1.5 million, or 19.0%, to $9.5 million for the three months ended September 30, 2012 from $8.0 million for the three months ended September 30, 2011. The increase in cost of sales resulted primarily from higher gross sales.

Cost of sales as a percentage of net sales remained relatively consistent at 49.7% for the three months ended September 30, 2012 compared to 50.3% for the three months ended September 30, 2011.

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $2.0 million, or 23.8%, to $10.3 million for the three months ended September 30, 2012 from $8.3 million for the three months ended September 30, 2011. The increase was primarily due to $1.3 million of transaction costs related to the Merger, a $1.3 million termination fee related to our decision to terminate our merger agreement with affiliates of Swander Pace Capital, a $183,000 increase in sales force and sales administrative expenses, a $102,000 increase in freight and warehouse costs and an $80,000 increase in corporate administrative costs, which were partially offset by a $726,000 decrease in marketing spend, a $174,000 decrease in realized and unrealized foreign currency exchange gains and a $107,000 decrease in stock-based compensation expense.

Interest Expense, Net. Interest expense, net, decreased $489,000, or 80.7%, to $117,000 for the three months ended September 30, 2012 from $606,000 for the three months ended September 30, 2011. The decrease was primarily due to the repayment of our senior subordinated note in November 2011 and a decrease in the average borrowings outstanding under our credit facility.

Other (Income) Expense. Other income was $11,000 for the three months ended September 30, 2012 compared to other expense of $43,000 for the three months ended September 30, 2011, which consisted of unrealized gains and losses related to investments held as part of our non-qualified deferred compensation plan.

Provision (Benefit) for Income Taxes. The provision for income taxes represents federal, state and local income taxes. For the three months ended September 30, 2012, the provision for income taxes was $571,000, representing an effective income tax rate of (74.1)%. The effective tax rate differed from the statutory rate for the three months ended September 30, 2012, as a result of fluctuations in permanent differences between book and taxable income projected for the year such as transaction related costs, the domestic production activities deduction and research and development credits resulting in a lower effective tax rate. For the three months ended September 30, 2011, the benefit for income taxes was $527,000, representing an effective income tax rate of 49.5%. The effective tax rate differed from the statutory rate for the three months ended September 30, 2011, as it was impacted by our forecasted pre-tax results for the year resulting in a higher effective tax rate for the quarter-to-date tax provision as well as fluctuations in permanent differences between book and taxable income such as the domestic production activities deduction, charitable contributions and research and development credits.

We incurred $2.6 million of transaction costs related to the potential sale of the Company pursuant to the Merger discussed in Note 10, Merger Agreement. For book purposes, these costs do not meet the criteria for inclusion in the purchase price and as such are expensed as incurred. For tax, these costs are not currently deductible pursuant to regulations promulgated under the Internal Revenue Code. The impact is an increase to our estimated annual effective tax rate of 17%. We currently expect that the Merger will be consummated and have treated the aforementioned costs as a permanent difference, thus increasing the effective tax rate in the current period. In the event the transaction is not consummated, these costs would be deductible and would decrease the rate accordingly.

Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011

Net Sales. Net sales includes revenue recognized from product sales, less estimates for returns and trade allowances. Net sales increased $13.6 million, or 23.5%, to $71.4 million for the nine months ended September 30, 2012 from $57.9 million for the nine months ended September 30, 2011. These results were driven by an increase in gross sales of $16.0 million, or 17.0%, and a decrease in our returns provision of $3.4 million, which was partially offset by an increase in trade spending of $5.8 million. The increase in gross sales was due to higher sales of color cosmetics and the new and expanded distribution of the skin care line.

Our provision for trade allowances with retailers increased $5.8 million, or 23.3%, to $30.9 million for the nine months ended September 30, 2012 from $25.1 million for the nine months ended September 30, 2011. The increase was primarily due to a $4.0 million increase in retail marketing and a $2.1 million increase in cooperative advertising, which resulted from our efforts to increase brand awareness and trial of our 2012 new products. Also contributing to the increase was a $569,000 increase in markdowns and a $293,000 increase in cash discounts and miscellaneous allowances, partially offset by a $1.2 million decrease in coupon expense.

Our provision for returns decreased $3.4 million, or 29.7%, to $8.0 million for the nine months ended September 30, 2012 from $11.4 million for the nine months ended September 30, 2011, primarily due to lower expected returns from retailers. Provision for returns as a percentage of net sales was 11.2% for the nine months ended September 30, 2012 compared to 19.7% for the nine months ended September 30, 2011.

