**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      DC 20549**





**FORM
      10-Q**





**x           QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934**





**For
      the quarterly period ended September 30, 2007**





**OR**





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





**For
      the transition period
      from            to            .**





**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**
            
            **91702****Azusa,
                California**
            
            (Zip
                Code)(Address
                of principal executive offices)





**(626)
      334-3395**





(Registrant’s
      telephone number, including area code)





**N/A**





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





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





Indicate
      by check mark whether the Registrant is a large accelerated filer, an accelerate
      filer, or a non-accelerated filer. See definition of “accelerated filer and
      larger accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
      one):




Large
                accelerated filer o
            Accelerated
                filer o
            Non-accelerated
                filer x





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





The
      number of shares outstanding of the registrant’s common stock, par value $.01
      per share, as of November 12, 2007, was 14,095,727.















**TABLE
      OF CONTENTS**





PART I. FINANCIAL INFORMATION
            
            1Item
                1.
            
            Financial
                Statements
            
            1Item
                2.
            
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            
            10Item
                3.
            
            Quantitative
                and Qualitative Disclosures About Market
                Risk
            
            16Item 4.
            
            Controls
                and Procedures
            
            16PART II. OTHER INFORMATION
            
            17Item
                1.
            
            Legal
                Proceedings
            
            17Item
                1A.
            
            Risk
                Factors
            
            17Item
                6.
            
            Exhibits
            
            17














**PART
      I.**





**FINANCIAL
      INFORMATION**





**ITEM
      1.  FINANCIAL STATEMENTS**





**PHYSICIANS
      FORMULA HOLDINGS, INC.**


**CONDENSED
      CONSOLIDATED BALANCE SHEETS**


**(unaudited)**


**(dollars
      in thousands, except share data)**




**September
                  30,**
              
              
              **December
                  31,****2007**
              
              
              **2006****ASSETS**CURRENT
                  ASSETS:Cash
                  and cash equivalents
              
              $
              56
              
              
              $
              26Accounts
                  receivable, net of allowance for bad debts of $384 and
                  $348
              
              
              15,368
              
              
              
              26,654Inventories
              
              
              28,205
              
              
              
              23,472Prepaid
                  expenses and other current assets
              
              
              1,221
              
              
              
              1,775Income
                  taxes receivables
              
              
              1,772
              
              
              
              -Deferred
                  income taxes—net
              
              
              4,905
              
              
              
              5,139Total
                  current assets
              
              
              51,527
              
              
              
              57,066PROPERTY
                  AND EQUIPMENT—Net
              
              
              3,690
              
              
              
              2,506OTHER
                  ASSETS—Net
              
              
              1,209
              
              
              
              968INTANGIBLE
                  ASSETS—Net
              
              
              54,987
              
              
              
              56,311GOODWILL
              
              
              17,463
              
              
              
              17,463TOTAL
              
              $
              128,876
              
              
              $
              134,314**LIABILITIES
                  AND STOCKHOLDERS' EQUITY**CURRENT
                  LIABILITIES:Accounts
                  payable
              
              $
              6,009
              
              
              $
              12,670Accrued
                  expenses
              
              
              2,041
              
              
              
              1,915Trade
                  allowances
              
              
              3,630
              
              
              
              3,479Sales
                  returns reserve
              
              
              7,293
              
              
              
              9,440Income
                  taxes payable
              
              
              -
              
              
              
              378Line
                  of credit borrowings
              
              
              6,761
              
              
              
              7,522Current
                  portion of long-term debt
              
              
              2,625
              
              
              
              2,063Total
                  current liabilities
              
              
              28,359
              
              
              
              37,467DEFERRED
                  COMPENSATION
              
              
              845
              
              
              
              721DEFERRED
                  INCOME TAXES-Net
              
              
              21,434
              
              
              
              21,617LONG-TERM
                  DEBT
              
              
              11,250
              
              
              
              12,937COMMITMENTS
                  AND CONTINGENCIESSTOCKHOLDERS'
                  EQUITY:Series A
                  preferred stock, $.01 par value—10,000,000 shares authorized, 0 and
                  0 shares issued and outstanding
              
              
              -
              
              
              
              -Common
                  stock, $.01 par value—50,000,000 shares authorized, 14,095,727 and
                  13,843,056 shares issued and outstanding
              
              
              141
              
              
              
              138Additional
                  paid-in capital
              
              
              58,579
              
              
              
              57,047Retained
                  earnings
              
              
              8,268
              
              
              
              4,387Total
                  stockholders' equity
              
              
              66,988
              
              
              
              61,572TOTAL
              
              $
              128,876
              
              
              $
              134,314




See
      notes
      to condensed consolidated financial statements.





-1-





**PHYSICIANS
      FORMULA HOLDINGS, INC.**


**CONDENSED
      CONSOLIDATED STATEMENTS OF INCOME**


**(unaudited)**


**(dollars
      in thousands, except per share data)**





**Three
                  Months Ended September 30,**
              
              
              **Nine
                  Months Ended September 30,****2007**
              
              
              **2006**
              
              
              **2007**
              
              
              **2006**NET
                  SALES
              
              $
              19,807
              
              
              $
              18,093
              
              
              $
              77,628
              
              
              $
              68,865COST
                  OF SALES
              
              
              10,085
              
              
              
              8,449
              
              
              
              35,108
              
              
              
              29,826GROSS
                  PROFIT
              
              
              9,722
              
              
              
              9,644
              
              
              
              42,520
              
              
              
              39,039SELLING,
                  GENERAL AND ADMINISTRATIVE EXPENSES
              
              
              8,902
              
              
              
              7,540
              
              
              
              34,467
              
              
              
              26,820INCOME
                  FROM OPERATIONS
              
              
              820
              
              
              
              2,104
              
              
              
              8,053
              
              
              
              12,219INTEREST
                  EXPENSE-NET
              
              
              370
              
              
              
              1,945
              
              
              
              1,086
              
              
              
              5,457OTHER
                  INCOME
              
              
              (24
              )
              
