UNITED STATES


SECURITIES 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 September 30, 2008





OR





o           TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934





For the transition period
from            to            .





COMMISSION FILE NUMBER:
001-33142





Physicians Formula Holdings,
Inc.





(Exact
name of registrant as specified in its charter)





DELAWARE
            
            20-0340099(State
      or other jurisdiction of
              incorporation
      or organization)
            
            (I.R.S.
      Employer
              Identification
      No.)1055 West 8th
      Street
            
            91702Azusa,
      California
            
            (Zip
      Code)(Address
      of principal executive offices)





(626) 334-3395





(Registrant’s
telephone number, including area code)





N/A





(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
the past 90 days. Yes x  No o





Indicate by
check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See the
definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.


Large
      accelerated filer o
            
            Accelerated
      filer xNon-accelerated
      filer  o
            
            Smaller
      reporting company o





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





The
number of shares outstanding of the registrant’s common stock, par value $.01
per share, as of October 31, 2008, was 13,577,118.















TABLE OF CONTENTS





PART I. FINANCIAL
      INFORMATION
                        
                        1Item 1.
                        
                        Financial
      Statements
                        
                        1Item 2.
                        
                        Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                        
                        12Item 3.
                        
                        Quantitative and Qualitative Disclosures About Market
      Risk
                        
                        18Item
      4.
                        
                        Controls and Procedures
                        
                        18PART II. OTHER INFORMATION
                        
                        19Item
      1.
                        
                        Legal
      Proceedings
                        
                        19Item
      1A.
                        
                        Risk
      Factors
                        
                        19Item
      2.
                        
                        Unregistered Sales of Equity Securities and Use of
      Proceeds
                        
                        19Item
      6.
                        
                        Exhibits
                        
                        19














PART
I.





FINANCIAL
INFORMATION





ITEM
1.  FINANCIAL STATEMENTS





PHYSICIANS FORMULA HOLDINGS,
INC.


CONDENSED CONSOLIDATED BALANCE
SHEETS


(unaudited)


(dollars in thousands, except share
data)




September
      30,
                                      
                                      
                                      December
      31,2008
                                      
                                      
                                      2007ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
                                      
                                      $
                                      1,074
                                      
                                      
                                      $
                                      -Accounts
      receivable, net of allowance for bad debts of $280 and
$436
                                      
                                      
                                      17,157
                                      
                                      
                                      
                                      33,421Inventories
                                      
                                      
                                      31,125
                                      
                                      
                                      
                                      31,648Prepaid
      expenses and other current assets
                                      
                                      
                                      880
                                      
                                      
                                      
                                      1,781Income
      tax receivables
                                      
                                      
                                      591
                                      
                                      
                                      
                                      -Deferred
      income taxes—Net
                                      
                                      
                                      6,455
                                      
                                      
                                      
                                      7,364Total
      current assets
                                      
                                      
                                      57,282
                                      
                                      
                                      
                                      74,214PROPERTY
      AND EQUIPMENT—Net
                                      
                                      
                                      3,864
                                      
                                      
                                      
                                      4,070OTHER
      ASSETS—Net
                                      
                                      
                                      1,425
                                      
                                      
                                      
                                      1,174INTANGIBLE
      ASSETS—Net
                                      
                                      
                                      53,223
                                      
                                      
                                      
                                      54,546GOODWILL
                                      
                                      
                                      16,761
                                      
                                      
                                      
                                      17,463TOTAL
                                      
                                      $
                                      132,555
                                      
                                      
                                      $
                                      151,467LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIES:Accounts
      payable
                                      
                                      $
                                      6,822
                                      
                                      
                                      $
                                      13,043Accrued
      expenses
                                      
                                      
                                      2,471
                                      
                                      
                                      
                                      2,134Trade
      allowances
                                      
                                      
                                      5,426
                                      
                                      
                                      
                                      5,001Sales
      returns reserve
                                      
                                      
                                      7,691
                                      
                                      
                                      
                                      10,396Current
      portion of long-term debt
                                      
                                      
                                      3,000
                                      
                                      
                                      
                                      3,000Income
      taxes payable
                                      
                                      
                                      -
                                      
                                      
                                      
                                      3,125Line
      of credit borrowings
                                      
                                      
                                      1,977
                                      
                                      
                                      
                                      10,168Total
      current liabilities
                                      
                                      
                                      27,387
                                      
                                      
                                      
                                      46,867DEFERRED
      COMPENSATION
                                      
                                      
                                      690
                                      
                                      
                                      
                                      829DEFERRED
      INCOME TAXES—Net
                                      
                                      
                                      18,655
                                      
                                      
                                      
                                      20,821LONG-TERM
      DEBT
                                      
                                      
                                      8,250
                                      
                                      
                                      
                                      10,500COMMITMENTS
      AND CONTINGENCIES (NOTE 9)STOCKHOLDERS'
      EQUITY:Series A
      preferred stock, $.01 par value—10,000,000 shares authorized, no
      shares issued and outstanding at September 30, 2008 and December 31,
      2007
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -Common
      stock, $.01 par value—50,000,000 shares authorized, 13,943,570 and
      14,095,727 shares issued and outstanding at September 30, 2008 and
      December 31, 2007, respectively
                                      
                                      
                                      139
                                      
                                      
                                      
                                      141Additional
      paid-in capital
                                      
                                      
                                      60,064
                                      
                                      
                                      
                                      59,173Retained
      earnings
                                      
                                      
                                      17,370
                                      
                                      
                                      
                                      13,136Total
      stockholders' equity
                                      
                                      
                                      77,573
                                      
                                      
                                      
                                      72,450TOTAL
                                      
                                      $
                                      132,555
                                      
                                      
                                      $
                                      151,467


See notes
to condensed consolidated financial statements.





-1-





PHYSICIANS FORMULA HOLDINGS,
INC.


CONDENSED CONSOLIDATED STATEMENTS OF
INCOME


(unaudited)


(dollars in thousands, except per
share data)




Three
      Months Ended September 30,
                        
                        
                        Nine
      Months Ended September 30,2008
                        
                        
                        2007
                        
                        
                        2008
                        
                        
                        2007NET
      SALES
                        
                        $
                        20,254
                        
                        
                        $
                        19,807
                        
                        
                        $
                        85,791
                        
                        
                        $
                        77,628COST
      OF SALES
                        
                        
                        8,431
                        
                        
                        
                        10,085
                        
                        
                        
                        39,696
                        
                        
                        
                        35,108GROSS
      PROFIT
                        
                        
                        11,823
                        
                        
                        
                        9,722
                        
                        
                        
                        46,095
                        
                        
                        
                        42,520SELLING,
      GENERAL AND ADMINISTRATIVE EXPENSES
                        
                        
                        9,878
                        
                        
                        
                        8,902
                        
                        
                        
                        38,377
                        
                        
                        
                        34,467INCOME
      FROM OPERATIONS
                        
                        
                        1,945
                        
                        
                        
                        820
                        
                        
                        
                        7,718
                        
                        
                        
                        8,053INTEREST
      EXPENSE-NET
                        
                        
                        147
                        
                        
                        
                        370
                        
                        
                        
                        731
                        
                        
                        
                        1,086OTHER
      EXPENSE (INCOME)
                        
                        
                        113
                        
                        
                        
                        (24
                        )
                        
                        
                        220
                        
                        
                        
                        (78
                        )INCOME
      BEFORE INCOME TAXES
                        
                        
                        1,685
                        
                        
                        
                        474
                        
                        
                        
                        6,767
                        
                        
                        
                        7,045(BENEFIT)
      PROVISION FOR INCOME TAXES
                        
                        
                        (1
                        )
                        
                        
                        372
                        
                        
                        
                        2,044
                        
                        
                        
                        3,164NET
      INCOME
                        
                        $
                        1,686
                        
                        
                        $
                        102
                        
                        
                        $
                        4,723
                        
                        
                        $
                        3,881NET
      INCOME PER COMMON SHARE:Basic
                        
                        $
                        0.12
                        
                        
                        $
                        0.01
                        
                        
                        $
                        0.33
                        
                        
                        $
                        0.28Diluted
                        
                        $
                        0.12
                        
                        
                        $
                        0.01
                        
                        
                        $
                        0.32
                        
                        
                        $
                        0.27WEIGHTED-AVERAGE
      COMMON SHARES OUTSTANDING:Basic
                        
                        
                        14,105,999
                        
                        
                        
                        14,011,041
                        
                        
                        
                        14,099,367
                        
                        
                        
                        13,935,389Diluted
                        
                        
                        14,620,427
                        
                        
                        
                        14,553,130
                        
                        
                        
                        14,604,105
                        
                        
                        
                        14,566,860





See notes
to condensed consolidated financial statements.