During the nine months ended September 30, 2012, our results included net sales of $8.6 million to our international customers compared to $7.3 million for the nine months ended September 30, 2011. The increase in sales to international customers resulted primarily from our Australian and Canadian businesses.

Cost of Sales. Cost of sales increased $5.0 million, or 16.8%, to $34.6 million for the nine months ended September 30, 2012 from $29.6 million for the nine months ended September 30, 2011. The increase in cost of sales resulted primarily from higher gross sales.

Cost of sales as a percentage of net sales improved to 48.5% for the nine months ended September 30, 2012 compared to 51.2% for the nine months ended September 30, 2011. The decrease in cost of sales as a percentage of net sales was due primarily to favorable product mix, reductions in manufacturing costs, lower air freight and increased product recoveries.

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $3.4 million, or 12.4%, to $30.5 million for the nine months ended September 30, 2012 from $27.2 million for the nine months ended September 30, 2011. The increase was primarily due to $1.3 million of transaction costs related to the Merger, a $1.3 million termination fee related to our decision to terminate our merger agreement with affiliates of Swander Pace Capital, a $514,000 increase in freight and warehouse costs, a $510,000 increase in sales force and sales administrative expenses, a $433,000 increase in distribution costs and a $403,000 increase in corporate administrative costs, which were partially offset by a $744,000 decrease in marketing spend, a $247,000 decrease in stock-based compensation expense and a $115,000 decrease in realized and unrealized foreign currency exchange gains.

Interest Expense, Net. Interest expense, net, decreased $1.4 million, or 78.4%, to $395,000 for the nine months ended September 30, 2012 from $1.8 million for the nine months ended September 30, 2011. The decrease was primarily due to the repayment of our senior subordinated note in November 2011 and a decrease in the average borrowings outstanding under our credit facility.

Other (Income) Expense. Other income was $33,000 for the nine months ended September 30, 2012 compared to other expense of $30,000 for the nine months ended September 30, 2011, which consisted of unrealized gains related to investments held as part of our non-qualified deferred compensation plan.

Provision (Benefit) for Income Taxes. The provision for income taxes represents federal, state and local income taxes. For the nine months ended September 30, 2012, the provision for income taxes was $2.9 million, representing an effective income tax rate of 48.9%. The effective tax rate differed from the statutory rate for the nine months ended September 30, 2012, as a result of fluctuations in permanent differences between book and taxable income projected for the year such as transaction related costs, the domestic production activities deduction and research and development credits resulting in a higher effective tax rate. For the nine months ended September 30, 2011, the benefit for income taxes was $353,000, representing an effective income tax rate of 46.0%. The effective tax rate differed from the statutory rate for the nine months ended September 30, 2011, as it was impacted by our forecasted pre-tax results for the year resulting in a higher annual effective tax rate for the year-to-date tax provision as well as fluctuations in permanent differences between book and taxable income such as the domestic production activities deduction, charitable contributions and research and development credits.

We incurred $2.6 million of transaction costs related to the potential sale of the Company pursuant to the Merger discussed in Note 10, Merger Agreement. For book purposes, these costs do not meet the criteria for inclusion in the purchase price and as such are expensed as incurred. For tax, these costs are not currently deductible pursuant to regulations promulgated under the Internal Revenue Code. The impact is an increase to our estimated annual effective tax rate of 17%. We currently expect that the Merger will be consummated and have treated the aforementioned costs as a permanent difference, thus increasing the effective tax rate in the current period. In the event the transaction is not consummated, these costs would be deductible and would decrease the rate accordingly.

In evaluating whether a valuation allowance is required, we consider all available evidence, including prior operating results, the nature and reason for any losses, its forecast of future taxable income, and the reversal of deferred income tax liabilities. These assumptions require a significant amount of judgment, including estimates of future taxable income. These estimates are based on our best judgment at the time made based on current and projected circumstances and conditions. At September 30, 2012, we had net deferred tax assets of $4.6 million, excluding the deferred tax liability related to our trade names. In evaluating the likelihood that these deferred tax assets will be realized, we considered, among other factors, our pre-tax results in each of the past years, the reasons for any losses in those periods and the projected financial results for 2012 and 2013. As a result of this evaluation, we concluded that it

was more likely than not that the deferred tax assets would be realized. If our business does not continue to be profitable in the near term as projected by management, we could be required to establish a non-cash valuation allowance against a portion or all of the deferred tax assets, which could adversely affect operating results and liquidity (as a result of potential non-compliance with certain financial covenants).