              
              (32
              )
              
              
              (78
              )
              
              
              (35
              )INCOME
                  BEFORE INCOME TAXES
              
              
              474
              
              
              
              191
              
              
              
              7,045
              
              
              
              6,797PROVISION
                  (BENEFIT) FOR INCOME TAXES
              
              
              372
              
              
              
              (32
              )
              
              
              3,164
              
              
              
              2,527NET
                  INCOME
              
              $
              102
              
              
              $
              223
              
              
              $
              3,881
              
              
              $
              4,270NET
                  INCOME PER COMMON SHARE:Basic
              
              $
              0.01
              
              
              $
              0.02
              
              
              $
              0.28
              
              
              $
              0.41Diluted
              
              $
              0.01
              
              
              $
              0.02
              
              
              $
              0.27
              
              
              $
              0.37WEIGHTED-AVERAGE
                  COMMON SHARES OUTSTANDING:Basic
              
              
              14,011,041
              
              
              
              10,421,916
              
              
              
              13,935,389
              
              
              
              10,399,331Diluted
              
              
              14,553,130
              
              
              
              11,614,506
              
              
              
              14,566,860
              
              
              
              11,603,042





See
      notes
      to condensed consolidated financial statements.





-2-





**PHYSICIANS
      FORMULA HOLDINGS, INC.**


**CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS**


**(unaudited)**


**(dollars
      in thousands)**





**Nine
                          Months Ended September 30,****2007**
                      
                      
                      **2006****CASH
                          FLOWS FROM OPERATING ACTIVITIES:**Net
                          income
                      
                      $
                      3,881
                      
                      
                      $
                      4,270Adjustments
                          to reconcile net income to net cash provided by operating
                          activities:Depreciation
                          and amortization
                      
                      
                      2,058
                      
                      
                      
                      1,898Exchange
                          rate gain
                      
                      
                      (78
                      )Deferred
                          income taxes
                      
                      
                      51
                      
                      
                      
                      762Provision
                          for bad debts
                      
                      
                      61
                      
                      
                      
                      58Amortization
                          of debt issuance costs
                      
                      
                      28
                      
                      
                      
                      150Accrued
                          payment-in-kind interest
                      
                      
                      -
                      
                      
                      
                      155Recognition
                          of stock-based compensation
                      
                      
                      1,507
                      
                      
                      
                      -Tax
                          benefit on exercise of options
                      
                      
                      (79
                      )
                      
                      
                      -Changes
                          in operating assets and liabilities:Accounts
                          receivable
                      
                      
                      11,303
                      
                      
                      
                      6,531Inventories
                      
                      
                      (4,673
                      )
                      
                      
                      113Prepaid
                          expenses and other current assets
                      
                      
                      554
                      
                      
                      
                      (367
                      )Other
                          assets
                      
                      
                      (100
                      )
                      
                      
                      (25
                      )Accounts
                          payable
                      
                      
                      (7,014
                      )
                      
                      
                      (1,531
                      )Accrued
                          expenses, trade allowances and sales returns reserve
                      
                      
                      (1,870
                      )
                      
                      
                      (2,158
                      )Income
                          taxes payable/receivable
                      
                      
                      (2,208
                      )
                      
                      
                      (3,271
                      )Net
                          cash provided by operating activities
                      
                      
                      3,421
                      
                      
                      
                      6,585**CASH
                          FLOWS FROM INVESTING ACTIVITIES:**Purchase
                          of property and equipment
                      
                      
                      (1,565
                      )
                      
                      
                      (528
                      )**CASH
                          FLOWS FROM FINANCING ACTIVITIES:**Paydowns
                          of term loans
                      
                      
                      (1,125
                      )
                      
                      
                      (2,088
                      )Net
                          paydowns under line of credit
                      
                      
                      (761
                      )
                      
                      
                      (3,607
                      )Debt
                          issuance costs
                      
                      
                      (45
                      )
                      
                      
                      (172
                      )Bank
                          overdraft
                      
                      
                      -
                      
                      
                      
                      (177
                      )Exercise
                          of stock options
                      
                      
                      26
                      
                      
                      
                      37Tax
                          benefit on exercise of options
                      
                      
                      79
                      
                      
                      
                      -Cash
                          payment of common stock dividend
                      
                      
                      -
                      
                      
                      
                      (46
                      )Net
                          cash used in financing activities
                      
                      
                      (1,826
                      )
                      
                      
                      (6,053
                      )NET
                          INCREASE IN CASH AND CASH EQUIVALENTS
                      
                      
                      30
                      
                      
                      
                      4CASH
                          AND CASH EQUIVALENTS—Beginning of period
                      
                      
                      26
                      
                      
                      
                      20CASH
                          AND CASH EQUIVALENTS—End of period
                      
                      $
                      56
                      
                      
                      $
                      24SUPPLEMENTAL
                          DISCLOSURE OF CASH FLOW INFORMATION—Cash paid during the period
                          for:Interest,
                          net of amounts capitalized
                      
                      $
                      1,103
                      
                      
                      $
                      3,715Income
                          taxes
                      
                      $
                      5,320
                      
                      
                      $
                      5,037SUPPLEMENTAL
                          DISCLOSURE OF NON-CASH INVESTING ACTIVITIES - The Company
                          had accounts
                          payable of $352,000 outstanding as of September 30, 2007,
                          relating to
                          purchases of property and equipment.





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’’), and its wholly owned subsidiary, Physicians Formula, Inc.
      (‘‘Physicians’’), a New York corporation, and its wholly owned subsidiaries,
      Physicians Formula Cosmetics, Inc., a Delaware corporation, and
      Physicians Formula DRTV, LLC, a Delaware limited liability company.





