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 March 31, 2009





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 has submitted electronically and
posted on its corporate Web site, if any, every Interactive Data File required
to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of
this chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit and post such files). Yes  o 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 May 8, 2009, was 13,577,118.















TABLE OF CONTENTS





PART I. FINANCIAL
      INFORMATION
                            
                            1Item 1.
                            
                            Financial
      Statements (UNAUDITED)
                            
                            1Item 2.
                            
                            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                            
                            11Item 3.
                            
                            Quantitative and Qualitative Disclosures About Market
      Risk
                            
                            16Item
      4.
                            
                            Controls and Procedures
                            
                            17PART II. OTHER INFORMATION
                            
                            17Item
      1.
                            
                            Legal
      Proceedings
                            
                            17Item
      1A.
                            
                            Risk
      Factors
                            
                            17Item
      6.
                            
                            Exhibits
                            
                            18














PART
I.





FINANCIAL
INFORMATION





ITEM
1.  FINANCIAL STATEMENTS





PHYSICIANS FORMULA HOLDINGS,
INC.


CONDENSED CONSOLIDATED BALANCE
SHEETS


(unaudited)


(dollars in thousands, except share
data)




March
      31,
                                          
                                          
                                          December
      31,2009
                                          
                                          
                                          2008ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
                                          
                                          $
                                          3
                                          
                                          
                                          $
                                          620Restricted
      cash
                                          
                                          
                                          4,768
                                          
                                          
                                          
                                          -Accounts
      receivable, net of allowance for bad debts of $1,052 and
    $838
                                          
                                          
                                          26,332
                                          
                                          
                                          
                                          29,186Inventories
                                          
                                          
                                          30,070
                                          
                                          
                                          
                                          29,694Prepaid
      expenses and other current assets
                                          
                                          
                                          1,797
                                          
                                          
                                          
                                          1,515Income
      tax receivables
                                          
                                          
                                          559
                                          
                                          
                                          
                                          -Deferred
      income taxes—net
                                          
                                          
                                          10,003
                                          
                                          
                                          
                                          9,224Total
      current assets
                                          
                                          
                                          73,532
                                          
                                          
                                          
                                          70,239PROPERTY
      AND EQUIPMENT—Net
                                          
                                          
                                          4,091
                                          
                                          
                                          
                                          4,138OTHER
      ASSETS—Net
                                          
                                          
                                          3,942
                                          
                                          
                                          
                                          2,838INTANGIBLE
      ASSETS—Net
                                          
                                          
                                          36,440
                                          
                                          
                                          
                                          36,881TOTAL
                                          
                                          $
                                          118,005
                                          
                                          
                                          $
                                          114,096LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIES:Bank
      overdraft
                                          
                                          $
                                          565
                                          
                                          
                                          $
                                          -Accounts
      payable
                                          
                                          
                                          11,318
                                          
                                          
                                          
                                          11,212Accrued
      expenses
                                          
                                          
                                          1,396
                                          
                                          
                                          
                                          1,523Trade
      allowances
                                          
                                          
                                          8,651
                                          
                                          
                                          
                                          4,580Sales
      returns reserve
                                          
                                          
                                          9,951
                                          
                                          
                                          
                                          12,613Income
      taxes payable
                                          
                                          
                                          -
                                          
                                          
                                          
                                          1,675Line
      of credit borrowings
                                          
                                          
                                          24,107
                                          
                                          
                                          
                                          7,935Current
      portion of long-term debt
                                          
                                          
                                          -
                                          
                                          
                                          
                                          10,500Total
      current liabilities
                                          
                                          
                                          55,988
                                          
                                          
                                          
                                          50,038OTHER
      LONG-TERM LIABILITIES
                                          
                                          
                                          984
                                          
                                          
                                          
                                          1,022DEFERRED
      INCOME TAXES—NET
                                          
                                          
                                          10,882
                                          
                                          
                                          
                                          11,475COMMITMENTS
      AND CONTINGENCIES (NOTE 9)STOCKHOLDERS'
      EQUITY:Series A
      preferred stock, $.01 par value—10,000,000 shares authorized, no
      shares issued and outstanding
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -Common
      stock, $.01 par value—50,000,000 shares authorized, 13,577,118 shares
      issued and outstanding
                                          
                                          
                                          136
                                          
                                          
                                          
                                          136Additional
      paid-in capital
                                          
                                          
                                          59,272
                                          
                                          
                                          
                                          58,968Retained
      deficit
                                          
                                          
                                          (9,257
                                          )
                                          
                                          
                                          (7,543
                                          )Total
      stockholders' equity
                                          
                                          
                                          50,151
                                          
                                          
                                          
                                          51,561TOTAL
                                          
                                          $
                                          118,005
                                          
                                          
                                          $
                                          114,096


See notes
to condensed consolidated financial
statements.





-1-





PHYSICIANS FORMULA HOLDINGS,
INC.


CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS


(unaudited)


(dollars in thousands, except per
share data)




Three
      Months Ended March 31,2009
                                
                                
                                2008NET
      SALES
                                
                                $
                                20,174
                                
                                
                                $
                                42,661COST
      OF SALES
                                
                                
                                10,431
                                
                                
                                
                                18,946GROSS
      PROFIT
                                
                                
                                9,743
                                
                                
                                
                                23,715SELLING,
      GENERAL AND ADMINISTRATIVE EXPENSES
                                
                                
                                12,774
                                
                                
                                
                                14,876(LOSS)
      INCOME FROM OPERATIONS
                                
                                
                                (3,031
                                )
                                
                                
                                8,839INTEREST
      EXPENSE-NET
                                
                                
                                208
                                
                                
                                
                                358OTHER
      EXPENSE
                                
                                
                                57
                                
                                
                                
                                87(LOSS)
      INCOME BEFORE INCOME TAXES
                                
                                
                                (3,296
                                )
                                
                                
                                8,394(BENEFIT)
      PROVISION FOR INCOME TAXES
                                
                                
                                (1,582
                                )
                                
                                
                                3,375NET
      (LOSS) INCOME
                                
                                $
                                (1,714
                                )
                                
                                $
                                5,019NET
      (LOSS) INCOME PER COMMON SHARE:Basic
                                
                                $
                                (0.13
                                )
                                
                                $
                                0.36Diluted
                                
                                $
                                (0.13
                                )
                                
                                $
                                0.34WEIGHTED-AVERAGE
      COMMON SHARES OUTSTANDING:Basic
                                
                                
                                13,577,118
                                
                                
                                
                                14,095,834Diluted
                                
                                
                                13,577,118
                                
                                
                                
                                14,579,437


See notes
to condensed consolidated financial
statements.





-2-





PHYSICIANS FORMULA HOLDINGS,
INC.