Liquidity and Capital Resources

Cash Flows

As of September 30, 2012, we had $5.4 million in cash and cash equivalents compared to $3,000 in cash and cash equivalents as of December 31, 2011. As of September 30, 2012, we had no balance outstanding and $14.6 million available for borrowing under our revolving credit facility. The significant components of our working capital are accounts receivable, inventories, deferred tax assets, net, accounts payable, trade allowances, sales returns reserve and revolving credit facility borrowings.

Operating Activities. Cash provided by operating activities increased $7.8 million, or 165.3%, to $12.5 million for the nine months ended September 30, 2012 from $4.7 million for the nine months ended September 30, 2011. The net increase in cash provided by operating activities resulted primarily from improved operating results and favorable changes in net working capital, partially offset by lower net non-cash activities.

Days sales outstanding ("DSO"), as calculated on a trailing 4-month basis, increased 2.4 days to 51.4 days at September 30, 2012 from 49.0 days at September 30, 2011. We regularly reevaluate our customers' ability to satisfy their credit obligations and record a provision for doubtful accounts based on such evaluations. As of September 30, 2012, we had $18.5 million of accounts receivable, net of which $9.2 million had not been collected as of October 31, 2012.

Our inventory turnover rate was an annualized 1.9 times per year for the nine months ended September 30, 2012, which is relatively consistent with our inventory turnover rate for the nine months ended September 30, 2011 of an annualized 1.8 times per year.

We categorize our inventories into three groups: salable inventory, excess (slow moving) inventory and obsolete inventory. Salable inventory are products that remain in distribution and for which we have less than twelve months of forecasted sales of inventory on hand. Slow moving inventory are products that also remain in distribution, but for which we have more than twelve months of forecasted sales of inventory on hand. Obsolete inventory are products that no longer are in distribution with our retailer customers.

We assess and reserve for salable, slow moving and obsolete inventory throughout the year based on our historical experience in conjunction with an analysis of our current slow moving and obsolete inventory levels, forecasted plans and sales trends and planned product discontinuances. Our assessment includes discussions with our retailer customers about products to include in future retail store shelf layouts and, if a product loses distribution across all retail partners, it will be deemed obsolete. Our retailer customers typically decide upon changes to shelf layouts annually and these decisions usually occur in the fourth quarter in anticipation of the new calendar year. As such, during the fourth quarter, the provision for obsolete and slow moving inventory is generally higher than other quarters during our fiscal year.

Based on the above process, our provision for slow moving and obsolete inventory was a benefit of $827,000 and an expense of $299,000 for the nine months ended September 30, 2012 and 2011, respectively. The decrease in our provision for obsolete and slow moving inventory for the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011 was primarily due to higher liquidation sales and improved supply chain management.

Included in our inventory balance as of September 30, 2012 is excess and obsolete inventory with a net carrying amount of $5.0 million, which has been adjusted by reserves based on our assessment process noted above. Based on the factors identified above, we anticipate that we will be able to fully realize the value of our net inventory. However, our reserve for slow moving and obsolete inventory requires management to make assumptions and to apply judgment regarding forecasted consumer demand and sales trends. If estimates regarding consumer demand are inaccurate, we may need to increase our provision for slow moving and obsolete inventory which could adversely affect our operating results and liquidity.

Investing Activities. Cash used in investing activities for the nine months ended September 30, 2012 was $1.9 million, which was primarily related to investments in retail permanent fixtures and capital expenditures for improvements to our manufacturing and distribution equipment and information technology infrastructure. Cash used in investing activities for the nine months ended September 30, 2011 was $3.3 million, which was primarily related to investments in retail permanent fixtures and capital expenditures for improvements to our information technology infrastructure.

Financing Activities. Cash used in financing activities was $5.3 million for the nine months ended September 30, 2012 compared to cash provided by financing activities of $1.2 million for the nine months ended September 30, 2011. The increase in cash used in financing activities was primarily due to higher net payments on our revolving credit facility and term loan from Wells Fargo, partially offset by proceeds from the exercise of stock options.

Future Liquidity and Capital Needs. Our net working capital increased $5.1 million, or 21.4%, to $28.9 million as of September 30, 2012 from $23.8 million as of December 31, 2011. We anticipate that requirements for working capital will increase during the fourth quarter of 2012, when we typically experience higher inventory levels as we produce new products for shipment in the first quarter of the following year. We have budgeted capital expenditures of $4.0 million for 2012 for several key projects, including $2.4 million in investments in retail permanent fixtures and $1.6 million of property and equipment expenditures. We incurred $1.0 million for investments in retail permanent fixtures and $488,000 for property and equipment expenditures for the nine months ended September 30, 2012. We believe that our cash flows from operations . . .