-2-


PHYSICIANS FORMULA HOLDINGS,
INC.
 CONDENSED CONSOLIDATED STATEMENTS OF
CHANGES IN STOCKHOLDERS' EQUITY
 (unaudited)
 (dollars in
thousands)
  Nine
      Months Ended September 30,2008
                                  
                                  
                                  2007Common
      StockAt
      beginning of period
                                  
                                  $
                                  141
                                  
                                  
                                  $
                                  138Repurchase
      and retirement of common stock (NOTE 7)
                                  
                                  
                                  (3
                                  )
                                  
                                  
                                  -Exercise
      of stock options
                                  
                                  
                                  1
                                  
                                  
                                  
                                  3At
      end of period
                                  
                                  
                                  139
                                  
                                  
                                  
                                  141Additional
      Paid-In CapitalAt
      beginning of period
                                  
                                  
                                  59,173
                                  
                                  
                                  
                                  57,047Stock-based
      compensation
                                  
                                  
                                  1,927
                                  
                                  
                                  
                                  1,567Repurchase and
      retirement of common stock (NOTE 7)
                                  
                                  
                                  (1,090
                                  )
                                  
                                  
                                  -Exercise
      of stock options
                                  
                                  
                                  9
                                  
                                  
                                  
                                  23Tax
      benefit on exercise of stock options
                                  
                                  
                                  45
                                  
                                  
                                  
                                  79Tax
      deficiency on exercise of stock options
                                  
                                  
                                  -
                                  
                                  
                                  
                                  (137
                                  )At
      end of period
                                  
                                  
                                  60,064
                                  
                                  
                                  
                                  58,579Retained
      EarningsAt
      beginning of period
                                  
                                  
                                  13,136
                                  
                                  
                                  
                                  4,387Repurchase
      and retirement of common stock (NOTE 7)
                                  
                                  
                                  (489
                                  )
                                  
                                  
                                  -Net
      income
                                  
                                  
                                  4,723
                                  
                                  
                                  
                                  3,881At
      end of period
                                  
                                  $
                                  17,370
                                  
                                  
                                  $
                                  8,268


See notes to condensed
consolidated financial statements.
  -3-
 
  PHYSICIANS FORMULA HOLDINGS,
INC.


CONDENSED CONSOLIDATED STATEMENTS OF
CASH FLOWS


(unaudited)


(dollars in
thousands)




Nine
      Months Ended September 30,2008
                                                                                                              
                                                                                                              
                                                                                                              2007CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
                                                                                                              
                                                                                                              $
                                                                                                              4,723
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              3,881Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
      and amortization
                                                                                                              
                                                                                                              
                                                                                                              2,240
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              2,058Unrealized foreign
      currency exchange rate loss (gain)
                                                                                                              
                                                                                                              
                                                                                                              106
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              (78
                                                                                                              )Deferred
      income taxes
                                                                                                              
                                                                                                              
                                                                                                              (554
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              51Provision
      for bad debts
                                                                                                              
                                                                                                              
                                                                                                              (141
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              61Amortization
      of debt issuance costs
                                                                                                              
                                                                                                              
                                                                                                              24
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              28Recognition
      of stock-based compensation
                                                                                                              
                                                                                                              
                                                                                                              1,836
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              1,507Tax
      benefit on exercise of stock options
                                                                                                              
                                                                                                              
                                                                                                              (45
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              (79
                                                                                                              )Changes
      in operating assets and liabilities:Accounts
      receivable
                                                                                                              
                                                                                                              
                                                                                                              16,299
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              11,303Inventories
                                                                                                              
                                                                                                              
                                                                                                              617
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              (4,673
                                                                                                              )Prepaid
      expenses and other current assets
                                                                                                              
                                                                                                              
                                                                                                              901
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              554Accounts
      payable
                                                                                                              
                                                                                                              
                                                                                                              (6,109
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              (7,014
                                                                                                              )Accrued
      expenses, trade allowances and sales returns reserve
                                                                                                              
                                                                                                              
                                                                                                              (2,349
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              (1,870
                                                                                                              )Income
      taxes payable/receivable
                                                                                                              
                                                                                                              
                                                                                                              (3,673
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              (2,208
                                                                                                              )Net
      cash provided by operating activities
                                                                                                              
                                                                                                              
                                                                                                              13,875
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              3,521CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of property and equipment
                                                                                                              
                                                                                                              
                                                                                                              (823
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              (1,565
                                                                                                              )Other
      assets
                                                                                                              
                                                                                                              
                                                                                                              (414
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              (100
                                                                                                              )Net
      cash used in investing activities
                                                                                                              
                                                                                                              
                                                                                                              (1,237
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              (1,665
                                                                                                              )CASH
      FLOWS FROM FINANCING ACTIVITIES:Paydowns
      of term loans
                                                                                                              
                                                                                                              
                                                                                                              (2,250
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              (1,125
                                                                                                              )Net
      paydowns under line of credit
                                                                                                              
                                                                                                              
                                                                                                              (8,191
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              (761
                                                                                                              )Debt
      issuance costs
                                                                                                              
                                                                                                              
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              (45
                                                                                                              )Tax
      benefit on exercise of stock options
                                                                                                              
                                                                                                              
                                                                                                              45
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              79Exercise
      of stock options
                                                                                                              
                                                                                                              
                                                                                                              10
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              26Repurchase
      and retirement of common stock
                                                                                                              
                                                                                                              
                                                                                                              (1,178
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              -Net
      cash used in financing activities
                                                                                                              
                                                                                                              
                                                                                                              (11,564
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              (1,826
                                                                                                              )NET
      INCREASE IN CASH AND CASH EQUIVALENTS
                                                                                                              
                                                                                                              
                                                                                                              1,074
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              30CASH
      AND CASH EQUIVALENTS—Beginning of period
                                                                                                              
                                                                                                              
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              26CASH
      AND CASH EQUIVALENTS—End of period
                                                                                                              
                                                                                                              $
                                                                                                              1,074
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              56SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION—Cash paid during the period
      for:Interest,
      net of amounts capitalized
                                                                                                              
                                                                                                              $
                                                                                                              772
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              1,103Income
      taxes
                                                                                                              
                                                                                                              $
                                                                                                              6,269
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              5,320SUPPLEMENTAL
      DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES - The Company
      had accounts payable of $27 and $352 outstanding as of September 30, 2008
      and 2007, respectively, relating to purchases of property and equipment.
      The Company had accrued expenses of $406 as of September 30, 2008 relating
      to the repurchase and retirement of shares of the Company's common stock,
      which had a settlement date during the first week of October
      2008.


See notes
to condensed consolidated financial statements.





-4-





PHYSICIANS FORMULA HOLDINGS,
INC.


NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS


(Unaudited)





1.  ORGANIZATION AND BASIS
OF PRESENTATION





The
accompanying unaudited condensed consolidated financial statements include the
accounts of Physicians Formula Holdings, Inc., a Delaware corporation (the
"Company," "we" or "our"), and its wholly owned subsidiary, Physicians
Formula, Inc., a New York corporation ("Physicians"), and its wholly owned
subsidiaries, Physicians Formula Cosmetics, Inc., a Delaware
corporation, and Physicians Formula DRTV, LLC, a Delaware limited liability
company.





The
Company develops, markets, manufactures and distributes innovative,
premium-priced products for the mass market channel. The Company’s products
include face powders, bronzers, concealers, blushes, foundations, eye shadows,
eyeliners, brow makeup and mascaras. The Company sells its products to mass
market retailers such as Wal-Mart, Target, CVS, Walgreens and
Kroger.





The
accompanying condensed consolidated balance sheet as of September 30, 2008,
the condensed consolidated statements of income for the three and nine
months ended September 30, 2008 and 2007, the condensed consolidated
statements of changes in stockholders' equity and the condensed
consolidated statements of cash flows for the nine months ended
September 30, 2008 and 2007 are unaudited. These unaudited
condensed consolidated interim financial statements have been prepared in
accordance with accounting principles generally accepted in the United
States of America ("GAAP"), the instructions to Quarterly Reports on Form
10-Q and Article 10 of Regulation S-X. In the opinion of the Company’s
management, the unaudited condensed consolidated interim financial statements
include all adjustments of a normal recurring nature necessary for the fair
presentation of the Company’s financial position as of September 30, 2008, its
results of operations for the three and nine months ended September 30,
2008 and 2007, and its cash flows for the nine months ended September 30,
2008 and 2007. The results for the interim periods are not necessarily
indicative of the results to be expected for any future period or for the fiscal
year ending December 31, 2008. The condensed consolidated balance sheet as of
December 31, 2007 has been derived from the audited consolidated balance sheet
as of that date.





These
condensed consolidated interim financial statements should be read in
conjunction with the Company’s audited financial statements and notes thereto
included in the Company’s Annual Report on Form 10-K for the year ended December
31, 2007.




Use of Estimates—The
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect the amounts reported in the
condensed consolidated financial statements and accompanying notes. Actual
results could differ from those estimates.




2.  NEW
ACCOUNTING STANDARDS
 
 In
September 2006, the Financial Accounting Standards Board ("FASB") issued FASB
Statement No. 157, Fair
Value Measurements("SFAS No. 157"). SFAS No. 157 defines fair value,
establishes a framework for measuring fair value and requires enhanced
disclosures about fair value measurements. SFAS No. 157 requires companies to
disclose the fair value of financial instruments according to a fair value
hierarchy as defined in the standard. SFAS No. 157 became effective for the
Company on January 1, 2008 and will be applied on a prospective basis.
In February 2008, the FASB issued FASB Staff Position No. 157-2, which defers
the effective date of SFAS No. 157 by a year for nonfinancial assets and
liabilities, except for items that are recognized or disclosed at fair value in
the financial statements on a recurring basis (at least annually). The
Company adopted SFAS No. 157 on January 1, 2008, except those provisions
related to non-financial assets and liabilities, which will be adopted on
January 1, 2009, as allowed under SFAS No. 157. The adoption did not have
an impact on the condensed consolidated financial statements. The Company
has not yet determined the impact, if any, on the condensed consolidated
financial statements for non-financial assets and liabilities.
 