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





The
      accompanying condensed consolidated balance sheet as of September 30, 2007,
      the
      condensed consolidated statements of income for the three and nine months ended
      September 30, 2007 and 2006 and the condensed consolidated statements of cash
      flows for the nine months ended September 30, 2007 and 2006 are unaudited.
      These
      unaudited condensed interim consolidated financial statements have been prepared
      in accordance with U.S. generally accepted accounting principles for interim
      financial information and Article 10 of Regulation S-X. In the opinion of the
      Company’s management, the unaudited condensed interim consolidated financial
      statements include all adjustments of a normal recurring nature necessary for
      the fair presentation of the Company’s financial position as of September 30,
      2007, its results of operations for the three and nine months ended September
      30, 2007 and 2006, and its cash flows for the nine months ended September 30,
      2007 and 2006. 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, 2007. The condensed consolidated balance sheet as
      of
      December 31, 2006 has been derived from the audited consolidated balance sheet
      as of that date.





These
      condensed interim consolidated 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, 2006.





***Use
      of Estimates—***The preparation of financial statements in conformity
      with accounting principles generally accepted in the United States of America
      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 STANDARD**





In
      June
      2006, the Financial Accounting Standards Board (‘‘FASB’’) issued FASB
      Interpretation No. (“FIN”) 48, *Accounting for Uncertainty in Income
      Taxes*. FIN 48 prescribes a more likely than not threshold for financial
      statement recognition and measurement of a tax position taken or expected to
      be
      taken in a tax return. FIN 48 also provides guidance on derecognition of income
      tax assets and liabilities, accounting for interest and penalties associated
      with tax positions, accounting for income taxes in interim periods and income
      tax disclosures. The Company adopted FIN 48 on January 1, 2007, and did not
      record any cumulative effect adjustment to retained earnings as a result of
      adopting FIN 48.  Interest and penalties, if any, related to
      unrecognized tax benefits are recorded in income tax expense. Total unrecognized
      tax benefits and interest and penalties were not significant at January 1,
      2007.
      The Company is subject to U.S. Federal income tax examinations for the tax
      years
      2003 through 2006, and is subject to state and local income tax examinations
      for
      the tax years 2002 through 2006.





-4-





**3.  NET
      INCOME PER SHARE**





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





**Three
                Months Ended September 30,**
            
            
            **Nine
                Months Ended September 30,****2007**
            
            
            **2006**
            
            
            **2007**
            
            
            **2006**Weighted-average
                number of common shares—basic
            
            
            14,011,041
            
            
            
            10,421,916
            
            
            
            13,935,389
            
            
            
            10,399,331Effect
                of dilutive employee stock options
            
            
            542,089
            
            
            
            1,192,590
            
            
            
            631,471
            
            
            
            1,203,711Weighted-average
                number of common shares—diluted
            
            
            14,553,130
            
            
            
            11,614,506
            
            
            
            14,566,860
            
            
            
            11,603,042





Stock
      options
      for the purchase of 325,000 shares of common stock were excluded from the above
      calculation during the three and nine months ended September 30, 2007, as the
      effect of those options was anti-dilutive.  There were no
      anti-dilutive options during the three months and nine months ended September
      30, 2006.





**4.  INVENTORIES**





Inventories
      consist of the following (dollars in thousands):





**September
                30,**
            
            
            **December
                31,****2007**
            
            
            **2006**Raw
                materials and components
            
            $
            16,076
            
            
            $
            11,955Finished
                goods
            
            
            12,129
            
            
            
            11,517Total
            
            $
            28,205
            
            
            $
            23,472





**5.  PROPERTY
      AND EQUIPMENT**





Property
      and equipment consist of the following (dollars in thousands):





**September
                        30,**
                    
                    
                    **December
                        31,****Useful
                        Lives**
                    
                    **2007**
                    
                    
                    **2006**Tooling
                    3
                        to 5 years
                    
                    $
                    406
                    
                    
                    $
                    379Leasehold
                        improvements
                    Lesser
                        of term of lease to 10 years
                    
                    
                    916
                    
                    
                    
                    753Machinery
                        and equipment
                    3
                        to 8 years
                    
                    
                    2,426
                    
                    
                    
                    2,284Furniture
                        and fixtures
                    5
                        to 8 years
                    
                    
                    275
                    
                    
                    
                    240Computer
                        equipment
                    3
                        years
                    
                    
                    1,036
                    
                    
                    
                    804Construction
                        in progress
                    
                    
                    
                    1,575
                    
                    
                    
                    408Total
                        property and equipment
                    
                    
                    
                    6,634
                    
                    
                    
                    4,868Accumulated
                        depreciation
                    
                    
                    
                    (2,944
                    )
                    
                    
                    (2,362
                    )Total
                    
                    
                    $
                    3,690
                    
                    
                    $
                    2,506





Depreciation
      expense was $252,000 and $198,000 for the three months ended September 30,
      2007
      and 2006, respectively.  Depreciation expense was $734,000 and
      $576,000 for the nine months ended September 30, 2007 and 2006,
      respectively.





Capitalized
      interest is recorded on construction-in-progress using the average interest
      rate over the construction period during the nine months ended
      September 30, 2007.  Interest of $46,000 and $0 was capitalized for
      the three and nine months ended September 30, 2007 and 2006, respectively,
      and
      is included in property and equipment.




-5-





**6.  INTANGIBLE
      ASSETS**





Intangible
      assets consist of the following as of September 30, 2007 (dollars in
      thousands):





**Gross
                Carrying Amount**
            
            
            **Accumulated
                Amortization**
            
            
            **Total**Trade
                names
            
            $
            29,500
            
            
            $
            -
            
            
            $
            29,500Patents
            
            
            8,699
            
            
            
            2,272
            
            
            
            6,427Distributor
                relationships
            
            
            23,701
            
            
            
            4,641
            
            
            
            19,060Total
            
            $
            61,900
            
            
            $
            6,913
            
            
            $
            54,987




Intangible
      assets consist of the following as of December 31, 2006 (dollars in
      thousands):





**Gross
                Carrying Amount**
            
            
            **Accumulated
                Amortization**
            
            
            **Total**Trade
                names
            
            $
            29,500
            
            
            $
            -
            
            
            $
            29,500Patents
            
            
            8,699
            
            
            
            1,836
            
            
            
            6,863Distributor
                relationships
            
            
            23,701
            
            
            
            3,753
            
            
            
            19,948Total
            
            $
            61,900
            
            
            $
            5,589
            
            
            $
            56,311





Amortization
      expense was $441,000 in each of the three month periods ended September 30,
      2007
      and 2006 and $1,324,000 in each of the nine month periods ended September 30,
      2007 and 2006. Amortization of intangible assets for the remainder of 2007
      will
      be approximately $441,000 and will be approximately $1,765,000 in each of the
      next five years.