CONDENSED CONSOLIDATED STATEMENTS OF
CASH FLOWS


(unaudited)


(dollars in
thousands)




Three
      Months Ended March 31,2009
                                                                                                            
                                                                                                            
                                                                                                            2008CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      (loss) income
                                                                                                            
                                                                                                            $
                                                                                                            (1,714
                                                                                                            )
                                                                                                            
                                                                                                            $
                                                                                                            5,019Adjustments to reconcile net (loss) income to net cash provided by
      operating activities:Depreciation
      and amortization
                                                                                                            
                                                                                                            
                                                                                                            848
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            712Unrealized
      exchange rate (loss) gain
                                                                                                            
                                                                                                            
                                                                                                            (144
                                                                                                            )
                                                                                                            
                                                                                                            
                                                                                                            317Deferred
      income taxes
                                                                                                            
                                                                                                            
                                                                                                            (1,372
                                                                                                            )
                                                                                                            
                                                                                                            
                                                                                                            670Provision
      for bad debts
                                                                                                            
                                                                                                            
                                                                                                            214
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            18Amortization
      and write-off of debt issuance costs
                                                                                                            
                                                                                                            
                                                                                                            36
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            9Recognition
      of stock-based compensation
                                                                                                            
                                                                                                            
                                                                                                            286
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            591Tax
      benefit on exercise of stock options
                                                                                                            
                                                                                                            
                                                                                                            -
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            (2
                                                                                                            )Changes
      in operating assets and liabilities:Accounts
      receivable
                                                                                                            
                                                                                                            
                                                                                                            2,784
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            (3,226
                                                                                                            )Inventories
                                                                                                            
                                                                                                            
                                                                                                            (358
                                                                                                            )
                                                                                                            
                                                                                                            
                                                                                                            3,819Prepaid
      expenses and other current assets
                                                                                                            
                                                                                                            
                                                                                                            (282
                                                                                                            )
                                                                                                            
                                                                                                            
                                                                                                            (53
                                                                                                            )Other
      assets
                                                                                                            
                                                                                                            
                                                                                                            -
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            5Accounts
      payable
                                                                                                            
                                                                                                            
                                                                                                            152
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            (3,792
                                                                                                            )Accrued
      expenses, trade allowances and sales returns reserve
                                                                                                            
                                                                                                            
                                                                                                            1,282
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            459Income
      taxes payable/receivable
                                                                                                            
                                                                                                            
                                                                                                            (2,234
                                                                                                            )
                                                                                                            
                                                                                                            
                                                                                                            (456
                                                                                                            )Other
      long-term liabilities
                                                                                                            
                                                                                                            
                                                                                                            4
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            -Net
      cash (used in) provided by operating activities
                                                                                                            
                                                                                                            
                                                                                                            (498
                                                                                                            )
                                                                                                            
                                                                                                            
                                                                                                            4,090CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of property and equipment
                                                                                                            
                                                                                                            
                                                                                                            (320
                                                                                                            )
                                                                                                            
                                                                                                            
                                                                                                            (308
                                                                                                            )Other
      assets
                                                                                                            
                                                                                                            
                                                                                                            (1,261
                                                                                                            )
                                                                                                            
                                                                                                            
                                                                                                            -Restricted
      cash
                                                                                                            
                                                                                                            
                                                                                                            (4,768
                                                                                                            )
                                                                                                            
                                                                                                            
                                                                                                            -Net
      cash used in investing activities
                                                                                                            
                                                                                                            
                                                                                                            (6,349
                                                                                                            )
                                                                                                            
                                                                                                            
                                                                                                            (308
                                                                                                            )CASH
      FLOWS FROM FINANCING ACTIVITIES:Paydowns
      of term loans
                                                                                                            
                                                                                                            
                                                                                                            -
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            (1,125
                                                                                                            )Net
      borrowings (paydowns) under line of credit
                                                                                                            
                                                                                                            
                                                                                                            5,672
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            (2,656
                                                                                                            )Debt
      issuance costs
                                                                                                            
                                                                                                            
                                                                                                            (7
                                                                                                            )
                                                                                                            
                                                                                                            
                                                                                                            -Tax
      benefit on exercise of stock options
                                                                                                            
                                                                                                            
                                                                                                            -
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            2Cash
      overdraft
                                                                                                            
                                                                                                            
                                                                                                            565
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            -Net
      cash provided by (used in) financing activities
                                                                                                            
                                                                                                            
                                                                                                            6,230
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            (3,779
                                                                                                            )NET
      (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
                                                                                                            
                                                                                                            
                                                                                                            (617
                                                                                                            )
                                                                                                            
                                                                                                            
                                                                                                            3CASH
      AND CASH EQUIVALENTS—Beginning of period
                                                                                                            
                                                                                                            
                                                                                                            620
                                                                                                            
                                                                                                            
                                                                                                            
                                                                                                            -CASH
      AND CASH EQUIVALENTS—End of period
                                                                                                            
                                                                                                            $
                                                                                                            3
                                                                                                            
                                                                                                            
                                                                                                            $
                                                                                                            3SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION—Cash paid during the period
      for:Interest
                                                                                                            
                                                                                                            $
                                                                                                            182
                                                                                                            
                                                                                                            
                                                                                                            $
                                                                                                            436Income
      taxes
                                                                                                            
                                                                                                            $
                                                                                                            2,020
                                                                                                            
                                                                                                            
                                                                                                            $
                                                                                                            3,161SUPPLEMENTAL
      DISCLOSURE OF NON-CASH OPERATING, INVESTING AND FINANCING ACTIVITIES - The
      Company had accounts payable of $51 and $62 outstanding as of March 31,
      2009 and 2008, respectively, relating to purchases of property and
      equipment. In addition, the Company incurred costs of $150 associated with
      obtaining the fourth amendment to the senior credit agreement
      on March 30, 2009. These costs were recorded as part of
      current assets and the related liability was included in accounts payable.
      Finally, the Company replaced its previously outstanding borrowings of
      $10,500 under its term loans with borrowings under the revolving credit
      facility in connection with the fourth amendment to the senior credit
      agreement on March 30, 2009.




See notes
to condensed consolidated financial statements.





-3-





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, Walgreens, Target, CVS, and Rite
Aid.





The
accompanying condensed consolidated balance sheet as of March
31, 2009, the condensed consolidated statements of operations for the
three months ended March 31, 2009 and 2008 and the condensed
consolidated statements of cash flows for the three months ended March
31, 2009 and 2008 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 March 31, 2009, its results of operations for the
three months ended March 31, 2009 and 2008, and its cash flows for
the three months ended March 31, 2009 and 2008. 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, 2009. The condensed
consolidated balance sheet as of December 31, 2008 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, 2008.




Liquidity— 
Our senior credit agreement required us to comply with financial covenants,
including a maximum total leverage ratio, a minimum fixed charge coverage ratio
and a minimum tangible net worth requirement. On March
30, 2009, we entered into an amendment to the senior credit agreement. The
amendment converted the entire senior credit facility, which
previously consisted of an amortizing term loan and a revolving credit
facility, into an asset-based revolving credit facility subject to
a limitation on availability under a borrowing base formula, which reduced
the overall availability under the senior credit agreement, increased the
applicable margin on interest rates for borrowings, restricted deposits
made into certain of our Canadian cash accounts and shortened the
term of the credit facility to March 2010.The Company intends to be able to support its operations
through continued development and growth of new products, addition of new
customers, obtaining new financing or extending the term of our
existing senior credit agreement, implementing a company-wide salary
reduction plan, eliminating cash bonuses in 2009, implementing cost
controls, reducing capital expenditures and re-evaluating various
non-strategic marketing and administrative costs. The Company reduced its
workforce by approximately 21 positions in March 2009 in an effort to reduce
costs.




Concentration of
Credit Risk— Certain financial instruments subject the Company to
concentrations of credit risk. These financial instruments consist primarily of
accounts receivable. The Company regularly reevaluates its customers’ ability to
satisfy credit obligations and records a provision for doubtful accounts based
on such evaluations. Significant customers that accounted for more than 10% of
gross sales are as follows:
 
 Three
      Months Ended March 31,Customer
                                                  
                                                  2009
                                                  
                                                  2008A
                                                  
                                                  22%
                                                  
                                                  15%B
                                                  
                                                  17%
                                                  
                                                  16%C
                                                  
                                                  13%
                                                  
                                                  15%D
                                                  
                                                  11%
                                                  
                                                  9%
 Four customers
individually accounted for 10% or more of gross accounts receivable and together
accounted for approximately 77% and 69% of gross accounts receivable
at March 31, 2009 and December 31, 2008, respectively. In the first quarter
of 2009, one of the Company's largest retailer
customers informed management that as a result of a change in
strategy, the customer intends to reduce its space allocated to the entire
color cosmetics category in its stores in 2010. In April 2009, this customer
informed us of its decision to discontinue selling Physicians Formula products
in 2010.  This change may have a material negative impact on our
net sales beginning in the second quarter of 2009 as the
customer reduces its inventory levels of Physicians
Formula products. No sales to this customer are expected beginning
September 2009. This change will eliminate our distribution in approximately
5,800 stores in 2010. This customer accounted for 13% of gross sales in the
three months ended March 31, 2009.