 In February 2007, the FASB
issued FASB Statement No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities—Including an amendment of FASB Statement No.
115 ("SFAS No. 159"). SFAS No. 159 permits entities to choose to measure
eligible items at fair value at specified election dates and report unrealized
gains and losses on items for which the fair value option has been elected in
earnings at each subsequent reporting date. As
required, the Company adopted SFAS No. 159 effective January 1, 2008;
however, the Company elected not to apply the fair value option to any of its
assets or liabilities. Accordingly, the adoption of SFAS No. 159 did not affect
the Company’s condensed consolidated financial statements.
  In December
2007, the FASB issued FASB Statement No. 141(R) – Business Combinations ("SFAS
No. 141(R)"). SFAS No. 141(R) expands the definition of a business,
thus increasing the number of transactions that will qualify as business
combinations. SFAS No. 141(R) requires the acquirer to recognize
100 percent of an acquired business’s assets and liabilities, including
goodwill and certain contingent assets and liabilities, at their fair values at
the acquisition date. Contingent consideration will be recognized at fair value
on the acquisition date, with changes in fair value recognized in earnings until
settled. Likewise, changes in acquired tax contingencies, including those
existing at the date of adoption, will be recognized in earnings if outside the
maximum allocation period (generally one year). Transaction-related expenses and
restructuring costs will be expensed as incurred, and any adjustments to
finalize the purchase accounting allocations, even within the allocation period,
will be shown as revised in the future consolidated financial statements to
reflect the adjustments as if they had been recorded on the acquisition date.
Finally, a gain could result in the event of a bargain purchase (acquisition of
a business below the fair market value of the assets and liabilities), or a gain
or loss in the case of a change in the control of an existing investment.
SFAS No. 141(R) will be applied prospectively to business combinations
with acquisition dates on or after January 1, 2009. Adoption of SFAS No.
141(R) is not expected to materially impact the Company’s consolidated financial
position or results of operations directly when it becomes effective in
2009.


-5-




In
April 2008, the FASB issued FASB Staff Position No. 142-3, Determination
of the Useful Life of Intangible Assets ("FSP 142-3"). FSP 142-3 amends
the factors that should be considered in developing renewal or extension
assumptions used to determine the useful life of a recognized intangible asset
under SFAS No. 142. This change is intended to improve the consistency between
the useful life of a recognized intangible asset under SFAS No. 142 and the
period of expected cash flows used to measure the fair value of the asset under
SFAS No. 141(R) and other GAAP. FSP 142-3 is effective for the Company at the
beginning of fiscal year 2009. The requirement for determining useful lives must
be applied prospectively to intangible assets acquired after the effective date
and the disclosure requirements must be applied prospectively to all intangible
assets recognized as of, and subsequent to, the effective date. Adoption of FSP
142-3 is not expected to materially impact the Company’s consolidated financial
position or results of operations directly when it becomes effective in 2009, as
the only impact that FSP 142-3 is expected to have relates to intangible assets
acquired subsequent to January 1, 2009 that are reflected in the
consolidated financial statements. 
 In
May 2008, the FASB issued FASB Statement No. 162, The
Hierarchy of Generally Accepted Accounting Principles ("SFAS No. 162").
SFAS No. 162 is intended to improve financial reporting by identifying a
consistent framework, or hierarchy, for selecting accounting principles to be
used in preparing financial statements that are presented in conformity with
GAAP for nongovernmental entities. SFAS No. 162 is effective 60 days following
the Securities and Exchange Commission’s approval of the Public Company
Accounting Oversight Board amendments to AU Section 411, The
Meaning of Present Fairly in Conformity with Generally Accepted Accounting
Principles. The Company is currently evaluating the impact of the
adoption of SFAS No. 162 on the consolidated financial
statements.




3.  NET INCOME
PER SHARE





Basic net
income per common share is computed as net income divided by the
weighted-average number of common shares outstanding during the period. Diluted
net income per share reflects the potential dilution that could occur from
the exercise of outstanding stock options and is computed by dividing
net income by the weighted-average number of common shares outstanding for
the period, plus the dilutive effect of outstanding stock options if any,
calculated using the treasury stock method. The following table summarizes the
potential dilutive effect of outstanding stock options, calculated using the
treasury stock method:





Three
      Months Ended September 30,
                            
                            
                            Nine
      Months Ended September 30,2008
                            
                            
                            2007
                            
                            
                            2008
                            
                            
                            2007Weighted-average
      number of common shares—basic
                            
                            
                            14,105,999
                            
                            
                            
                            14,011,041
                            
                            
                            
                            14,099,367
                            
                            
                            
                            13,935,389Effect
      of dilutive employee stock options
                            
                            
                            514,428
                            
                            
                            
                            542,089
                            
                            
                            
                            504,738
                            
                            
                            
                            631,471Weighted-average
      number of common shares—diluted
                            
                            
                            14,620,427
                            
                            
                            
                            14,553,130
                            
                            
                            
                            14,604,105
                            
                            
                            
                            14,566,860





Stock options
for the purchase of 662,000 and 325,000 shares of common stock were
excluded from the above calculation during the three and nine months ended
September 30, 2008 and 2007, respectively, as the effect of those options was
anti-dilutive.




4.  INVENTORIES





Inventories
consisted of the following (dollars in thousands):





September
      30,
                            
                            
                            December
      31,2008
                            
                            
                            2007Raw
      materials and components
                            
                            $
                            15,340
                            
                            
                            $
                            17,307Finished
      goods
                            
                            
                            15,785
                            
                            
                            
                            14,341Total
                            
                            $
                            31,125
                            
                            
                            $
                            31,648





-6-




5.  PROPERTY AND
EQUIPMENT
 
 Property
and equipment consisted of the following (dollars in thousands):
 
 September
      30,
                                        
                                        
                                        December
      31,Useful
      Lives
                                        
                                        2008
                                        
                                        
                                        2007Tooling
                                        3
      to 5 years
                                        
                                        $
                                        509
                                        
                                        
                                        $
                                        479Leasehold
      improvements
                                        Lesser
      of term of lease to 5 years
                                        
                                        
                                        1,062
                                        
                                        
                                        
                                        1,054Machinery
      and equipment
                                        3
      to 8 years
                                        
                                        
                                        3,910
                                        
                                        
                                        
                                        2,493Furniture
      and fixtures
                                        5
      to 8 years
                                        
                                        
                                        334
                                        
                                        
                                        
                                        330Computer
      equipment
                                        3
      years
                                        
                                        
                                        2,053
                                        
                                        
                                        
                                        1,840Construction
      in progress
                                        
                                        
                                        
                                        111
                                        
                                        
                                        
                                        1,073Total
      property and equipment
                                        
                                        
                                        
                                        7,979
                                        
                                        
                                        
                                        7,269Accumulated
      depreciation
                                        
                                        
                                        
                                        (4,115
                                        )
                                        
                                        
                                        (3,199
                                        )Total
                                        
                                        
                                        $
                                        3,864
                                        
                                        
                                        $
                                        4,070
 
 Depreciation
expense was $357,000 and $252,000 for the three months ended September 30,
2008 and 2007, respectively. Depreciation expense was $916,000 and $734,000 for
the nine months ended September 30, 2008 and 2007,
respectively.
 
 Capitalized
interest is recorded on construction-in-progress using the average interest
rate over the construction period. Capitalized interest for the three
and nine months ended September 30, 2008 was not significant. Interest of
$46,000 was capitalized for the three and nine months ended September 30, 2007
and is included in property and equipment.


6.  INTANGIBLE
ASSETS





Intangible
assets consisted of the following as of September 30, 2008 (dollars in
thousands):





Gross
      Carrying Amount
                                
                                
                                Accumulated
      Amortization
                                
                                
                                TotalTrade
      names
                                
                                $
                                29,500
                                
                                
                                $
                                -
                                
                                
                                $
                                29,500Patents
                                
                                
                                8,699
                                
                                
                                
                                2,851
                                
                                
                                
                                5,848Distributor
      relationships
                                
                                
                                23,701
                                
                                
                                
                                5,826
                                
                                
                                
                                17,875Total
                                
                                $
                                61,900
                                
                                
                                $
                                8,677
                                
                                
                                $
                                53,223




Intangible
assets consisted of the following as of December 31, 2007 (dollars in
thousands):





Gross
      Carrying Amount
                          
                          
                          Accumulated
      Amortization
                          
                          
                          TotalTrade
      names
                          
                          $
                          29,500
                          
                          
                          $
                          -
                          
                          
                          $
                          29,500Patents
                          
                          
                          8,699
                          
                          
                          
                          2,417
                          
                          
                          
                          6,282Distributor
      relationships
                          
                          
                          23,701
                          
                          
                          
                          4,937
                          
                          
                          
                          18,764Total
                          
                          $
                          61,900
                          
                          
                          $
                          7,354
                          
                          
                          $
                          54,546





Amortization
expense was $441,000 in each of the three month periods ended September 30, 2008
and 2007 and $1,324,000 in each of the nine month periods ended September
30, 2008 and 2007. Amortization of intangible assets for the remainder of 2008
will be approximately $442,000 and is expected to approximate $1,765,000 in each
of the next five years.