**7.  STOCKHOLDERS’
      EQUITY**





***Secondary
      Public Offering***





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




***Initial
        Public Offering***
 
 On
        November 14, 2006, the Company completed an initial public offering of shares
        of
        the Company’s common stock. In the initial public offering, the Company sold
        3,125,000 shares of common stock and the selling stockholders sold 5,500,000
        shares of common stock, which included 1,125,000 shares of common stock sold
        by
        the selling stockholders pursuant to the underwriters' over-allotment
        option.





-6-






**8.  EQUITY
      AND STOCK OPTION PLANS**





***2006
      Equity Incentive Plan***





In
      connection with the Company’s initial public offering, the Company adopted the
      Physicians Formula Holdings, Inc. 2006 Equity Incentive Plan (the “2006 Plan”).
      The 2006 Plan provides for grants of stock options, stock appreciation rights,
      restricted stock, restricted stock units, deferred stock units and other
      performance awards to directors, officers and employees of the Company, as
      well
      as others performing services for the Company. The options generally have a
      10-year life and vest in equal monthly installments over a four-year period.
      As
      of September 30, 2007, a total of 851,861 shares of the Company’s common stock
      were available for issuance under the 2006 Plan. This amount will automatically
      increase on the first day of each fiscal year ending in 2016 by the lesser
      of:
      (i) 2% of the shares of common stock outstanding on the last day of the
      immediately preceding fiscal year or (ii) such lesser number of shares as
      determined by the compensation committee of the Board of Directors. On February
      6, 2007, the Company granted 300,000 stock options to certain employees and
      on
      August 30, 2007, the Company granted 25,000 stock options to a newly elected
      director under the 2006 Plan.





***2003
      Stock Option Plan***





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





The
      equity incentive and stock option plan activity is summarized
      below:





**Time-Vesting
                Options**
            
            
            **Performance-Vesting
                Options****Weighted-Average
                Exercise Price**
            
            
            **Aggregate
                Intrinsic Value**
            
            
            
            
            
            **Weighted-Average
                Exercise Price**
            
            
            **Aggregate
                Intrinsic Value**Options
                outstanding—January 1, 2007
            
            
            652,053
            
            
            $
            0.11
            
            
            
            
            
            
            254,641
            
            
            $
            0.10Options
                granted
            
            
            325,000
            
            
            
            19.91
            
            
            $
            -
            
            
            
            -
            
            
            
            -Options
                exercised
            
            
            (134,711
            )
            
            
            0.10
            
            
            
            2,014,000
            
            
            
            (117,960
            )
            
            
            0.10
            
            
            $
            1,061,000Options
                forfeited
            
            
            (5,000
            )
            
            
            20.75
            
            
            
            -Options
                outstanding—September 30, 2007
            
            
            837,342
            
            
            $
            7.79
            
            
            $
            3,295,000
            
            
            
            136,681
            
            
            $
            0.10
            
            
            $
            1,590,000Vested
                and expected to vest-September 30, 2007
            
            
            837,342
            
            
            $
            7.79
            
            
            $
            3,295,000
            
            
            
            136,681
            
            
            $
            0.10
            
            
            $
            1,590,000





The
      fair
      value of options granted during the nine months ended September 30, 2007 totaled
      $3,277,000. The Company utilized the Black-Scholes option valuation model to
      calculate the fair value of these options using the following weighted-average
      assumptions:




**2007****August**
            
            
            **February**Risk-free
                interest rate
            
            
            4.2
            %
            
            
            4.9
            %Volatility
            
            
            47.9
            %
            
            
            52.2
            %Dividend
                rate
            
            None
            
            
            NoneLife
                in years
            
            
            5.0
            
            
            
            5.0





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




-7-


The
        vesting activity for the equity incentive and stock option plans is summarized
        below:
 
 **Time-Vesting
                  Options**
              
              **Performance-Vesting
                  Options****Weighted-Average**
              
              
              
              
              
              
              
              **Weighted-Average****Vested
                  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 Value**January
                  1, 2007
              
              
              246,108
              
              
              $
              25,000
              
              
              
              
              
              
              254,641
              
              
              $
              25,000Vesting
                  during period
              
              
              131,413
              
              
              
              912,000
              
              
              
              
              
              
              -
              
              
              
              -Options
                  exercised
              
              
              (134,711
              )
              
              
              (14,000
              )
              
              
              
              
              
              (117,960
              )
              
              
              (12,000
              )Options
                  forfeited
              
              
              (520
              )
              
              
              (11,000
              )
              
              
              
              
              
              -
              
              
              
              -September
                  30, 2007
              
              
              242,290
              
              
              $
              912,000
              
              $            
                  3.76
              7.5
                  years
              $   1,930,000
              
              
              136,681
              
              
              $
              13,000
              
              $         
                  0.10
              6.1
                  years
              $    1,590,000


As
      of
      September 30, 2007, the options outstanding under the 2003 Plan and 2006 Plan
      had exercise prices between $0.10 and $20.75 and the weighted-average remaining
      contractual life for all options was 7.3 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 Value**January
                1, 2007
            
            
            405,945
            
            
            $
            6.56Vested
            
            
            (131,413
            )
            
            
            11.33Granted
            
            
            325,000
            
            
            
            10.08Forfeited
            
            
            (4,480
            )
            
            
            10.54September
                30, 2007
            
            
            595,052
            
            
            $
            7.36





The
      total
      fair value of options that vested during the nine months ended September 30,
      2007 and 2006 was $1,489,000 and $6,000, respectively.