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 April
2009, the Financial Accounting Standards Board (“FASB”) issued FASB
Staff Position No. FAS 107-1 and APB 28-1 (“FSP FAS 107-1 and
APB 28-1”),
“Interim
Disclosures About Fair Value of Financial Instruments.” The FSP FAS 107-1
and APB 28-1 amends SFAS 107, “Disclosure about Fair Value of Financial
Instruments," and Accounting Principles Board Opinion No. 28, “Interim Financial
Reporting,” to require disclosures about fair value of financial instruments for
interim reporting periods of publicly traded companies as well as in annual
financial statements. The Company will be required to adopt FSP FAS 107-1 and
APB 28-1 in the second quarter of 2009. The Company does not believe that
adoption of the FSP FAS 107-1 and APB 28-1 will have a material impact on
our condensed consolidated financial statements.


-4-




3.  NET (LOSS)
INCOME PER COMMON SHARE





Basic net
(loss) income per common share is computed as net (loss) 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:





Three
      Months Ended March 31,2009
                                      
                                      
                                      2008Weighted-average
      number of common shares—basic
                                      
                                      
                                      13,577,118
                                      
                                      
                                      
                                      14,095,834Effect
      of dilutive employee stock options
                                      
                                      
                                      -
                                      
                                      
                                      
                                      483,603Weighted-average
      number of common shares—diluted
                                      
                                      
                                      13,577,118
                                      
                                      
                                      
                                      14,579,437





Stock options
for the purchase of 1,205,680 and 662,000 shares of common stock were
excluded from the above calculation during the three months ended March 31,
2009 and 2008, respectively, as the effect of those options was
anti-dilutive.




4.  INVENTORIES





Inventories
consisted of the following (dollars in thousands):





March
      31,
                                                
                                                
                                                December
      31,2009
                                                
                                                
                                                2008Raw
      materials and components
                                                
                                                $
                                                18,822
                                                
                                                
                                                $
                                                17,655Finished
      goods
                                                
                                                
                                                11,248
                                                
                                                
                                                
                                                12,039Total
                                                
                                                $
                                                30,070
                                                
                                                
                                                $
                                                29,694





5.  OTHER
ASSETS


Other
assets consist of the following (dollars in thousands):
  March
      31,
                                                                          
                                                                          
                                                                          December
      31,2009
                                                                          
                                                                          
                                                                          2008Capitalized
      debt issuance costs, net of accumulated amortization of $80
                                                                          
                                                                          $
                                                                          -
                                                                          
                                                                          
                                                                          $
                                                                          116Restricted
      investments
                                                                          
                                                                          
                                                                          497
                                                                          
                                                                          
                                                                          
                                                                          540Deposits
                                                                          
                                                                          
                                                                          305
                                                                          
                                                                          
                                                                          
                                                                          284Income
      tax receivable
                                                                          
                                                                          
                                                                          312
                                                                          
                                                                          
                                                                          
                                                                          312Retail
      permanent fixtures, net of accumulated amortization of $86 and $0,
      respectively
                                                                          
                                                                          
                                                                          2,828
                                                                          
                                                                          
                                                                          
                                                                          1,586Total
                                                                          
                                                                          $
                                                                          3,942
                                                                          
                                                                          
                                                                          $
                                                                          2,838
 Restricted
investments represent a diversified portfolio of mutual funds held in a Rabbi
Trust, which fund the nonqualified, unfunded deferred compensation plans (the
“Deferred Compensation Plans”). These investments, which are considered trading
securities, are recorded at fair value and
their unrealized losses were $57,000 and $87,000 for the three
months ended March 31, 2009 and 2008, respectively.
  During the three months
ended March 31, 2009, the Company incurred costs of $1.3 million for retail
permanent fixtures, which are being delivered to certain retail customers
for the display of the Company's cosmetic products. These
retail permanent fixtures are being placed in service in connection
with the retail customers' resets of selling space and these costs
will be amortized over a period of three years. Amortization expense was
$86,000 for the three months ended March 31, 2009. Amortization
of retail permanent fixtures is expected to be approximately $728,000
for the remainder of 2009, $971,000 for 2010, $971,000 for 2011 and
$158,000 for 2012.
  -5-


6.  INTANGIBLE
ASSETS





Intangible
assets consisted of the following as of March 31, 2009 (dollars in
thousands):





Gross
      Carrying Amount
                                                        
                                                        
                                                        Accumulated
      Amortization
                                                        
                                                        
                                                        TotalTrade
      names (indefinite-lived)
                                                        
                                                        $
                                                        13,600
                                                        
                                                        
                                                        $
                                                        -
                                                        
                                                        
                                                        $
                                                        13,600Patents
                                                        
                                                        
                                                        8,699
                                                        
                                                        
                                                        
                                                        3,141
                                                        
                                                        
                                                        
                                                        5,558Distributor
      relationships
                                                        
                                                        
                                                        23,701
                                                        
                                                        
                                                        
                                                        6,419
                                                        
                                                        
                                                        
                                                        17,282Total
                                                        
                                                        $
                                                        46,000
                                                        
                                                        
                                                        $
                                                        9,560
                                                        
                                                        
                                                        $
                                                        36,440




Intangible
assets consisted of the following as of December 31, 2008 (dollars in
thousands):





Gross
      Carrying Amount
                                                  
                                                  
                                                  Accumulated
      Amortization
                                                  
                                                  
                                                  TotalTrade
      names (indefinite-lived)
                                                  
                                                  $
                                                  13,600
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  13,600Patents
                                                  
                                                  
                                                  8,699
                                                  
                                                  
                                                  
                                                  2,997
                                                  
                                                  
                                                  
                                                  5,702Distributor
      relationships
                                                  
                                                  
                                                  23,701
                                                  
                                                  
                                                  
                                                  6,122
                                                  
                                                  
                                                  
                                                  17,579Total
                                                  
                                                  $
                                                  46,000
                                                  
                                                  
                                                  $
                                                  9,119
                                                  
                                                  
                                                  $
                                                  36,881





Amortization
expense was $441,000 in each of the three month periods ended March 31, 2009 and
2008. Amortization of intangible assets for the remainder of 2009 will be
approximately $1,324,000 and is expected to be approximately $1,765,000 in each
of the next five years.




The
Physicians Formula trade name has been used since 1937 and is a recognized brand
within the cosmetics industry. It is management's intent to leverage the
Company's trade names indefinitely into the future. Trade names are tested for
impairment annually as of June 30, or whenever events or indicators of
impairment occur between annual impairment tests.




As a
result of the continued downturn in the U.S. economy during the fourth quarter
of 2008 which lowered consumer discretionary spending, resulting in lowered
demand for our products, along with the continued deterioration of the Company's
market capitalization, we conducted an impairment test of goodwill and other
intangibles as of December 31, 2008. As a result, we recorded a non-cash
impairment charge of $16.8 million representing the entire amount of our
previously recorded goodwill and a $15.9 million non-cash impairment charge to
write-down the carrying value of the Company's trade names to their fair
value during 2008.




The
Company will continue to monitor operational performance measures and general
economic conditions. A continued downward trend could result in our recognizing
an impairment charge of the Physicians Formula trade name in connection with a
future impairment test.