The
Company evaluates its goodwill and indefinite-lived intangible assets for
impairment in the second quarter of each fiscal year.  Accordingly, the
Company tested its goodwill and indefinite-lived intangible assets and noted
no impairment for the fiscal quarter ended June 30, 2008. In addition to
the annual impairment test, the Company assesses whether events or circumstances
occurred that potentially indicate that the carrying amounts of these assets may
not be recoverable. Due to the crisis in the global financial markets and the
deterioration of the market price of the Company's common stock during
the fiscal quarter ended September 30, 2008, the Company tested goodwill and
indefinite-lived intangible assets and noted no impairment as of September 30,
2008. The Company will continue to closely monitor current events and
circumstances to determine if another assessment is warranted at December 31,
2008.




-7-




7.  STOCKHOLDERS'
EQUITY




On September
11, 2008, the Board of Directors of the Company authorized the repurchase of up
to $10 million of the Company’s outstanding common stock pursuant to a stock
repurchase program (the "Repurchase Program"). Under the terms of the Repurchase
Program, the Company may repurchase shares through open market purchases or
through privately negotiated transactions. The stock repurchase activities will
be conducted in compliance with the safe harbor provisions of Rule 10b-18 of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). On
September 12, 2008, the Company entered into a written trading
plan under Rule 10b5-1 of the Exchange Act (the "Rule 10b5-1 Trading
Plan"), with Deutsche Bank Securities, Inc. ("Deutsche Bank"), to facilitate the
repurchase of common stock under the Repurchase Program. The Rule 10b5-1 Trading
Plan authorizes daily share repurchases from September 12, 2008 through November
6, 2008 at varying prices. The Repurchase Program does not obligate the
Company to repurchase any dollar amount or number of shares of its common stock,
and the program may be extended, modified, suspended or discontinued at any
time. From September 12, 2008 through September 30, 2008, the Company
repurchased 254,741 shares for an aggregate price of $1.6
million pursuant to the Rule 10b5-1 Trading Plan.
  On October 9,
2008, the Company gave notice of termination of the Rule 10b5-1
Trading Plan with Deutsche Bank due to the unanticipated change in the
volume limitation under Rule 10b-18 of the Exchange Act. The notice took
effect on October 10, 2008. From September 12, 2008 through October 9,
2008, the Company repurchased 621,193 shares for an aggregate price of $3.6
million under the Repurchase Program.


On April 25,
2007, the Company completed a secondary public offering in which certain
stockholders sold 5,049,650 shares of the Company’s common stock, which included
658,650 shares of common stock sold pursuant to the underwriters’ over-allotment
option. The Company did not receive any proceeds from the sale of the shares but
incurred approximately $725,000 of the expenses of the offering.
 
 8.  EQUITY AND STOCK OPTION
PLANS


2006 Equity Incentive
Plan





In
connection with the Company’s initial public offering in November 2006, the
Company adopted the Physicians Formula Holdings, Inc. 2006 Equity Incentive Plan
(the “2006 Plan”). The 2006 Plan provides for grants of stock options, stock
appreciation rights, restricted stock, restricted stock units, deferred stock
units and other performance awards to directors, officers and employees of the
Company, as well as others performing services for the Company. The options
generally have a 10-year life and vest in equal monthly installments over a
four-year period. As of September 30, 2008, a total of 796,775 shares of the
Company’s common stock were available for issuance under the 2006 Plan. This
amount will automatically increase on the first day of each fiscal year ending
in 2016 by the lesser of: (i) 2% of the shares of common stock outstanding on
the last day of the immediately preceding fiscal year or (ii) such lesser number
of shares as determined by the compensation committee of the Board of Directors.
On January 30, 2008, the Company granted 317,000 stock options to certain
employees under the 2006 Plan.  As of September 30, 2008, only grants
of stock options to the Company's directors, officers and
employees have been made under the 2006 Plan.





2003 Stock Option
Plan





In
November 2003, the Board of Directors adopted the 2003 Stock Option Plan (the
“2003 Plan”) and reserved a total of 2,500,000 shares for grants under the 2003
Plan. The 2003 Plan provides for the issuance of stock options for common stock
to executives and other key employees. The options generally have a 10-year life
and vest over a period of time ranging from 24 months to 48 months. Options
granted under the 2003 Plan were originally granted as time-vesting options and
performance-vesting options. The original time-vesting options vest in equal
annual installments over a four-year period. In connection with the initial
public offering during 2006, the 713,334 performance-vesting options were
amended to accelerate the vesting of 550,781 of such options, and 296,140 of
these options were exercised. The remaining 162,553 performance-vesting options
were converted to time-vesting options that vest in equal monthly installments
over a two-year period. Options are granted with exercise prices not less than
the fair value at the date of grant, as determined by the Board of Directors,
which subsequent to the Company's initial public offering is the
closing price on the grant date.





-8-




The 2006
Plan and 2003 Plan activity is summarized below:





Time-Vesting
      Options
                
                
                Performance-Vesting
      OptionsWeighted-Average
      Exercise Price
                
                
                Aggregate
      Intrinsic Value
                
                
                
                
                
                Weighted-Average
      Exercise Price
                
                
                Aggregate
      Intrinsic ValueOptions
      outstanding—January 1, 2008
                
                
                862,342
                
                
                $
                7.80
                
                
                
                
                
                
                136,681
                
                
                $
                0.10Options
      granted
                
                
                317,000
                
                
                
                9.54
                
                
                
                
                
                
                -
                
                
                
                -Options
      exercised
                
                
                (102,584
                )
                
                
                0.10
                
                
                $
                595,000
                
                
                
                -
                
                
                
                -Options
      outstanding—September 30, 2008
                
                
                1,076,758
                
                
                $
                9.04
                
                
                $
                (3,330,000
                )
                
                
                136,681
                
                
                $
                0.10
                
                
                $
                800,000Vested
      and expected to vest—September 30, 2008
                
                
                1,076,758
                
                
                $
                9.04
                
                
                $
                (3,330,000
                )
                
                
                136,681
                
                
                $
                0.10
                
                
                $
                800,000





The fair
value of options granted during the nine months ended September 30, 2008
and 2007 totaled $1.6 million and $3.3 million, respectively. The
Company utilized the Black-Scholes option valuation model to calculate the fair
value of these options using the following assumptions:




2008
                  
                  
                  2007Risk-free
      interest rate
                  
                  
                  3.3
                  %
                  
                  
                  4.8
                  %Volatility
                  
                  
                  50.7
                  %
                  
                  
                  51.9
                  %Dividend
      rate
                  
                  None
                  
                  
                  NoneLife
      in years
                  
                  
                  6.5
                  
                  
                  
                  5.0





The
risk-free interest rate is based-upon the U.S. Treasury yield curve in effect at
the time of grant for periods corresponding with the expected life of the
options. The expected volatility rate is based on companies of similar growth
and maturity and the Company's peer group in the industry in which it
does business. The dividend rate assumption is excluded from the calculation, as
the Company intends to retain all earnings. The expected life of the
Company's stock options represents management’s best estimate based upon
historical and expected trends in the Company's stock option
activity.




The vesting
activity for the 2006 Plan and 2003 Plan is summarized below:


Time-Vesting
      Options
                          
                          Performance-Vesting
      OptionsWeighted-Average
                          
                          
                          
                          
                          
                          
                          Weighted-AverageVested
      and Exercisable
                          
                          Aggregate
      Exercise Price
                          
                          Exercise
      Price
                          
                          Remaining
      Contractual Life
                          
                          Aggregate
      Intrinsic Value
                          
                          Vested
      and Exercisable
                          
                          Aggregate
      Exercise Price
                          
                          Exercise
      Price
                          
                          Remaining
      Contractual Life
                          
                          Aggregate
      Intrinsic ValueJanuary
      1, 2008
                          475,572
                          
                          $
      1,393,000
                          
                          
                          
                          
                          
                          
                          
                          136,681
                          
                          $   14,000Vesting
      during period
                          211,690
                          
                          1,822,000
                          
                          
                          
                          
                          
                          
                          
                          -
                          
                          -Options
      exercised
                          (102,584
                          )
                          (10,000)
                          
                          
                          
                          
                          
                          
                          
                          -
                          
                          -September
      30, 2008
                          584,678
                          
                          $
      3,205,000
                          
                          $   5.48
                          
                          7.5
      years
                          
                          $275,000
                          
                          136,681
                          
                          $   14,000
                          
                          $   0.10
                          
                          5.1
      years
                          
                          $
      800,000




As
of September 30, 2008, the options outstanding under the 2003 Plan and
2006 Plan had exercise prices between $0.10 and $20.75 and the weighted-average
remaining contractual life for all options was 7.2 years.





A summary
of the weighted-average grant date fair value of the non-vested stock option
awards is presented in the table below:





Weighted-Average
      Grant Date Fair ValueJanuary
      1, 2008
                    
                    
                    386,770
                    
                    
                    $
                    10.24Vested
                    
                    
                    (211,690
                    )
                    
                    
                    9.27Granted
                    
                    
                    317,000
                    
                    
                    
                    5.13September
      30, 2008
                    
                    
                    492,080
                    
                    
                    $
                    7.36





The total
fair value of options that vested during the nine months ended September
30, 2008 and 2007 was $2.0 million and $1.5 million,
respectively.