As
      of
      September 30, 2007, total unrecognized estimated compensation cost related
      to
      non-vested stock options was approximately $4,277,000, which is expected to
      be
      recognized over a weighted-average period of approximately 2.6 years. The
      Company recorded cash received from the exercise of stock options of $26,000
      during the nine months ended September 30, 2007. Upon option exercise, the
      Company issues new shares of stock.





The
      Company incurred $1,877,000 and $0 of pre-tax non-cash share-based compensation
      expense for the nine months ended September 30, 2007 and 2006,
      respectively.  A non-cash share-based compensation cost of $370,000
      was a component of cost of sales and $1,507,000 was a component of selling,
      general and administrative expenses in the accompanying condensed consolidated
      statement of income for the nine months ended September 30, 2007. The tax
      benefit recognized of $826,000 and $0 was recorded for the nine months ended
      September 30, 2007 and 2006, respectively.  The Company capitalized
      non-cash share-based compensation expense of $63,000 in inventory for the nine
      months ended September 30, 2007.





Excess
      tax benefits exist when the tax deduction resulting from the exercise of options
      exceeds the compensation cost recorded.  Prior to the adoption of SFAS
      No. 123R, the Company presented all such excess benefits as operating cash
      flows
      on the condensed consolidated statements of cash flows.  SFAS No. 123R
      requires the cash flows resulting from such excess tax benefits to be classified
      as financing cash flows.  Under SFAS No. 123R, the Company has
      classified excess tax benefits of $79,000 for the nine months ended September
      30, 2007 as financing cash inflows.




The
        stock
        options exercised during the three months ended September 30, 2007 resulted
        in a
        reduction in a deferred income tax asset because the share-based compensation
        cost previously recognized by the Company was greater than the deduction
        allowed
        for income tax purposes based on the price of the stock on the date of
        exercise.  This reduction in the deferred income tax asset was in
        excess of the Company's additional paid-in capital pool by $333,000. Therefore,
        there was an increase in the Company's effective income tax rate for the
        three
        and nine month periods ended September 30, 2007.




-8-


**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.
 
 ***Manufacturing—***The
        Company is party to an agreement that requires it to purchase equipment to
        automate a product assembly line for approximately $1,100,000, of which $762,000
        has been incurred as of September 30, 2007.


***Environmental—***The
      shallow soils and groundwater below our City of Industry facilities were
      contaminated by the former operator of the property. The former operator
      performed onsite cleanup and we anticipate that we will receive written
      confirmation from the State of California that no further onsite cleanup is
      necessary. Such confirmation would not rule out potential liability for regional
      groundwater contamination or alleged potable water supply contamination
      discussed below. If further onsite cleanup is required, the Company believes
      the
      cost, which the Company is not able to estimate, would be indemnified, without
      contest or material limitation, by companies that have fulfilled similar
      indemnity obligations to the Company in the past, and that the Company believes
      remain financially able to do so.





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





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





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





**10.  GEOGRAPHIC
      INFORMATION**





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





**Three
                Months Ended September 30,**
            
            
            **Nine
                Months Ended September 30,****Customer**
            
            **2007**
            
            
            **2006**
            
            
            **2007**
            
            
            **2006**United
                States
            
            $
            18,069
            
            
            $
            16,521
            
            
            $
            69,411
            
            
            $
            63,787Canada
            
            
            1,552
            
            
            
            1,451
            
            
            
            7,814
            
            
            
            4,776Other
            
            
            185
            
            
            
            121
            
            
            
            403
            
            
            
            302$
            19,807
            
            
            $
            18,093
            
            
            $
            77,628
            
            
            $
            68,865





-9-





**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, 2006.





**Overview
      of the Business**





We
      are
      one of the fastest growing cosmetics companies of the ten largest in the U.S.
      mass market channel by retail sales. We specialize in developing and marketing
      innovative, premium-priced products for the mass market channel. Our products
      focus on addressing skin imperfections through a problem-solution approach,
      rather than focusing on changing fashion trends. Our products address specific,
      everyday cosmetics needs and include face powders, bronzers, concealers,
      blushes, foundations, eye shadows, eyeliners, brow makeup and
      mascaras.





We
      sell
      our products to mass market retailers such as Wal-Mart, Target, CVS, Walgreens
      and Albertsons. Our products provide above-average profitability for retailers
      due to their higher price points and sales per linear foot. Our products are
      currently sold in approximately 26,000 of the 49,000 stores in which we estimate
      our *masstige* competitors’ products are sold. We seek to be
      first-to-market with new products within this channel, and are able to take
      new
      products from concept development to shipment in less than 12 months. New
      products are a very important part of our business and have contributed, on
      average, approximately 38% of our net sales for the last three
      years.





**Overview
      of U.S. Market Share Data**





We
      define
      the *masstige* market as products sold in the mass market channel under
      the following premium-priced brands: Physicians Formula, Almay, L’Oreal, Max
      Factor, Neutrogena, Revlon and Vital Radiance. The following table sets forth
      the approximate market share, based on retail sales, of our products in total
      and for selected categories within the *masstige* market, as we define
      it, based on ACNielsen(1)data for
      the 52
      weeks ended October 6, 2007:




**52
                        Weeks Ended October 6, 2007*****Masstige
                        ($ Share)(1)***
                    
                    **%
                        Change vs. Prior Year ($ Sales)(1)**Total
                        Company
                    7.3%
                    
                    13%Face
                    14.3%
                    
                    17%Eye
                    4.9%
                    
                    -5%





(1)ACNielsen
                is an independent research entity. ACNielsen data does not include
                Wal-Mart, which is our largest
                customer.