7.  FINANCING
ARRANGEMENTS
 
 On March 30, 2009,
Physicians entered into a fourth amendment to the senior credit agreement (the
“fourth amendment”) which converted the entire facility, which previously
consisted of an amortizing term loan and a revolving credit facility, into an
asset-based revolving credit facility, and the outstanding term loan was
replaced with borrowings under the revolving credit
facility.The fourth amendment to the senior credit
agreement, among
other things, eliminated the minimum fixed charge coverage ratio and the maximum
total leverage ratio covenants and replaced them with a minimum interest
coverage ratio and a minimum EBITDA (as defined by the senior credit agreement)
covenant and amended the minimum tangible net worth covenant. The
fourth amendment also included a reduction in permitted capital
expenditures to not more than $2.0 million per year (excludes retail permanent
fixtures). Additionally, Physicians is no longer permitted to purchase shares of
the Company’s common stock or to make cash distributions to the Company to allow
it to repurchase shares of the Company’s common
stock.
  Pursuant
to the fourth amendment, the maximum amount available for borrowing under the
revolving credit facility is equal to the lesser of (i) $27.5 million and (ii)
the sum of (a) up to 65% of the book value of eligible accounts
receivable, (b) the lesser of (1) up to 25% of eligible inventory (with a
permanent reduction to 15% of eligible inventory after June 30, 2009) and (2)
$8.0 million (with a permanent reduction to $5.0 million after June 30, 2009),
(c) the balance of certain foreign currency accounts denominated in
Canadian dollars (the “Canadian Pledged Accounts”), and (d) the orderly
liquidation value of eligible equipment not to exceed $1.0 million, all as
determined in accordance with the fourth amendment.  On June 30, 2009,
the maximum availability for borrowing under the revolving credit facility will
be permanently reduced to $25.0 million.  The revolving credit
facility will mature on March 31, 2010.  In addition, the fourth
amendment increased the applicable interest rate to a percentage equal to the
lender’s reference rate plus 3.50% (with a reduction to 3.00% after June 30,
2009), eliminated the option to elect an interest rate based on LIBOR and
increased the commitment fee on unused commitments to 0.50%.  In connection
with the fourth amendment, the Company paid the bank a fee of $75,000
and incurred approximately $100,000 of costs.


-6-




All
revenue received by Physicians and its subsidiaries in Canadian dollars is
required to be deposited into the Canadian Pledged Accounts, which are pledged
to the agent to secure borrowings under the revolving credit
facility.  Physicians may use the balance in the Canadian Pledged
Accounts to repay borrowings under the revolving credit facility, or, if the
Company demonstrates availability under the borrowing base of at least $1.5
million and other conditions are met, Physicians may make monthly transfers from
the Canadian Pledged Accounts to a Canadian disbursement account in an amount
that will not cause the balance of the Canadian disbursement account to exceed
CDN$500,000, and, if other conditions are met, Physicians may use the Canadian
disbursement account to pay amounts due to its Canadian vendors in the ordinary
course of business. As of March 31, 2009, the Canadian Pledged Accounts had a
balance of $4.8 million, which is recorded as restricted cash in the
accompanying condensed consolidated balance sheet.  Borrowings
under the senior credit agreement are guaranteed by Physicians Formula
Holdings, Inc. and the domestic subsidiaries of Physicians Formula, Inc. and
borrowings under the senior credit agreement are secured by a pledge of the
capital stock of Physicians Formula, Inc. and its equity interests in each of
its subsidiaries and substantially all of the assets Physicians Formula,
Inc. and its domestic subsidiaries.
 At March
31, 2009, there was $24.1 million outstanding under the revolving
credit facility at an interest rate of 6.75% and we had $3.4 million of
availability under the revolving credit facility. At December 31,
2008, there was $7.9 million outstanding under the revolving credit
facility at an interest rate of 3.50%.
  The amount outstanding
under the term loan as of December 31, 2008 was $10.5 million and quarterly
payments were due through September 30, 2011. The interest rate on the term loan
was 3.39% at December 31, 2008. As described above, on March 30, 2009,
pursuant to the fourth amendment, the outstanding term loan was replaced with
borrowings under the revolving credit facility.Accordingly, the
Company included the $10.5 million outstanding under the term loan as
of December 31, 2008 in the current portion of long-term
debt in the accompanying condensed consolidated balance
sheets.
  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
(as amended, 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 March 31, 2009, a total of 804,535 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.





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
Company's 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 vested
in equal monthly installments over a two-year period through November
2008.




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.





-7-




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, 2009
                          
                          
                          1,075,758
                          
                          
                          $
                          9.04
                          
                          
                          
                          
                          
                          
                          136,681
                          
                          
                          $
                          0.10Options
      forfeited
                          
                          
                          (6,759
                          )
                          
                          
                          11.14
                          
                          
                          
                          
                          
                          
                          
                          -
                          
                          
                          
                          -Options
      outstanding—March 31, 2009
                          
                          
                          1,068,999
                          
                          
                          $
                          9.03
                          
                          
                          $
                          (7,558,000
                          )
                          
                          
                          136,681
                          
                          
                          $
                          0.10
                          
                          
                          $
                          254,000Vested
      and expected to vest—March 31, 2009
                          
                          
                          1,068,999
                          
                          
                          $
                          9.03
                          
                          
                          $
                          (7,558,000
                          )
                          
                          
                          136,681
                          
                          
                          $
                          0.10
                          
                          
                          $
                          254,000





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, 2009
                                      637,759
                                      
                                      $
      3,793,000
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      136,681
                                      
                                      $   14,000Vesting
      during period
                                      48,652
                                      
                                      597,000
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      -
                                      
                                      -March
      31, 2009
                                      686,411
                                      
                                      $
      4,390,000
                                      
                                      $   6.40
                                      
                                      6.0
      years
                                      
                                      $(3,048,000)
                                      
                                      136,681
                                      
                                      $   14,000
                                      
                                      $   0.10
                                      
                                      4.6
      years
                                      
                                      $
      254,000




As
of March 31, 2009, 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 6.7 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, 2009
                    
                    
                    437,999
                    
                    
                    $
                    7.04Vested
                    
                    
                    (48,652
                    )
                    
                    
                    6.33Forfeited
                    
                    
                    (6,759
                    )
                    
                    
                    5.90March
      31, 2009
                    
                    
                    382,588
                    
                    
                    $
                    7.15





The total
fair value of options that vested during the three months ended March 31,
2009 and 2008 was $0.1 million and $0.7 million, respectively.





-8-




As of
March 31, 2009, total unrecognized estimated compensation cost related to
non-vested stock options was approximately $2.7 million, which is expected to be
recognized over a weighted-average period of approximately 2.3 years. There
were no exercises of stock options during the three months ended March 31,
2009.





The
Company incurred $0.3 million and $0.6 million of pre-tax non-cash
share-based compensation expense for the three
month periods ended March 31, 2009 and 2008,
respectively.  Non-cash share-based compensation cost of $24,000 was a
component of cost of sales and $0.3 million was a component
of selling, general and administrative expenses in the accompanying
condensed consolidated statement of operations for the three months
ended March 31, 2009. Non-cash share-based compensation cost of $23,000 was
a component of cost of sales and $0.6 million was a component
of selling, general and administrative expenses in the accompanying
condensed consolidated statement of operations for the three months
ended March 31, 2008. The Company recognized a tax related benefit of $0.1
million and $0.3 million for the three months ended March 31, 2009 and
2008, respectively.  The Company capitalized non-cash share-based
compensation expense of $18,000 and $28,000 in inventory for the three
months ended March 31, 2009 and 2008, 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 PVOU PRP (the "Work
PRP") 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 Work PRP indemnified the Company against most claims for
PVOU contamination and is performing the PVOU remediation. The Company
has entered into a consent decree with the EPA and the other PRP that will
resolve the Company's liability for the cleanup of regional groundwater
contamination without any payment by the Company to the EPA. The
consent decree has been executed by the EPA and filed with the court and,
following the mandatory public notice and comment period, is expected to be
approved and entered by the court in the third quarter of 2009.
Depending on the scope and duration of the cleanup, the Company may be
requested 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 to be covered by indemnities given to the
Company by the 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’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 consolidated balance
sheets.