-9-




As of
September 30, 2008, total unrecognized estimated compensation cost related to
non-vested stock options was approximately $3.6 million, which is expected to be
recognized over a weighted-average period of approximately 2.7 years. The
Company recorded cash received from the exercise of stock options of $10,000
during the nine months ended September 30, 2008. Upon option exercise, the
Company issues new shares of stock.





The
Company incurred $1.9 million of pre-tax non-cash share-based compensation
expense for each of the nine
month periods ended September 30, 2008 and 2007.  Non-cash
share-based compensation cost of $85,000 was a component of cost of sales and
$1.8 million was a component of selling, general and administrative
expenses in the accompanying condensed consolidated statement of income for
the nine months ended September 30, 2008. Non-cash share-based compensation
cost of $370,000 was a component of cost of sales and $1.5 million was
a component of selling, general and administrative expenses in the
accompanying condensed consolidated statement of income for the nine
months ended September 30, 2007. The Company recognized a tax related
benefit of $748,000 and $826,000 for the nine months ended September
30, 2008 and 2007, respectively.  The Company capitalized non-cash
share-based compensation expense of $88,000 and $63,000 in inventory for
the nine months ended September 30, 2008 and 2007,
respectively.





Excess
tax benefits exist when the tax deduction resulting from the exercise of options
exceeds the compensation cost recorded. The cash flows resulting from such
excess tax benefits are classified as financing cash flows.







9.  COMMITMENTS AND
CONTINGENCIES


Litigation—The Company
is involved in various lawsuits in the ordinary course of business. In
management’s opinion, the ultimate resolution of these matters will not result
in a material impact to the Company’s condensed consolidated financial
statements.
 
 Environmental—The
shallow soils and groundwater below the Company's City of Industry
facility was contaminated by the former operator of the property. The former
operator performed onsite cleanup and the Company anticipates
that it will receive written confirmation from the State of California that
no further onsite cleanup is necessary. Such confirmation would not rule out
potential liability for regional groundwater contamination or alleged potable
water supply contamination discussed below. If further onsite cleanup is
required, the Company believes the cost, which the Company is not able to
estimate, would be indemnified, without contest or material limitation, by
companies that have fulfilled similar indemnity obligations to the Company in
the past, and that the Company believes remain financially able to do
so.





The
facility is located within an area of regional groundwater contamination known
as the Puente Valley “operable unit” (“PVOU”) of the San Gabriel Valley
Superfund Site. The Company, along with many others, was named a potentially
responsible party (“PRP”) for the regional contamination by the United States
Environmental Protection Agency (“EPA”). The Company entered into a settlement
with another PRP at the site, pursuant to which, in return for a payment the
Company has already made and that was fully indemnified and paid by a second
company, the other PRP indemnified the Company against most claims for PVOU
contamination. The Company has entered into a consent decree with EPA and the
other PRP that will resolve its liability for the cleanup of regional
groundwater contamination without any payment by the Company to EPA.
The consent decree is expected to be approved and entered by the court in the
fourth quarter of 2008. Depending on the scope and duration of the cleanup, the
Company may be required to make further payments to the other PRP for regional
groundwater remediation costs. The Company estimates the amount of any such
additional payments would not exceed approximately $130,000. The estimate is
based on component estimates for two distinct contaminants that may require
remediation. Those estimates in turn are based on a number of assumptions
concerning the likelihood that remediation will be required, the cost of
remediation if required and other matters. Uncertainty in predicting these
matters limits the reliability and precision of the estimates. The Company
expects any such additional payments by the Company to be covered by indemnities
given to the Company by other companies. Those companies may contest their
indemnity obligation for these payments. The Company believes the companies are
financially able to pay the liability. Because the Company believes it is not
probable that it will be held liable for any of these expenses, the Company has
not recorded a liability for such potential claims.




The
Company was one of approximately 25 parties considered potentially liable by a
regional water authority for alleged contamination of two of that water
authority’s wells. The Company is fully indemnified for this liability under a
past settlement with a private company. The indemnity is not materially limited
and the Company does not believe it would be contested. The Company believes
that the indemnifying private company is financially able to pay the liability.
Because the Company believes it is not probable that it will be held liable for
any of these expenses, the Company has not recorded a liability for such
potential claims for alleged contamination of the area’s potable water supply.
Additionally, during September 2008, the indemnifying private
company entered into a settlement with the water authority, which was
approved and entered by the court in the third quarter of
2008.





The Company’s
liability for these contamination matters and related claims is substantially
covered by third-party indemnities and resolved by prior settlements, and borne
by prior operators of the facility, their successors and their insurers. The
Company is attempting to recoup approximately $0.7 million in defense costs from
one of these indemnitors. These costs have been expensed as paid by the Company
and are not recorded in its condensed consolidated balance sheets.





-10-




10.  GEOGRAPHIC
INFORMATION





Geographic
revenue information is based on the location of the customer. All of the
Company’s assets are located in the United States. Net sales
to unaffiliated customers by geographic region are as follows (dollars in
thousands):





Three
      Months Ended September 30,
                                
                                
                                Nine
      Months Ended September 30,Customer
                                
                                2008
                                
                                
                                2007
                                
                                
                                2008
                                
                                
                                2007United
      States
                                
                                $
                                17,070
                                
                                
                                $
                                18,070
                                
                                
                                $
                                73,245
                                
                                
                                $
                                69,411Canada
                                
                                
                                2,881
                                
                                
                                
                                1,552
                                
                                
                                $
                                11,925
                                
                                
                                
                                7,814Other
                                
                                
                                303
                                
                                
                                
                                185
                                
                                
                                $
                                621
                                
                                
                                
                                403$
                                20,254
                                
                                
                                $
                                19,807
                                
                                
                                $
                                85,791
                                
                                
                                $
                                77,628





-11-





ITEM
2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS





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
for the year ended December 31, 2007.





Overview of the
Business





We are
one of the fastest growing cosmetics companies of the ten largest in the U.S.
mass market channel by retail sales for the 52 weeks ended October 4, 2008.
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, rather than focusing on changing fashion
trends. Our products address specific, everyday cosmetics needs and include face
powders, bronzers, concealers, blushes, foundations, eye shadows, eyeliners,
brow makeup and mascaras.





We sell
our products to mass market retailers such as Wal-Mart, Target, CVS, Walgreens
and Kroger. Our products provide above-average profitability for retailers due
to their higher price points and sales per linear foot. Our products are
currently sold in approximately 27,000 of the 49,000 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, which are primarily
introduced during the first and fourth quarters, are a very important
part of our business and have contributed, on average, approximately 45.2% of
our net sales for the last three years.





Overview of U.S. Market Share
Data





Based on
retail sales data provided by ACNielsen, our approximate share of the masstige market, as we define
it, was 8.0% for the 52 weeks ended October 4, 2008, or a gain
of 3.9% when compared to 7.7% for the same period in the prior year. We
define the masstige
market as products sold in the mass market channel under the following
premium-priced brands: Physicians Formula, Almay, L’Oreal, Max Factor,
Neutrogena, Revlon and Vital Radiance. ACNielsen is an independent research
entity and its data does not include retail sales from Wal-Mart and
Canada.




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 removal of slow-selling
items. For example, our net sales for the three months ended September 30, 2008
were lower than our net sales for the first quarter of 2008
and fourth quarter of 2007, as a result
of this seasonality. Our quarterly results of operations may also fluctuate as a
result of a variety of other reasons, including the timing of new product
introductions, general economic conditions or consumer buying behavior. In
addition, results for any one quarter may not be indicative of results for the
same quarter in subsequent years.




Critical Accounting
Policies




Our
condensed consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America,
which require management to make estimates and assumptions that affect the
amounts reported in the condensed consolidated financial statements and
accompanying notes. Actual results could differ from those estimates. Critical
accounting policies represent the areas where more significant judgments and
estimates are used in the preparation of our condensed consolidated financial
statements. A discussion of such critical accounting policies, which include
revenue recognition, inventory valuation, goodwill and other intangible assets,
share-based compensation and income taxes can be found in our Annual Report on
Form 10-K for the year ended December 31, 2007. There have been
no material changes to these policies as of this Quarterly Report on
Form 10-Q for the three and nine months ended September 30,
2008.