**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 on a plan for
      how much retail space will be allotted to each supplier and the number of new
      and existing products to be offered in their stores. We refer to these plans
      as
      "Plan-o-grams". For us, this period has historically been from
      December through April. Sales during these months are typically greater due
      to the shipments required to fill the inventory at retail stores and the
      retailers’ warehouses. Retailers typically reset their retail selling space
      during these months to accommodate changes in space allocation to each supplier
      and to incorporate the addition of new products and the deletion of slow-selling
      items. For example, our net sales for the three months ended September 30,
      2006
      were lower than our net sales for the first and fourth quarter of 2006, as
      a
      result of this seasonality. Our quarterly results of operations may also
      fluctuate as a result of a variety of other reasons including the timing of
      new
      product introductions, general economic conditions or consumer buyer behavior.
      In addition, results for any one quarter may not be indicative of results for
      the same quarter in subsequent years.




**Critical
      Accounting Policies**




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, 2006. Except for income
      taxes, there have been no material changes to these policies as of this
      Quarterly Report on Form 10-Q for the three and nine months ended
      September 30, 2007. The methodology applied to management’s estimate for
      income taxes has changed due to the implementation of a new accounting
      pronouncement as described below.


Effective
        January 1, 2007, we adopted the provisions of Financial Accounting
        Standards Board Interpretation No. (“FIN”) 48, *Accounting for
        Uncertainty in Income Taxes*. FIN 48 prescribes a more likely than not
        threshold for financial statement recognition and measurement of a tax position
        taken or expected to be taken in a tax return. Upon adoption of FIN 48 on
        January 1, 2007, we did not record any cumulative effect adjustment to retained
        earnings.





-10-




**Results
      of Operations**





The
      following table sets forth our condensed consolidated statements of income
      for
      the three and nine months ended September 30, 2007 and 2006:





**Three
                  Months Ended September 30,**
              
              
              **Nine
                  Months Ended September 30,****2007**
              
              
              **2006**
              
              
              **2007**
              
              
              **2006****(dollars
                  in thousands, except per share data)****Statement
                  of Income Data:**Net
                  sales
              
              $
              19,807
              
              
              $
              18,093
              
              
              $
              77,628
              
              
              $
              68,865Cost
                  of sales
              
              
              10,085
              
              
              
              8,449
              
              
              
              35,108
              
              
              
              29,826Gross
                  profit
              
              
              9,722
              
              
              
              9,644
              
              
              
              42,520
              
              
              
              39,039Selling,
                  general and administrative expenses
              
              
              8,902
              
              
              
              7,540
              
              
              
              34,467
              
              
              
              26,820Income
                  from operations
              
              
              820
              
              
              
              2,104
              
              
              
              8,053
              
              
              
              12,219Interest
                  expense-net
              
              
              370
              
              
              
              1,945
              
              
              
              1,086
              
              
              
              5,457Other
                  income
              
              
              (24
              )
              
              
              (32
              )
              
              
              (78
              )
              
              
              (35
              )Income
                  before income taxes
              
              
              474
              
              
              
              191
              
              
              
              7,045
              
              
              
              6,797Provisions
                  (benefit) for income taxes
              
              
              372
              
              
              
              (32
              )
              
              
              3,164
              
              
              
              2,527Net
                  income
              
              $
              102
              
              
              $
              223
              
              
              $
              3,881
              
              
              $
              4,270Net
                  income per common share:Basic
              
              $
              0.01
              
              
              $
              0.02
              
              
              $
              0.28
              
              
              $
              0.41Diluted
              
              $
              0.01
              
              
              $
              0.02
              
              
              $
              0.27
              
              
              $
              0.37Weighted-average
                  common shares outstanding:Basic
              
              
              14,011,041
              
              
              
              10,421,916
              
              
              
              13,935,389
              
              
              
              10,399,331Diluted
              
              
              14,553,130
              
              
              
              11,614,506
              
              
              
              14,566,860
              
              
              
              11,603,042





The
      following is a discussion of our results of operations for the three and nine
      months ended September 30, 2007 and 2006.




-11-


***Three
        Months Ended September 30, 2007 Compared to Three Months Ended September
        30,
        2006***





*Net
      Sales.*Net sales increased $1.7 million, or 9.4%, to $19.8
      million for the three months ended September 30, 2007, from $18.1 million for
      the three months ended September 30, 2006.  The increase was primarily
      attributable to growth in sales of our face makeup products, as we continued
      to
      broaden our total distribution. Total distribution represents the number of
      stores in which we sell products multiplied by our number of stock keeping
      units
      per store. Unit sales for our face makeup increased by 0.4 million units, or
      13.3%, to 3.4 million units for the three months ended September 30, 2007 from
      3.0 million units for the same period a year ago. New products represented
      22%
      of our net sales for the three months ended September 30, 2007, 11% lower
      than the same period a year ago, when new products contributed 33% of net sales.
      Partially offsetting our net sales growth for the three months ended September
      30, 2007 was a decrease in sales of our eye makeup products and an increase
      in
      trade spending with retailers.  Unit sales for our eye makeup
      decreased by 0.6 million units, or 35.3%, to 1.1 million units for the three
      months ended September 30, 2007 from 1.7 million units for the same period
      a
      year ago. Trade spending with retailers increased by $2.4 million, which
      includes an increase in cooperative advertising expense of $2.0 million and
      an
      increase in our provision for markdowns of $0.3 million.  The variance
      is primarily due to management's strategic decision to increase trade spending
      with retailers for in-store advertising and promotions to increase consumer
      retail sales. During the three months ended September 30, 2007, our results
      included net sales of $1.7 million from our international customers, compared
      to
      $1.6 million for the three months ended September 30, 2006.





*Cost
      of Sales.*Cost of sales increased $1.6 million, or 18.8%, to
      $10.1 million for the three months ended September 30, 2007, from $8.5 million
      for the three months ended September 30, 2006. The increase in cost of sales
      resulted primarily from a change in product mix as volume of higher
      cost products increased when compared to the same period a year ago. Cost
      of sales as a percentage of net sales was 50.9% of net sales for the three
      months ended September 30, 2007, compared to 46.7% for the three months ended
      September 30, 2006. The increase in cost of sales, as a percentage of net sales,
      was primarily due to the impact of higher trade spending with retailers in
      an
      effort to increase consumer retail sales.