-9-




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 and Canada. Approximately
$223,000
of the Company's retail permanent fixtures are located in Canada
and are classified in other assets on the accompanying condensed consolidated
balance sheet as of March 31, 2009.Net sales to unaffiliated
customers by geographic region are as follows (dollars in
thousands):





Three
      Months Ended March 31,Customer
                                                                  
                                                                  2009
                                                                  
                                                                  
                                                                  2008United
      States
                                                                  
                                                                  $
                                                                  17,720
                                                                  
                                                                  
                                                                  $
                                                                  35,437Canada
                                                                  
                                                                  
                                                                  2,424
                                                                  
                                                                  
                                                                  
                                                                  7,072Other
                                                                  
                                                                  
                                                                  30
                                                                  
                                                                  
                                                                  
                                                                  152$
                                                                  20,174
                                                                  
                                                                  
                                                                  $
                                                                  42,661





-10-





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, 2008.




Overview
of the Business




We specialize in developing
and marketing innovative, premium-priced cosmetics 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, Walgreens, Target, CVS
and Rite Aid. Our products are currently sold in approximately 29,500 of the
45,000 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 44.1% of
our net sales for the last three years.




Our
results during the first quarter were adversely impacted by drastic changes in
the retail environment compared to the first quarter of last year, including the
following items: (i)
during the three months ended March 31, 2008, our total distribution, which is
the number of stores in which we sell products multiplied by our number of stock
keeping units per store, increased, resulting in higher net sales for that
quarter as customers ordered larger quantities of our products to fill the new
space, while our total distribution was flat in the three months ended March 31,
2009; (ii) our drug chain retailers implemented unprecedented tight inventory
control, which has led to destocking that began in the three months ended
December 31, 2008 and continued through the three months ended March 31, 2009,
which is typically a strong quarter for us due to the seasonality of our new
product pipelines; (iii) new products, which are primarily introduced during the
first and fourth quarters, represented 24% of our net sales for the three months
ended March 31, 2009, 50% lower than the same period a year ago, when new
products contributed 48% of net sales; and (iv) we decreased our promotional
activity, and our sales of promotional kits in particular, in the three months
ended March 31, 2009.In
addition, we are only selling our promotional programs to each retailer’s top
volume stores to reduce the return liability moving
forward.
  In
the first quarter of 2009, one of our largest retailer customers informed us
that as a result of a change in strategy, the customer intends to reduce the
space allocated to the entire color cosmetics category in its stores in
2010.  In April 2009, this customer informed us of its decision to
discontinue selling Physicians Formula products in 2010.  This
change may have a material negative impact on our net sales beginning
 in the second quarter of 2009 as the customer reduces its
inventory levels of our products, and we do not expect to have any sales to this
customer beginning September 2009. This change will eliminate our distribution
in approximately 5,800 stores in 2010.  This customer accounted for
13% of our gross sales for the three months ended March 31, 2009 and 16% of our
gross sales for the year ended December 31,
2008.




Our senior credit
agreement required us to comply with financial covenants, including a maximum
total leverage ratio, a minimum fixed charge coverage ratio and a minimum
tangible net worth requirement. On March
30, 2009, we entered into an amendment to the senior credit agreement to, among
other things,
eliminate the minimum fixed charge coverage ratio and the maximum total leverage
ratio covenants and replace them with a minimum interest coverage ratio and a
minimum EBITDA (as defined in the senior credit agreement) covenant and
amend the minimum tangible net worth covenant, to give us relief under the
financial covenants in 2009. The amendment also converted
the entire senior credit facility, which previously consisted of an
amortizing term loan and a revolving credit facility, into an asset-based
revolving credit facility subject to a limitation on availability under a
borrowing base formula, which reduced the overall availability under the senior
credit agreement, increased the applicable margin on interest rates for
borrowings, restricted deposits made into certain of our Canadian Pledged
Accounts and shortened the term of the credit facility to March 2010,as described in more detail under “Liquidity and Capital Resources —
Credit Facilities.” The Company intends to be able to support its
operations through continued development and growth of new products, addition of
new customers, obtaining new financing or extending the term of our
existing senior credit agreement, implementing a company-wide salary
reduction plan, eliminating cash bonuses in 2009, implementing cost
controls, reducing capital expenditures and
re-evaluating various non-strategic marketing and administrative costs. The
Company reduced its workforce by approximately 21 positions in March 2009 in an
effort to reduce costs.




U.S. Market Share
Data


Based on
retail sales data provided by ACNielsen, the Company’s approximate share of the
masstige market, as
defined below, was 7.9% for the 52 weeks ended April 18, 2009 compared to 8.1%
for the same period in the prior year. This represents a 2% increase in dollar
sales, compared to growth of 4% for the overall masstige market during this
period, or a 2.5% decrease in the Company’s share of the masstige
market.


The Company
defines the masstigemarket as products sold in the mass market channel under the
following premium-priced brands: Physicians Formula, Almay, L'Oreal, Max Factor,
Neutrogena, Revlon, OPI, Borghese and Iman. ACNielsen is an independent research
entity and its data does not include retail sales from Wal-Mart, the Company’s
largest customer, and Canada. In addition, ACNielsen data is based on sampling
methodology, and extrapolates from those samples, which means that estimates
based on that data may not be precise. The Company’s estimates have been based
on information obtained from our customers, trade and business organizations and
other contacts in the market in which the Company operates, as well as
management's knowledge and experience in the market in which the Company
operates.
 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; however, we expect the sell-in period to continue through
June in 2009. Sales during these months are typically greater due to the
shipments required to fill the inventory at retail stores and retailers’
warehouses. Retailers typically reset their retail selling space during
these months to accommodate changes in space allocation to each supplier and to
incorporate the addition of new products and the deletion of slow-selling items.
Our
quarterly results of operations may fluctuate as a result of a variety of
reasons, including the timing of new product introductions, general economic
conditions or consumer and retailer 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, 2008. There have been
no material changes to these policies as of this Quarterly Report on
Form 10-Q for the three months ended March 31, 2009.





-11-




Results of
Operations





The
following table sets forth our condensed consolidated statements
of operations for the three months ended March 31 , 2009
and 2008:





Three
      Months Ended March 31,2009
                                                      
                                                      
                                                      2008(dollars
      in thousands, except per share data)Net
      sales
                                                      
                                                      $
                                                      20,174
                                                      
                                                      
                                                      $
                                                      42,661Cost
      of sales
                                                      
                                                      
                                                      10,431
                                                      
                                                      
                                                      
                                                      18,946Gross
      profit
                                                      
                                                      
                                                      9,743
                                                      
                                                      
                                                      
                                                      23,715Selling,
      general and administrative expenses
                                                      
                                                      
                                                      12,774
                                                      
                                                      
                                                      
                                                      14,876(Loss)
      income from operations
                                                      
                                                      
                                                      (3,031
                                                      )
                                                      
                                                      
                                                      8,839Interest
      expense-net
                                                      
                                                      
                                                      208
                                                      
                                                      
                                                      
                                                      358Other
      expense
                                                      
                                                      
                                                      57
                                                      
                                                      
                                                      
                                                      87(Loss)
      income before income taxes
                                                      
                                                      
                                                      (3,296
                                                      )
                                                      
                                                      
                                                      8,394(Benefit)
      provision for income taxes
                                                      
                                                      
                                                      (1,582
                                                      )
                                                      
                                                      
                                                      3,375Net
      (loss) income
                                                      
                                                      $
                                                      (1,714
                                                      )
                                                      
                                                      $
                                                      5,019Net
      (loss) income per common share:Basic
                                                      
                                                      $
                                                      (0.13
                                                      )
                                                      
                                                      $
                                                      0.36Diluted
                                                      
                                                      $
                                                      (0.13
                                                      )
                                                      
                                                      $
                                                      0.34Weighted-average
      common shares outstanding:Basic
                                                      
                                                      
                                                      13,577,118
                                                      
                                                      
                                                      
                                                      14,095,834Diluted
                                                      
                                                      
                                                      13,577,118
                                                      
                                                      
                                                      
                                                      14,579,437





The
following is a discussion of our results of operations for the three months
ended March 31, 2009 and 2008.