-12-




Results of
Operations





The
following table sets forth our condensed consolidated statements of income
for the three and nine months ended September 30 , 2008
and 2007:





Three
      Months Ended September 30,
                                            
                                            
                                            Nine
      Months Ended September 30,2008
                                            
                                            
                                            2007
                                            
                                            
                                            2008
                                            
                                            
                                            2007(dollars
      in thousands, except per share data)Statement
      of Income Data:Net
      sales
                                            
                                            $
                                            20,254
                                            
                                            
                                            $
                                            19,807
                                            
                                            
                                            $
                                            85,791
                                            
                                            
                                            $
                                            77,628Cost
      of sales
                                            
                                            
                                            8,431
                                            
                                            
                                            
                                            10,085
                                            
                                            
                                            
                                            39,696
                                            
                                            
                                            
                                            35,108Gross
      profit
                                            
                                            
                                            11,823
                                            
                                            
                                            
                                            9,722
                                            
                                            
                                            
                                            46,095
                                            
                                            
                                            
                                            42,520Selling,
      general and administrative expenses
                                            
                                            
                                            9,878
                                            
                                            
                                            
                                            8,902
                                            
                                            
                                            
                                            38,377
                                            
                                            
                                            
                                            34,467Income
      from operations
                                            
                                            
                                            1,945
                                            
                                            
                                            
                                            820
                                            
                                            
                                            
                                            7,718
                                            
                                            
                                            
                                            8,053Interest
      expense-net
                                            
                                            
                                            147
                                            
                                            
                                            
                                            370
                                            
                                            
                                            
                                            731
                                            
                                            
                                            
                                            1,086Other
      expense (income)
                                            
                                            
                                            113
                                            
                                            
                                            
                                            (24
                                            )
                                            
                                            
                                            220
                                            
                                            
                                            
                                            (78
                                            )Income
      before income taxes
                                            
                                            
                                            1,685
                                            
                                            
                                            
                                            474
                                            
                                            
                                            
                                            6,767
                                            
                                            
                                            
                                            7,045(Benefit)
      provision for income taxes
                                            
                                            
                                            (1
                                            )
                                            
                                            
                                            372
                                            
                                            
                                            
                                            2,044
                                            
                                            
                                            
                                            3,164Net
      income
                                            
                                            $
                                            1,686
                                            
                                            
                                            $
                                            102
                                            
                                            
                                            $
                                            4,723
                                            
                                            
                                            $
                                            3,881Net
      income per common share:Basic
                                            
                                            $
                                            0.12
                                            
                                            
                                            $
                                            0.01
                                            
                                            
                                            $
                                            0.33
                                            
                                            
                                            $
                                            0.28Diluted
                                            
                                            $
                                            0.12
                                            
                                            
                                            $
                                            0.01
                                            
                                            
                                            $
                                            0.32
                                            
                                            
                                            $
                                            0.27Weighted-average
      common shares outstanding:Basic
                                            
                                            
                                            14,105,999
                                            
                                            
                                            
                                            14,011,041
                                            
                                            
                                            
                                            14,099,367
                                            
                                            
                                            
                                            13,935,389Diluted
                                            
                                            
                                            14,620,427
                                            
                                            
                                            
                                            14,553,130
                                            
                                            
                                            
                                            14,604,105
                                            
                                            
                                            
                                            14,566,860





The
following is a discussion of our results of operations for the three and nine
months ended September 30, 2008 and 2007.




-13-


Three
Months Ended September 30, 2008 Compared to Three Months Ended September 30,
2007
 
 Net Sales.Net sales
increased $0.5 million, or 2.5%, to $20.3 million for the three months ended
September 30, 2008, from $19.8 million for the three months ended September 30,
2007.  The increase was primarily attributable to growth in sales of
our eye makeup products and a decrease in trade spending. The increase in sales
of our eye makeup products is due to new products as well as increased
promotional programs related to our new products, as we continued to broaden our
total distribution. Total distribution represents the number of stores in which
we sell products multiplied by our number of stock keeping units per store. Unit
sales for our eye makeup increased by 0.2 million units, or 18.2%, to 1.3
million units for the three months ended September 30, 2008 from 1.1 million
units for the same period a year ago. New products, which are primarily
introduced during the first and fourth quarters, represented 32% of our net
sales for the three months ended September 30, 2008, 10% higher than the same
period a year ago, when new products contributed 22% of net sales. Trade
spending with retailers decreased by $1.3 million, which includes a decrease in
cooperative advertising expense of $0.6 million, a decrease in miscellaneous
allowances of $0.4 million and a decrease in coupon expense of $0.3
million. Partially offsetting our net sales growth for the three months
ended September 30, 2008 was a decrease in sales of our face makeup products and
higher returns from our retailers.  Unit sales for our face makeup
products decreased by 0.2 million units, or 5.8%, to 3.2 million units for the
three months ended September 30, 2008 from 3.4 million units for the same period
a year ago. Our provision for returns increased by $1.2 million, or 25.0%, to
$6.0 million for the three months ended September 30, 2008, from $4.8 million
for the three months ended September 30, 2007 due to higher returns from our
retailers relating primarily to lower than anticipated retail sell-through
on higher-priced promotional kits and retailer customers' wall display changes.
During the three months ended September 30, 2008, our results included net sales
of $3.2 million from our international customers, compared to $1.7 million for
the three months ended September 30, 2007.
  Cost of Sales.Cost of sales
decreased $1.7 million, or 16.8%, to $8.4 million for the three months ended
September 30, 2008, from $10.1 million for the three months ended September 30,
2007. The decrease in cost of sales resulted primarily from a decrease in
product cost and an increase in inventory recovery (inventory returned by
customers deemed to be resaleable) offset by an increase in our provision
for excess and obsolete inventory. Product cost decreased by $0.8 million due to
a change in product mix as volume of higher cost products decreased when
compared to the same period a year ago, including a decrease in face makeup
units sold.  Inventory recovery for returns from retailers increased
$1.9 million when compared to the same period a year ago due to higher
returns from our retailers. Cost of sales as a percentage of net sales was 41.6%
of net sales for the three months ended September 30, 2008, compared to 50.9%
for the three months ended September 30, 2007. The decrease in cost of sales, as
a percentage of net sales, was primarily due to an increase in inventory
recovery for returns from retailers and a decrease in product
costs offset by an increase in our provision for excess and obsolete
inventory for the three months ended September 30,
2008.
  Selling, General and Administrative
Expenses.Selling, general and administrative expenses
increased $1.0 million, or 11.2%, to $9.9 million for the three months ended
September 30, 2008, from $8.9 million for the three months ended September 30,
2007. The increase was primarily due to a $0.3 million increase in realized and
unrealized foreign currency exchange losses, a $0.3 million increase in
corporate administration expense, a $0.1 million increase in distribution costs
related to our growth, a $0.1 million increase in expense for stock option
awards and a $0.1 million increase in freight and warehouse
costs.
  Interest
Expense-Net.Interest expense-net decreased $0.2
million, or 50.0%, to $0.2 million for the three months ended September 30,
2008, from $0.4 million for the three months ended September 30, 2007. The
decrease in interest expense was due to the decrease in average borrowings
outstanding under our credit facility and a slight decline in interest
rates.
  Other Expense
(Income).Other expense for the three months ended
September 30, 2008 was $113,000 compared to other income of $24,000 for the
three months ended September 30, 2007. Other expense for the three months ended
September 30, 2008 and other income for the three months ended September 30,
2007 were attributable to realized and unrealized gains and losses related to
investments held as part of our non-qualified deferred compensation
plan.
  (Benefit) Provision for Income
Taxes.The (benefit) provision for income taxes
represents federal, state and local income taxes. For the three months
ended September 30, 2008, income tax benefit was $1,000, representing an
effective income tax rate of (0.06)%, compared to income tax expense of $0.4
million for the three months ended September 30, 2007, representing an
effective income tax rate of 78.5%.  The
effective rate differed from the statutory rate for the three months ended
September 30, 2008, primarily due to our change in filing position in various
state tax jurisdictions, changes in federal and state tax estimates and, to
a lesser extent, fluctuations in permanent differences between book and taxable
income, which collectively decreased our income tax provision by approximately
$0.6 million. The effective rate differed from the statutory rate for the three
months ended September 30, 2007, due to changes in the deferred carrying rate
and certain permanent items such as tax benefit deficiencies on stock options
exercised and research and development
credits.
  -14-
  Nine
Months Ended September 30, 2008 Compared to Nine Months Ended September 30,
2007
  Net
Sales.  Net sales increased $8.2 million, or 10.6%, to $85.8
million for the nine months ended September 30, 2008, from $77.6 million for the
nine months ended September 30, 2007.  The increase was primarily
attributable to growth in sales of our face makeup products due to new products
as well as increased promotional programs related to new products, as we
continued to broaden our total distribution. Total distribution represents the
number of stores in which we sell products multiplied by our number of stock
keeping units per store. Unit sales for our face makeup increased by 0.8 million
units, or 6.1%, to 13.9 million units for the nine months ended September 30,
2008 from 13.1 million units for the same period a year ago. New products, which
are primarily introduced during the first and fourth quarters, represented 41%
of our net sales for the nine months ended September 30, 2008, 4% higher than
the same period a year ago, when new products contributed 37% of net sales.
Partially offsetting our net sales growth for the nine months ended September
30, 2008 was a decrease in sales of our eye makeup products and an increase in
our provision for returns.  Unit sales for our eye makeup decreased by
0.8 million units, or 16.0%, to 4.2 million units for the nine months ended
September 30, 2008 from 5.0 million units for the same period a year ago. Our
provision for returns increased $5.9 million when compared to the same period a
year ago due to higher returns from our retailers due primarily to lower than
anticipated retail sell-through of higher-priced promotional kits and retailer
customers' wall display changes. During the nine months ended September 30,
2008, our results included net sales of $12.5 million from our international
customers, compared to $8.2 million for the nine months ended September 30,
2007.
  Cost of Sales.Cost
of sales increased $4.6 million, or 13.1%, to $39.7 million for the nine months
ended September 30, 2008, from $35.1 million for the nine months ended September
30, 2007. The increase in cost of sales resulted primarily from an increase in
product costs of $6.0 million and an increase in our provision for excess and
obsolete inventory of $1.3 million.  The variance in product costs is
due to a change in product mix as volume of higher cost products increased when
compared to the same period a year ago, including an increase in face makeup
units sold.  The increase was offset by an increase in inventory
recovery (inventory returned by customers deemed to be resaleable) of $2.7
million for the nine months ended September 30, 2008 due to higher returns from
our retailers. Cost of sales as a percentage of net sales was 46.3% of net
sales for the nine months ended September 30, 2008, compared to 45.2% for the
nine months ended September 30, 2007. The increase in cost of sales, as a
percentage of net sales, was primarily due to an increase in our provision for
returns from retailers offset by an increase in inventory recovery for the nine
months ended September 30, 2008.
  Selling, General and Administrative
Expenses.Selling, general and administrative expenses
increased $3.9 million, or 11.3%, to $38.4 million for the nine months ended
September 30, 2008, from $34.5 million for the nine months ended September 30,
2007. The increase was primarily due to a $1.5 million increase in marketing
spending, a $0.9 million increase in freight and warehouse costs, a $0.9 million
increase in distribution costs related to our growth, a $0.8 million increase in
realized and unrealized foreign currency exchange losses and a $0.3 million
increase in expense for stock option awards.  The increase was offset
by a $0.3 million decrease in transaction fees that were associated with the
second public offering in the second quarter of 2007 and a $0.2 million decrease
in professional service fees related to SOX
compliance.
  Interest
Expense-Net.Interest expense decreased $0.4 million,
or 36.4%, to $0.7 million for the nine months ended September 30, 2008, from
$1.1 million for the nine months ended September 30, 2007. The decrease in
interest expense was due to the decrease in average borrowings outstanding under
our credit facility and a slight decline in interest
rates.
  Other Expense
(Income).Other expense for the nine months ended
September 30, 2008 was $0.2 million compared to other income of $0.1 million for
the nine months ended September 30, 2007. Other expense for the nine months
ended September 30, 2008 and other income for the nine months ended September
30, 2007 were attributable to realized and unrealized gains and losses related
to investments held as part of our non-qualified deferred compensation
plan.
  (Benefit) Provision for
Income Taxes.The provision for income
taxes represents federal, state and local income taxes. For the nine months
ended September 30, 2008, income tax expense was $2.0 million, representing an
effective income tax rate of 30.2%, compared to income tax expense of $3.2
million for the nine months ended September 30, 2007, representing an effective
income tax rate of 44.9%. The
effective rate differed from the statutory rate for the nine months ended
September 30, 2008, primarily due to our change in filing position in various
state tax jurisdictions, changes in federal and state tax estimates and, to
a lesser extent, fluctuations in permanent differences between book and taxable
income, which collectively decreased our income tax provision by approximately
$0.6 million. The effective rate differed from the statutory rate for
the nine months ended September 30, 2007, due to changes in the
deferred carrying rate and certain permanent items such as tax benefit
deficiencies on stock options exercised and research and development credits and
certain transaction fees associated with the secondary public
offering.