*Selling,
      General and Administrative Expenses.*Selling, general and
      administrative expenses increased by $1.4 million, or 18.7%, to $8.9 million
      for
      the three months ended September 30, 2007, from $7.5 million for the three
      months ended September 30, 2006. The increase was primarily due to a $1.3
      million increase in fixed costs that included a $0.6 million expense for stock
      option awards, a $0.4 million increase in employee compensation associated
      with
      our growth, a $0.2 million increase in distribution costs related to our growth,
      as well as an increase in accounting and other expenses associated with being
      a
      public company.





*Interest
      Expense-Net.*Interest expense decreased by $1.5 million, or
      78.9%, to $0.4 million for the three months ended September 30, 2007, from
      $1.9
      million for the three months ended September 30, 2006. The decrease in interest
      expense was due to the decrease in average borrowings outstanding under our
      credit facility as we repaid all borrowings under our former senior credit
      agreement with the net proceeds of the initial public offering and borrowings
      under our senior credit agreement.





*Other
      Income.*Other income decreased by $8,000, or 25.0%, to $24,000
      for the three months ended September 30, 2007, from $32,000 for the three months
      ended September 30, 2006. Other income for the three months ended September
      30,
      2007 and 2006 was attributable to realized and unrealized gains related to
      investments held as part of our non-qualified deferred compensation
      plan.





*Provision
      (Benefit) for Income Taxes.*The income tax expense for the three
      months ended September 30, 2007 was $372,000 compared to an income tax benefit
      of $32,000 for the three months ended September 30, 2006. The effective rates
      differed from the statutory rates due to the effect of varying state and local
      taxes, the impact of the change in the deferred carrying rate and certain
      permanent items such as tax benefit deficiencies on stock options
      exercised, extra-territorial income exclusion, and research and development
      credits.




-12-




*Nine Months Ended September 30, 2007 Compared
      to
      Nine Months Ended September 30, 2006*


**


*Net
      Sales.*Net sales increased $8.7 million, or 12.6%, to $77.6
      million for the nine months ended September 30, 2007, from $68.9 million for
      the
      nine months ended September 30, 2006. The increase was primarily attributable
      to
      growth in sales of our face makeup products, as we continued to broaden our
      total distribution. Total distribution represents the number of stores in which
      we sell products multiplied by our number of stock keeping units per store.
      Total unit volume increased by 1.6 million units, or 9.2%, to 18.9 million
      units
      for the nine months ended September 30, 2007 from 17.3 million units for the
      same period a year ago. New products represented 37% of our net sales for the
      nine months ended September 30, 2007, 1% lower than the same period a year
      ago,
      when new products contributed 38% of net sales. Partially offsetting our net
      sales growth for the nine months ended September 30, 2007 was an increase in
      trade spending with retailers of $12.4 million, which includes an increase
      in
      cooperative advertising expense of $6.1 million and an increase in coupon
      expense of $0.5 million, as well as an increase in our provision for markdowns
      of $3.0 million and an increase in our provision for returns of $2.3
      million.  The variance in cooperating advertising expense and coupon
      expense is primarily due to management's strategic decision to increase trade
      spending with retailers for in-store advertising and promotions in an effort
      to
      increase consumer retail sales. The variance in our provision for markdowns
      is
      primarily due to retailers resetting their Plan-o-grams, including changing
      their wall displays during the nine months ended September 30, 2007. The
      variance in our provision for returns is due to higher returns resulting
      from our retailer customers' wall display changes. During the nine months ended
      September 30, 2007, our results included net sales of $8.2 million from our
      international customers, compared to $5.1 million for the nine months ended
      September 30, 2006.





*Cost
      of Sales.*Cost of sales increased $5.3 million, or 17.8%, to
      $35.1 million for the nine months ended September 30, 2007, from $29.8 million
      for the nine months ended September 30, 2006.  The increase in cost of
      sales resulted primarily from an increase in volume for the nine months ended
      September 30, 2007. Cost of sales as a percentage of net sales was 45.2% for
      the
      nine months ended September 30, 2007, compared to 43.3% for the nine months
      ended September 30, 2006. The increase in cost of sales, as a percentage of
      net
      sales, was primarily due to the impact of higher trade spending with
      retailers in an effort to increase consumer retail sales, including cooperative
      advertising expense and coupon expense, as well as an increase in our provision
      for markdowns.





*Selling,
      General and Administrative Expenses.*Selling, general and
      administrative expenses increased by $7.7 million, or 28.7%, to $34.5 million
      for the nine months ended September 30, 2007, from $26.8 million for the nine
      months ended September 30, 2006. The increase was primarily due to a $1.3
      million increase in marketing spending and a $5.7 million increase in fixed
      costs that included a $1.9 million increase in employee compensation associated
      with our growth, a $1.5 million expense for our stock option awards, a $0.7
      million expense for transaction fees associated with the secondary public
      offering, a $0.5 million increase in distribution costs related to our growth,
      as well as an increase in accounting and other expenses associated with
      being a public company. In addition, there were higher costs associated with
      increased sales volumes, including a $0.6 million increase in outbound freight
      costs.





*Interest
      Expense-Net.*Interest expense decreased by $4.4 million, or 80%,
      to $1.1 million for the nine months ended September 30, 2007, from $5.5 million
      for the nine months ended September 30, 2006. The decrease in interest expense
      was due to the decrease in average borrowings outstanding under our credit
      facility as we repaid all borrowings under our former senior credit agreement
      with the net proceeds of the initial public offering and borrowings under our
      senior credit agreement.





*Other
      Income.*Other income increased by $43,000 to $78,000 for the
      nine months ended September 30, 2007, from $35,000 for the nine months ended
      September 30, 2006. Other income for the nine months ended September 30, 2007
      and 2006 was attributable to realized and unrealized gains related to
      investments held as part of our non-qualified deferred compensation
      plan.