-12-


Three
Months Ended March 31, 2009 Compared to Three Months Ended March 31,
2008
 
 Net Sales.  The consumer environment
continued to weaken this quarter and unprecedented tightening of inventory
control levels at our retail customers had a significant impact on our sales
this quarter.Net sales decreased $22.5 million, or 52.7%, to $20.2
million for the three months ended March 31, 2009, from $42.7 million for the
three months ended March 31, 2008.  The decrease was primarily
attributable to a decrease in sales of our makeup products, an
increase in our provision for returns and an increase in trade spending.
The decrease in sales of our makeup products is due to the weakened consumer
environment and tight inventory control by retailers leading to destocking,
which reduced the pipeline orders for new products during the three
months ended March 31, 2009 when compared to the same period a year ago. In
addition, in the three months ended March 31, 2008, our total distribution,
which is the number of stores in which we sell products multiplied by our number
of stock keeping units per store, increased, resulting in
higher net sales for that quarter as customers ordered larger quantities of our
products to fill the new space.  Our total distribution was flat in the
three months ended March 31,
2009. Unit sales for
our makeup products decreased by 2.8 million units, or 33.3%,
to 5.6 million units for the three months ended March 31, 2009
from 8.4 million units for the same period a year ago. New products, which
are primarily introduced during the first and fourth quarters, represented 24%
of our net sales for the three months ended  March 31, 2009, 50% lower
than the same period a year ago, when new products contributed 48% of net sales.
In addition, we decreased our promotional activity, and our sales of promotional
kits in particular, in the three months ended March 31, 2009. Our provision for
returns increased by $2.2 million, or 45.8%, to $7.0 million for the three
months ended March 31, 2009, from $4.8 million for the three months ended
March 31, 2008 due to higher returns from our retailers relating primarily
to retailer customers' wall display changes and lower than anticipated retail
sell-through on higher-priced promotional kits. Trade spending with retailers
increased by $0.4 million for the three months ended March 31, 2009 compared to
the same period a year ago, which includes an increase in our provision for
markdowns of $1.1 million and an increase in our provision for coupon
programs of $0.3 million, offset by a decrease in our provision for
cooperative advertising expense of $0.6 million, a decrease in our provision for
cash discounts of $0.3 million and a decrease in our provision for
miscellaneous deductions of $0.1 million. During the three months ended
March 31, 2009, our results included net sales of $2.5 million from our
international customers, compared to $7.2 million for the three months ended
March 31, 2008. For information on our sell through performance, please
see U.S. Market Share Data on page 11.
  Cost of Sales.Cost of sales
decreased $8.5 million, or 45.0%, to $10.4 million for the three months ended
March 31, 2009, from $18.9 million for the three months ended March 31, 2008.
The decrease in cost of sales resulted primarily from a decrease in product
costs and an increase in inventory recovery (inventory returned by
customers deemed to be resaleable). Product costs decreased $9.0
million due to a decrease in sales of our makeup products when
compared to the same period a year ago. Inventory recovery for returns from
retailers increased $0.5 million when compared to the same period a year
ago due to higher returns from our retailers. The decrease was offset by an
increase in the write-down of obsolete and slow moving inventory of
$1.0 million. Cost of sales as a percentage of net sales was 51.7% of net sales
for the three months ended March 31, 2009, compared to 44.4% for the three
months ended March 31, 2008. The increase in cost of sales, as a percentage of
net sales, was primarily due to an increase in our provision for returns and
trade spending with retailers and an increase in our write-down of
obsolete and slow moving inventory, which was partially offset
by an increase in inventory recovery for returns from
retailers.
  Selling, General and Administrative
Expenses.Selling, general and administrative expenses
decreased $2.1 million, or 14.1%, to $12.8 million for the three months ended
March 31, 2009, from $14.9 million for the three months ended March 31, 2008.
The variance was primarily due to a $0.8 million decrease in freight and
warehouse costs, a $0.8 million decrease in sales force and sales administrative
expense, a $0.3 million decrease in marketing spending, a $0.3 million decrease
in expense for stock option awards, a $0.1 million decrease in realized and
unrealized foreign currency exchange losses, and a $0.2 million increase in
allowance for bad debt.
  Interest
Expense-Net.Interest expense-net decreased $0.2
million, or 50.0%, to $0.2 million for the three months ended March 31, 2009,
from $0.4 million for the three months ended March 31, 2008. The decrease in
interest expense was due to a decline in our weighted-average interest
rate.
  Other Expense.Other expense
for the three months ended March 31, 2009 was $57,000 compared to $87,000 for
the three months ended March 31, 2008, which consisted
of unrealized 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 March 31, 2009, the income tax benefit was $1.6
million, representing an effective income tax rate of (48.0)%. The
effective rate differed from the statutory rate for the three months ended March
31, 2009, primarily due to our change in the federal deferred carrying rate and
fluctuations in permanent differences between book and taxable income such as
research and development credits. For the three months ended March 31,
2008, the income tax expense was $3.4 million, representing an
effective income tax rate of 40.2%.  Theeffective rate differed from the statutory rate for the three months ended March
31, 2008, due to fluctuations in permanent differences between book and taxable
income such as research and development
credits.
  -13-