-15-




Liquidity
and Capital Resources
  Cash
Flows
  As
of September 30, 2008, we had $1.1 million in cash and cash equivalents compared
to no cash and cash equivalents as of December 31, 2007. The increased level of
cash reflects higher cash inflows provided by our operating activities. As of
September 30, 2008, we had $18.0 million of availability under our revolving
credit facility. The significant components of our working capital are accounts
receivable and inventories, reduced by accounts payable, accrued expenses, line
of credit borrowings and the current portion of our long-term debt.
  Operating
activities.Cash provided by operating activities increased by
$10.4 million, or 297.1%, to $13.9 million for the nine months ended September
30, 2008, from $3.5 million for the nine months ended September 30, 2007. The
net increase in cash provided by operating activities resulted primarily from
favorable changes in accounts receivable, inventories and prepaid expenses. The
net increase in cash provided by operating activities was offset by unfavorable
changes in accounts payable, accrued expenses, sales return reserve and income
taxes payable/receivable. Our inventory turnover rate remained relatively
consistent at an annualized 1.8 times per year for the nine months ended
September 30, 2008 compared to 1.9 times per year for the nine months ended
September 30, 2007. Days sales outstanding increased by 1.8 days, to 47.7 days
for the nine months ended September 30, 2008 from 45.9 days for the nine months
ended September 30, 2007.
  Investing
activities.Cash used in investing activities for the nine
months ended September 30, 2008 was $1.2 million, which was primarily related to
capital expenditures for the replacement of machinery and equipment, the
automation of the assembly line to accommodate future growth and improvements to
our warehouse distribution systems. Cash used in investing activities for the
nine months ended September 30, 2007 of $1.7 million was primarily related to
capital expenditures for the replacement of machinery and equipment, the
automation of the assembly line and improvements to our warehouse distribution
systems.
  Financing
activities.Cash used in financing activities was $11.6
million for the nine months ended September 30, 2008 compared to cash used in
financing activities of $1.8 million for the nine months ended September 30,
2007. The increase in cash used in financing activities between periods
primarily resulted from higher paydowns on our term loan and revolving credit
facilities offset by stock repurchases under our Repurchase
Program.
  Future
Liquidity and Capital Needs.Net working capital requirements
increased by $6.7 million, or approximately 28.9%, to $29.9 million as of
September 30, 2008, from $23.2 million as of September 30, 2007. We anticipate
that requirements for working capital will increase during the fourth quarter of
2008, 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 $3.4 million for 2008 for several key projects,
including investment in our information technology
infrastructure, improvements to our fixture infrastructure and
improvements to our manufacturing and distribution equipment. We
expect capital requirements related to fixture infrastructure to total $4.1
million in 2008 and 2009. A total of $1.3 million is budgeted in
2008, of which $0.4 million was incurred as of September 30, 2008. 
Capital requirements related to manufacturing include a major project undertaken
in 2007 to automate a product assembly line that is used to assemble products
that represented approximately 36.9% of our total sales in 2007. We expect the
aggregate capital requirements of this project to total $1.7 million, of which
$1.4 million was incurred as of September 30, 2008. In addition to an estimated
$0.3 million in new equipment for the automated assembly line project, we expect
to need to make improvements to other manufacturing and distribution equipment
at a cost of approximately $0.8 million and improvements to our leasehold
facilities of approximately $0.2 million in the fourth quarter of 2008. We
incurred $1.2 million of capital expenditures for the nine months ended
September 30, 2008. We believe that our cash flows from operations and funds
from our revolving credit facility will provide adequate funds for our working
capital needs and planned capital expenditures for at least the next twelve
months. No assurance can be given, however, that this will be the
case.
  Current
economic conditions, including the difficulty in obtaining financing and
decreased consumer spending, could have a negative impact on the financial
stability of our retailer customers. A small number of our customers account for
a large percentage of our net sales and accounts receivable. If any of our
significant retailer customers is unable to finance purchases for our products
or defaults on amounts owed to us, it would have an adverse impact on our
results of operations and financial condition, including our liquidity. A
decrease in consumer discretionary spending as a result of the current economic
conditions may also decrease the demand for our products.  Reduced
consumer spending may cause us to lower prices, increase our trade spending or
suffer significant product returns from our retail customers, any of which would
have a negative impact on our gross margins.





-16-




Credit
Facilities


On
November 14, 2006, we entered into a senior credit agreement with a bank that
will terminate in 2011 and consists of a $15.0 million term loan facility and a
revolving credit facility providing for borrowings of up to $20.0 million. At
September 30, 2008, we had $2.0 million of outstanding indebtedness under our
revolving credit facility and $18.0 million available for borrowing. The
availability under the revolving credit facility is reduced by outstanding
letters of credit.
 
 Borrowings
under the senior credit agreement are guaranteed by Physicians Formula Holdings,
Inc. and the domestic subsidiaries of Physicians Formula, Inc., and are secured
by liens on substantially all of the assets of Physicians Formula, Inc.,
including the assets of its subsidiaries. Amounts outstanding under the term
loan facility totaled $11.3 million at September 30, 2008. There were no
outstanding letters of credit as of September 30, 2008. The interest rate on the
term loan was 4.6% at September 30, 2008. Payments under the term loan facility
are due quarterly, increasing from initial quarterly payments of $375,000 to
$562,500 as of December 31, 2007, $750,000 as of December 31, 2008, $937,500 as
of December 31, 2009 and $1,125,000 as of December 31, 2010. Quarterly payments
of $375,000 were made on January 1, 2007, April 2, 2007, July 16, 2007 and
October 2, 2007 and quarterly payments of $562,500 were made on January 2, 2008,
March 31, 2008, June 30, 2008 and September 11, 2008.
 
 On July
8, 2008, we entered into the first amendment to our senior credit agreement,
which reduced the applicable interest rates on borrowings under the term loan
and revolving credit facilities by 0.25%. The revolving credit facility is also
subject to a commitment fee of 0.25% on any unused commitments.
 
 On
September 9, 2008, we entered into the second amendment to our senior credit
agreement, which permits Physicians Formula, Inc. to directly
purchase shares of our common stock or to make cash distributions to us to
allow us to repurchase shares of our common stock in an amount not to
exceed $12 million in the aggregate.
 
 The senior credit agreement contains
the following financial covenants: a maximum total leverage ratio; a minimum
fixed charge coverage ratio; a minimum net worth requirement; and a limitation
on capital expenditures (which may be no more than $3,000,000 per fiscal year).
As of September 30, 2008, we were in compliance with these
covenants.
 