Liquidity
and Capital Resources
  Cash
Flows
  As
of March 31, 2009, we had $3,000 in cash and cash equivalents and $4.8
million in restricted cash compared to approximately $0.6 million in cash
and cash equivalents as of December 31, 2008. The increased level of cash
reflects higher cash inflows provided by our financing activities. As of
March 31, 2009, we had $3.4 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
and line of credit borrowings.
  Operating
activities.Cash flows from operating activities
decreased by $4.6 million to ($0.5) million for the three months ended
March 31, 2009, from $4.1 million for the three months ended March 31,
2008. The net decrease in cash flows from operating activities resulted
primarily from unfavorable changes in net income, deferred income taxes, income
taxes payable/receivable and inventories. The net decrease in cash flows
from operating activities was offset by favorable changes in accounts
receivable, accounts payable, accrued expenses, trade allowances and sales
return reserve. Our inventory turnover rate remained relatively consistent at an
annualized 1.6 times per year for the three months ended March 31,
2009 compared to 1.8 times per year for the three months ended March
31, 2008. Days sales outstanding remained relatively consistent at 51.2
days for the three months ended March 31, 2009 and
2008.
  Investing
activities.Cash used in investing activities for
the three months ended March 31, 2009 was $6.3 million, which was primarily
related to deposits made into our Canadian Pledged Accounts as required by
the fourth amendment to our senior credit agreement entered in March 30,
2009, investments in retail permanent fixtures and capital expenditures for
the replacement of machinery and equipment and improvements to our warehouse
distribution systems. Cash used in investing activities for the three
months ended March 31, 2008 of $0.3 million was primarily related to capital
expenditures for the replacement of machinery and equipment, the automation
of an assembly line and improvements to our warehouse distribution
systems.
  Financing
activities.Cash provided by financing activities was
$6.2 million for the three months ended March 31, 2009 compared to cash
used in financing activities of $3.8 million for the three months ended
March 31, 2008. The increase in cash provided by financing activities between
periods primarily resulted from higher borrowings under our senior
credit agreement.
  Capital
Needs.Net working capital requirements decreased by $14.7
million, or approximately 45.7%, to $17.5 million as of March 31, 2009, from
$32.2 million as of March 31, 2008. We anticipate that requirements for working
capital will increase during the fourth quarter of 2009, 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 $3.9 million for 2009 for several key projects, including investments in
retail permanent fixtures (classified as other assets in the accompanying
condensed consolidated balance sheets), investments in our information
technology infrastructure and improvements to our manufacturing and
distribution equipment. We expect capital requirements related to fixture
infrastructure to total $4.1 million upon completion in 2009, of which $2.9
million was incurred as of March 31, 2009.  Capital requirements related to
manufacturing include an upgrade to a major project undertaken in 2007 to
automate a product assembly line that is used to assemble products that
represented approximately 24.5% of our total sales in 2008. We expect the aggregate capital requirements of this
project to total $1.7 million upon completion in 2009, of which $1.4 million was
incurred as of March 31, 2009. In addition to an estimated $2.5 million related
to investments in retail permanent fixtures and $0.3 million required to upgrade
the assembly line project, we expect to need to make improvements to other
manufacturing and distribution equipment at a cost of approximately $0.7
million, improvements to our information technology infrastructure of
approximately $0.3 million and improvements to our research and development
equipment of approximately $0.1 million in 2009. We incurred $0.3 million of
capital expenditures for the three months ended March 31,
2009.
  The Company intends to be able to support its
operations through continued development and growth of new products, addition of
new customers, obtaining new financing or extending the term of our
existing senior credit agreement, implementing a company-wide salary
reduction plan, eliminating cash bonuses in 2009, implementing cost
controls, reducing capital expenditures and re-evaluating various
non-strategic marketing and administrative costs. In March 2009,
we reduced our workforce by approximately 21 positions in an
effort to reduce costs.


-14-




Credit
Facilities


On
November 14, 2006, Physicians Formula, Inc. entered into a senior credit
agreement with a bank that consisted of an amortizing term loan facility and a
revolving credit facility. The term loan facility was replaced with borrowings
under the revolving credit facility on March 30, 2009 in connection with the
fourth amendment as described below. At March
31, 2009, there was $24.1 million outstanding under the revolving credit
facility under the revolving credit facility. There were no outstanding letters
of credit as of March 31, 2009.  Borrowings
under the senior credit agreement are guaranteed by Physicians Formula Holdings,
Inc. and the domestic subsidiaries of Physicians Formula, Inc., and borrowings
under the senior credit agreement are secured by a pledge of the capital
stock of Physicians Formula, Inc. and its equity interests in each of its
subsidiaries and substantially all of the assets of Physicians Formula, Inc.
and its subsidiaries.
  On
March 30, 2009, we entered into a fourth amendment to our senior credit
agreement (the “fourth amendment”) to, among
other things, eliminate the minimum fixed charge coverage ratio and the maximum
total leverage ratio covenants and replace them with a minimum interest coverage
ratio and a minimum EBITDA (as defined in the senior credit agreement) covenant
and amend the minimum tangible net worth covenant, to give us relief under the
financial maintenance covenants in 2009. As of
March 31, 2009, we were in compliance with these covenants in the senior credit
agreement, as amended by the fourth
amendment.
  However, we
continue to operate in a challenging economic environment. Our ability to
comply with the new financial covenants in the senior credit agreement may be
affected by future economic or business conditions beyond our
control.  If market conditions do not improve or continue to worsen,
we may be unable to comply with the interest coverage ratio and the minimum
EBITDA covenants in the near future, or we may be unable to generate enough
borrowing capacity under our asset-based loan to meet our liquidity
needs. A failure to satisfy the EBITDA covenant or any other financial
covenants would be an event of default under our senior credit agreement, if not
amended or waived. If there is an event of default under our senior credit
agreement, we would be precluded from borrowing under our revolving credit
facility, and the indebtedness under our senior credit agreement could be
declared immediately due and payable, which would have a material adverse effect
on our business, financial condition and liquidity. There is no assurance
that we would receive waivers should we not meet our financial covenant
requirements. Even if we are able to obtain a waiver, in connection with
negotiating a waiver we may be required to agree to other changes in the senior
credit agreement including increased interest rates, tighter covenants or lower
availability thresholds or pay a fee for such waiver. If we are not able to
comply with the new financial covenants in the senior credit agreement and we
are unable to obtain waivers, we would need to obtain additional sources of
liquidity; however, given the unprecedented instability in worldwide credit
markets, there can be no assurance that we will be able to obtain additional
sources of liquidity on terms acceptable to us, or at
all.
  The fourth
amendment converted the entire facility, which previously consisted of an
amortizing term loan and a revolving credit facility, into an asset-based
revolving credit facility, and the outstanding term loan was replaced with
borrowings under the revolving credit
facility. Pursuant
to the fourth amendment, the maximum amount available for borrowing under the
revolving credit facility is equal to the lesser of (i) $27.5 million and (ii)
the sum of (a) up to 65% of the book value of our eligible accounts receivable,
(b) the lesser of (1) up to 25% of our eligible inventory (with a permanent
reduction to 15% of eligible inventory after June 30, 2009) and (2) $8.0 million
(with a permanent reduction to $5.0 million after June 30, 2009), (c) the
balance of certain foreign currency accounts denominated in Canadian dollars
(the “Canadian Pledged Accounts”), and (d) the orderly liquidation value of
eligible equipment not to exceed $1.0 million, all as determined in accordance
with the fourth amendment.
  On June 30,
2009, the maximum availability for borrowing under the revolving credit facility
will be permanently reduced to $25.0 million.  The revolving credit
facility will mature on March 31, 2010. Our
ability to extend the senior credit agreement after maturity, or to repay or
refinance borrowings under the senior credit agreement, will depend on, among
other things, our financial condition at the time and the availability of
financing.  We may not be able to repay borrowings under the senior
credit agreement when they become due, and there can be no assurance that we
will be able to extend the senior credit agreement, or if we are unable to do
so, to obtain other financing necessary to operate our business.  Any
extension of the senior credit agreement or other financing may only be
available on terms that are less favorable to us, and could cause an increase in
our interest expense and decrease the amount of cash available for operations
and investments in our business.
  The fourth
amendment increased the applicable interest rate to a percentage equal to the
lender’s reference rate plus 3.50% (with a reduction to 3.00% after June 30,
2009), eliminated the option to elect an interest rate based on LIBOR and
increased the commitment fee on unused commitments to 0.50%.
 All revenue
received by us in Canadian dollars is required to be deposited into the Canadian
Pledged Accounts, which are pledged to the agent to secure borrowings under the
revolving credit facility.  We may use the balance in the Canadian
Pledged Accounts to repay borrowings under the revolving credit facility, or, if
we demonstrate availability under the borrowing base of at least $1.5 million
and other conditions are met, we may make monthly transfers from the Canadian
Pledged Account to a Canadian disbursement account in an amount that will not
cause the balance of the Canadian disbursement account to
exceed CDN$500,000, and, if other conditions are met, we may use the
Canadian disbursement account to pay amounts due to Canadian vendors in the
ordinary course of business.
  The fourth
amendment changed certain restrictive covenants in the senior credit agreement,
including a reduction in permitted capital expenditures to not more than $2.0
million per year (excludes retail permanent fixtures) and a general prohibition
on the ability of Physicians Formula, Inc. to pay dividends to us, subject to a
limited exception for certain expenses.  Pursuant to the fourth
amendment, Physicians Formula, Inc. is no longer permitted to purchase shares of
our common stock or to make cash distributions to us to allow us to repurchase
shares of our common stock.


-15-




The
senior credit agreement contains certain additional negative covenants,
including limitations on our ability to: incur other indebtedness and liens;
fundamentally change our business through a merger, consolidation, amalgamation
or liquidation; sell assets; make restricted payments; pay cash dividends
from Physicians Formula, Inc. 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.  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.
  Assuming we
are able to extend or refinance our senior credit agreement at or prior to
maturity, we believe that our cash flows from operations, borrowings under our
revolving credit facility and an extension of our revolving credit facility or
other future refinancing will provide adequate funds for our working capital
needs and planned capital expenditures for the next twelve months.  No
assurance can be given, however, that this will be the case.  An
inability to extend the senior credit agreement or refinance our borrowings
would materially adversely affect our business, results of operations and
liquidity.
 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, 2008 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 senior
credit agreement. Interest on borrowings under our senior credit agreement is
based upon variable interest rates. Our weighted-average borrowings outstanding
under our senior credit agreement during the three months ended March
31, 2009 was $22.5 million, and the weighted-average interest rate in
effect at March 31, 2009, was 6.75%. A hypothetical 1% increase or decrease in
interest rates would have resulted in a $56,000 change to interest expense for
the three months ended March 31, 2009.







-16-




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.
 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, 2008,
except as follows:




We
depend on a limited number of retailer customers for a majority of our sales and
the loss of one or more of these customers would reduce our sales and harm our
market share and our business.
  We depend on
a small number of core retailer customers for a majority of our sales, including
Wal-Mart, Walgreens, CVS, Target and Rite Aid. Sales to these five retailer
customers accounted for an aggregate of 73.7% of our gross sales in 2008. None
of our customers is under an obligation to continue purchasing products from us
in the future. The fact that we do not have long-term contracts with our
customers means that we have no recourse in the event a customer no longer wants
to purchase products from us. In the future, retailers in the mass market
channel may undergo restructurings or reorganizations, realign their
affiliations, close stores or otherwise suffer losses, any of which could
decrease their orders for our products. The loss of one or more of our customers
that, individually or in the aggregate, accounts for a significant portion of
our sales, any significant decrease in sales to those customers, any significant
decrease in our retail selling space in any of those customers’ stores, an
interruption or decline of our customers’ business or a successful demand by
those customers that we decrease our prices would reduce our sales and harm our
business. In the first quarter of 2009, one of our largest retailer
customers informed us that as a result of a change in strategy, the
customer intends to reduce the space allocated to the entire color
cosmetics category in its stores in 2010. In April
2009, this customer informed us of its decision to discontinue selling
Physicians Formula products in 2010.  This change will have a material
negative impact on our net sales beginning in the second quarter of 2009
as the customer reduces its inventory levels of our products,
and we do not expect to have any sales to this customer beginning in
September 2009. This change will eliminate our distribution in
approximately 5,800 stores in 2010 .  This customer accounted for 13%
of our gross sales for the three months ended March 31, 2009 and 16% of our
gross sales for the year ended December 31, 2008.
  Our
business and results of operations have been adversely impacted by the severe
downturn in the U.S. economy and will continue to be impacted by general
economic conditions.
  Our
operations and financial performance are directly impacted by changes in the
U.S. economy.  The significant downturn in the U.S. economy during the
first quarter of 2009 significantly lowered consumer discretionary spending,
which lowered the demand for our products.  Reduced consumer
discretionary spending may cause us to lower prices, increase our trade spending
or suffer significant product returns from our retailer customers, any of which
would have a negative impact in our gross margins.  For example, in
the three months ended March 31, 2009, as a result of tighter inventory
controls imposed by our retailer customers, we received a lower volume of orders
of new products than we have in the past. Additionally,
a continued weakened consumer environment may create additional declines in the
Company's market capitalization relative to its net book value resulting in a
potential impairment of intangible assets, including trade
names.
  Current
economic conditions could also 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 of 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.  It is uncertain if economic conditions or consumer
confidence will deteriorate further, or when economic conditions or consumer
confidence will improve.  If there is a prolonged recession, reduced
consumer spending could have a material and adverse effect on our business,
results of operations or financial condition, including recognizing an
impairment charge of the Physicians Formula trade name.


-17-




We
recently amended our senior credit agreement to, among other things, provide
relief under the financial covenants in 2009.  If we are unable
to comply with the new covenants, our business, results of operations and
liquidity could be materially and adversely affected.
 Our senior
credit agreement required us to comply with financial covenants, including a
maximum total leverage ratio, a minimum fixed charge coverage ratio and a
minimum tangible net worth requirement. On March
30, 2009, we entered into an amendment to the senior credit agreement to, among
other things,
eliminate the minimum fixed charge coverage ratio and the maximum total leverage
ratio covenants and replace them with a minimum interest coverage ratio and a
minimum EBITDA (as defined in the senior credit agreement) covenant and
amend the minimum tangible net worth covenant, to give us relief under the
financial covenants in 2009. The amendment also converted
the entire senior credit facility, which previously consisted of an
amortizing term loan and a revolving credit facility, into an asset-based
revolving credit facility subject to a limitation on availability under a
borrowing base formula, which reduced the overall availability under the senior
credit agreement, increased the applicable margin on interest rates for
borrowings, restricted deposits made into certain of our Canadian Pledged
Accounts and shortened of the term of the credit facility to March 2010,as described in more detail under “Management’s Discussion and Analysis
of Financial Condition and Results of Operations — Liquidity and Capital
Resources — Credit Facilities.” We are operating in a challenging economic
environment and our ability to comply with the new financial maintenance
covenants in the senior credit agreement may be affected by future economic or
business conditions beyond our control. If market conditions do not improve
or continue to worsen, we may be unable to comply with the interest coverage
ratio and the minimum EBITDA covenants in the near future, or we may be unable
to generate enough borrowing capacity under our asset-based loan to meet our
liquidity needs. Afailure
to maintain the financial covenants in our senior credit
agreement, if we are not able to obtain an amendment or waiver in the
future, would be an event of default under our senior credit
agreement.  If there is an event of default under our senior credit
agreement, we would be precluded from borrowing under our revolving credit
facility and the indebtedness under our senior credit agreement could be
declared immediately due and payable, which would have a material adverse effect
on our business, financial condition and liquidity. There is
no assurance that we would receive waivers should we not meet our financial
covenants. Even if
we are able to obtain a waiver, in connection with negotiating a waiver we may
be required to agree to other changes in the senior credit agreement, including
increased interest rates, tighter covenants or lower availability thresholds, or
pay a fee for such waiver.If we are not able to comply with the new
financial covenants in the senior credit agreement and we are unable to
obtain waivers, we would need to obtain additional sources of liquidity;
however, given the unprecedented instability in worldwide credit markets, there
can be no assurance that we will be able to obtain additional sources of
liquidity on terms acceptable to us, or at
all.
  ITEM
6.  EXHIBITS
 
 Exhibit
                              Number
                            
                            
                            
                            Description10.1
                            
                            Fourth
      Amendment to Credit Agreement, dated March 30, 2009, by and among
      Physicians Formula, Inc. , the several banks and other lenders from time
      to time parties to the Credit Agreement and Union Bank, N.A., as
      administrative agent (incorporated by reference to the registrant's
      current report on Form 8-K (File No. 001-33142) filed on March 31,
      2009).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: May 11,
      2009
            
            By:
      Ingrid JackelIts:   Chief Executive
      Officer
              (principal executive officer)/s/
      Joseph J. JaegerDate:
      May 11, 2009
            
            By:
      Joseph J. JaegerIts:   Chief Financial
      Officer
              (principal financial officer)




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