 The
senior credit agreement contains certain additional negative covenants,
including limitations on the ability of Physicians Formula, Inc., our operating
subsidiary, to: incur other indebtedness and liens; fundamentally change in its
business through a merger, consolidation, amalgamation or liquidation; sell
assets; pay cash dividends or pay for expenses of Physicians Formula Holdings,
Inc., unless certain conditions are satisfied; make certain acquisitions,
investments, loans and advances; engage in transactions with our affiliates;
enter into certain agreements; engage in sale-leaseback transactions; incur
certain unfunded liabilities; and change our line of business. Also,
the senior
credit agreement requires us to make mandatory prepayments with the proceeds of
certain asset dispositions and upon the receipt of insurance or condemnation
proceeds to the extent we do not use the proceeds for the purchase of
satisfactory replacement assets.


Off-Balance Sheet
Transactions





We do not
have any relationships with unconsolidated entities or financial partnerships,
such as entities often referred to as structured finance or special purpose
entities, which would have been established for the purpose of facilitating
off-balance sheet arrangements or other contractually narrow or limited
purposes. In addition, we do not engage in trading activities involving
non-exchange traded contracts that rely on estimation techniques to calculate
fair value. As such, we are not exposed to any financing, liquidity, market or
credit risk that could arise if we had engaged in such
relationships.





-17-


Forward-Looking
Statements





This
section and other parts of this Quarterly Report on Form 10-Q contain
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934,
as amended. In some cases, forward-looking statements can be identified by words
such as "anticipates," "expects," "believes," "plans," "predicts," and similar
terms. Such forward-looking statements are based on current expectations,
estimates and projections about our industry, management’s beliefs and
assumptions made by management. Forward-looking statements are not guarantees of
future performance and our actual results may differ significantly from the
results discussed in the forward-looking statements. Factors that might cause
such differences include, but are not limited to those discussed in Part I, Item
1A, "Risk Factors" in our Annual Report on Form 10-K for the year ended December
31, 2007 and Part II, Item 1A, "Risk Factors" in this Quarterly Report on Form
10-Q. Unless otherwise required by law, we expressly disclaim any obligation to
update publicly any forward-looking statements, whether as result of new
information, future events or otherwise.




ITEM
3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK





(a)  Foreign Currency
Risk.





The
Company sells to Canadian customers in Canadian dollars and pays overseas
suppliers and third-party manufacturers in U.S. dollars. An increase in the
Canadian dollar relative to the U.S. dollar could result in lower net sales and
higher selling, general and administrative expenses. Additionally, the Company
holds Canadian dollars in a cash account, which could result in
higher unrealized foreign currency exchange losses due to a decrease in the
Canadian dollar relative to the U.S. dollar. Further, a decrease in the value of
the Euro and the Chinese Yuan relative to the U.S. dollar could cause our
suppliers to raise prices that would result in higher cost of sales. The
volatility of the applicable rates and prices are dependent on many factors that
cannot be forecasted with reliable accuracy. Our current sales to Canadian
customers and reliance on foreign suppliers for many of the raw materials and
components used to produce products make it possible that our operating results
may be affected by fluctuations in the exchange rate of the currencies
of our customers and suppliers. We do not have any foreign currency
hedges.





(b)  Interest Rate
Risk.





We are
exposed to interest rate risks primarily through borrowings under our revolving
loan and term loan facilities. Interest on these borrowings is based upon
variable interest rates. Our weighted-average borrowings outstanding
under our revolving loan and term loan facilities during
the nine months ended September 30, 2008, was $17.9 million and the
weighted-average interest rate in effect at September 30, 2008, was 4.7%. A
hypothetical 1% increase or decrease in interest rates would have resulted in a
$134,000 change to interest expense for the nine months ended September 30,
2008.





ITEM
4.  CONTROLS AND PROCEDURES





The
Company maintains disclosure controls and procedures that are designed to ensure
that information required to be disclosed in its reports pursuant to the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in Rule 13a-15 under the Exchange Act, and that such
information is accumulated and communicated to the Company’s management,
including its Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosure. Management
is responsible for establishing and maintaining adequate internal control over
financial reporting.





As
required by Rule 13a-15(b) under the Exchange Act, the Company carried out an
evaluation, under the supervision and with the participation of its management,
including the Chief Executive Officer and the
Chief Financial Officer, of the effectiveness of the design and operation of the
Company’s disclosure controls and procedures. Based on the foregoing, the
Company's Chief Executive Officer and Chief Financial Officer determined that
disclosure controls and procedures were effective at a reasonable assurance
level as of the end of the period covered by this report. 
 There has
been no change in internal controls over financial reporting during the most
recent fiscal quarter that has materially affected, or is reasonably likely to
materially affect, internal controls over financial
reporting.





-18-




PART
II.


OTHER INFORMATION





ITEM
1.  LEGAL PROCEEDINGS





The
Company is involved in various lawsuits in the ordinary course of business. In
management’s opinion, the ultimate resolution of these matters will not result
in a material impact to the Company’s condensed consolidated financial
statements.





ITEM
1A.  RISK FACTORS





There
have been no material changes to our risk factors as disclosed in Item 1A. “Risk
Factors” in our Annual Report on Form 10-K for the year ended December 31, 2007
except as
follows:


Current
economic conditions and disruptions in the financial markets could have an
adverse effect on our retailer customers and, in turn, on our business, results
of operations and financial condition.
 
 Current economic
conditions, including the difficulty in obtaining financing and decreased
consumer spending, could have a negative impact on the financial stability of
our retailer customers. A small number of our customers account for a large
percentage of our net sales and accounts receivable. If any of our significant
retailer customers is unable to finance purchases for our products or defaults
on amounts owed to us, it would have an adverse impact on our results of
operations and financial condition, including our liquidity. A decrease in
consumer discretionary spending as a result of the current economic conditions
may also decrease the demand for our products.  Reduced consumer
spending may cause us to lower prices, increase our trade spending or suffer
significant product returns from our retail customers, any of which would have a
negative impact on our gross margins.


ITEM 2. UNREGISTERED SALES OF
EQUITY SECURITIES AND USE OF PROCEEDS
  (c) Purchases
of Equity Securities by the Issuer
  The
following table provides information about our repurchases of our common stock
during the three months ended September 30, 2008:
  Period
                                                                          
                                                                          Total
      Number of Shares Purchased (1)
                                                                          
                                                                          
                                                                          Average
      Price Paid per Share
                                                                          
                                                                          
                                                                          Total
      Number of Shares Purchased as Part of Publicly Announced Plans or Programs
      (1)
                                                                          
                                                                          
                                                                          Approximate
      Dollar Value of Shares that May Yet Be Purchased Under the Plans or
      Programs (2)July
      1, 2008 through July 31, 2008
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          -August
      1, 2008 through August 31, 2008
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          -September
      1, 2008 through September 30, 2008
                                                                          
                                                                          
                                                                          254,741
                                                                          
                                                                          
                                                                          $
                                                                          6.22
                                                                          
                                                                          
                                                                          
                                                                          254,741
                                                                          
                                                                          
                                                                          $
                                                                          8,400,000Total
                                                                          
                                                                          
                                                                          254,741
                                                                          
                                                                          
                                                                          $
                                                                          6.22
                                                                          
                                                                          
                                                                          
                                                                          254,741
                                                                          
                                                                          
                                                                          $
                                                                          8,400,000
 
 (1)
                Represents
      shares purchased under the Repurchase Program announced and
      approved by the Board of Directors on September 11, 2008. All shares were
      repurchased in open market transactions under the Rule 10b5-1 Trading Plan
      which the Company entered into in connection with the Repurchase
      Program.
 (2)
              The
      Repurchase Program authorizes the Company to repurchase up to $10 million
      of its outstanding common stock. The Repurchase Program has no expiration
      date and does not obligate the Company to repurchase any dollar
      amount or number of shares of its common stock, and the program may be
      extended, modified, suspended or discontinued at any time.


ITEM
6.  EXHIBITS





Exhibit
                    Number
                  
                  
                  
                  Description10.1
                  
                  First
      Amendment to Credit Agreement, dated July 8, 2008, by and among Physicians
      Formula, Inc., the several banks and other lenders from time to time party
      to the Credit Agreement and Union Bank of California, N.A., as
      administrative agent (incorporated by reference to Exhibit 10.1 to the
      registrant's current report on Form 8-K (File No. 001-33142) filed on July
      11, 2008).10.2
                  
                  Second
      Amendment to Credit Agreement, dated September 9, 2008, by and among
      Physicians Formula, Inc., the several banks and other lenders from time to
      time party to the Credit Agreement and Union Bank of California, N.A., as
      administrative agent (incorporated by reference to Exhibit 10.1 to the
      registrant's current report on Form 8-K (File No. 001-33142) filed
      on September 12, 2008).10.3
                  
                  Stock
      Repurchase Instruction, dated September 12, 2008, between the registrant
      and Deutsche Bank Securities, Inc.31.1
                  
                  Certification
      by Ingrid Jackel, Chief Executive Officer.31.2
                  
                  Certification
      by Joseph J. Jaeger, Chief Financial Officer.32.1
                  
                  Certification
      Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
      Section 906 of the Sarbanes-Oxley Act of 2002.32.2
                  
                  Certification
      Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
      Section 906 of the Sarbanes-Oxley Act of
  2002.




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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.





Physicians
      Formula Holdings, Inc./s/
      Ingrid JackelDate:
      November 3, 2008
            
            By:
      Ingrid JackelIts:   Chief Executive
      Officer
              (principal executive officer)/s/
      Joseph J. JaegerDate:
      November 3, 2008
            
            By:
      Joseph J. JaegerIts:   Chief Financial
      Officer
              (principal financial officer)




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