*Provision
      (Benefit) for Income Taxes.*The income tax expense for the nine
      months ended September 30, 2007 was $3.2 million, representing an effective
      income tax rate of 44.9%, compared to income tax expense of $2.5 million,
      representing an effective income tax rate of 37.2%, for the nine months ended
      September 30, 2006. The effective rates differed from the statutory rates due
      to
      the effect of varying state and
      local
      taxes, the impact of the change in the deferred carrying rate and certain
      permanent items such as tax benefit deficiencies on stock options
      exercised, extra-territorial income exclusions, research and development credits
      and certain transaction fees associated with the secondary public
      offering.





-13-




**Liquidity
      and Capital Resources**





*Cash
      Flows*





As
      of
      September 30, 2007, we had $56,000 in cash and cash equivalents compared to
      $26,000 in cash and cash equivalents as of December 31, 2006. The low level
      of
      cash reflects the use of cash to pay down the revolving credit facility on
      a
      regular basis. As of September 30, 2007, we had $13.2 million of availability
      under our revolving credit facility. The significant components of our working
      capital are accounts receivable and inventories, reduced by accounts payable
      and
      accrued expenses.





*Operating
      activities.*Cash provided by operating activities decreased $3.2
      million, or 48.5%, to $3.4 million for the nine months ended September 30,
      2007,
      from $6.6 million for the nine months ended September 30, 2006. The net decrease
      in cash provided by operating activities resulted primarily from unfavorable
      changes in working capital such as inventory, accounts payable and accrued
      expenses. The net decrease in cash provided by operating activities was offset
      by favorable changes in accounts receivable.  Inventory increased by
      $4.7 million when compared to prior year end due to lower than expected unit
      sales resulting from a softer consumer spending environment. Our inventory
      turnover rate decreased slightly to an annualized 1.9 times per year for the
      nine months ended September 30, 2007, from an annualized 2.1 times per year
      for
      the nine months ended September 30, 2006. Days sales outstanding decreased
      by 1
      day, to 45.9 days for the nine months ended September 30, 2007 from 46.9 days
      for the nine months ended September 30, 2006.





*Investing
      activities.*Cash used in investing activities for the nine
      months ended September 30, 2007 was $1.6 million, which was related to capital
      expenditures for the replacement of machinery and equipment, the automation
      of
      an assembly line to accommodate future growth and improvements to our warehouse
      distribution systems. Cash used in investing activities for the nine months
      ended September 30, 2006 of $528,000 was related to capital expenditures for
      the
      replacement and upgrade of machinery and equipment.





*Financing
      activities.*Cash used in financing activities was $1.8 million
      for the nine months ended September 30, 2007 compared to cash used in financing
      activities of $6.1 million for the nine months ended September 30, 2006. The
      decrease in cash used in financing activities between periods primarily resulted
      from lower debt service related to our long-term debt, as well as prior
      year repayments of our revolving credit facility.





*Future
      Liquidity and Capital Needs.*The significant components of our
      working capital are accounts receivable and inventory, reduced by accounts
      payable and accrued expenses. Net working capital requirements increased by
      $13.2 million, or approximately 132%, to $23.2 million in the nine months ended
      September 30, 2007, from $10.0 million in the nine months ended September 30,
      2006. We anticipate that working capital will increase during the fourth quarter
      of 2007, 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 $2.5 million for 2007, compared to $1.0 million
      in 2006, for several key projects, including completion of our automated
      assembly line, investment in our information technology infrastructure and
      improvements to our warehouse distribution systems. Capital requirements related
      to manufacturing include a major project to automate a product assembly line
      that is used to assemble products representing approximately 44% of our net
      sales in 2006. We expect this to add approximately $800,000 of a $1.1 million
      project to our normal level of capital expenditures in 2007, of which $300,000
      was incurred in 2006 and $462,000 was incurred during the nine months ended
      September 30, 2007. We have completed the replacement of our IBM AS/400
      mainframe computer to accommodate future growth at a cost of approximately
      $0.3
      million. Further, we are implementing improvements to our warehouse distribution
      systems at a cost of approximately $0.5 million we expect to incur during the
      fourth quarter of 2007. We believe that our cash flows from operations and
      funds
      from our revolving credit facility will provide adequate funds for our working
      capital needs and planned capital expenditures for at least the next twelve
      months. No assurance can be given, however, that this will be the
      case.





-14-




*Credit
      Facilities*





On
      November 14, 2006, we entered into a senior credit agreement with a bank that
      will terminate in 2011 and consists of a $15.0 million term loan facility and
      a
      revolving credit facility providing for borrowings of up to $20.0 million.
      At
      September 30, 2007, there was $6.8 million outstanding under the revolving
      credit facility at an interest rate of 8.25% and we had $13.2 million of
      availability under the revolving credit facility. The interest rate on the
      term
      loan was 7.5% at September 30, 2007. The availability under the revolving credit
      facility is reduced by outstanding letters of credit. There were no outstanding
      letters of credit as of September 30, 2007.





We
      used
      the borrowings under our senior credit agreement and a portion of the net
      proceeds of our initial public offering to repay borrowings and accrued interest
      under our former senior credit agreement. Borrowings under our senior credit
      agreement are guaranteed by Physicians Formula Holdings, Inc. and the domestic
      subsidiaries of Physicians Formula, Inc., and borrowings under our senior credit
      agreement are secured by liens on substantially all of the assets of Physicians
      Formula, Inc., including the assets of its subsidiaries. Amounts outstanding
      under the term loan facility totaled $13.9 million at September 30,
      2007. Payments under the term loan facility are due quarterly, increasing
      from initial quarterly payments of $375,000 to $562,500 as of
      December 31, 2007, $750,000 as of December 31, 2008, $937,500 as of December
      31,
      2009 and $1,125,000 as of December 31, 2010. Quarterly payments of $375,000
      were made on January 1, 2007, April 2, 2007, July 16, 2007
      and October 2, 2007.





Amounts
      outstanding under the term loan facility and the revolving credit facility
      bear
      interest at a LIBOR Adjusted Rate (as defined in our senior credit agreement)
      plus 2.0% or at a Base Rate (as defined in our senior credit agreement) plus
      0.5%. The revolving credit facility is also subject to a commitment fee of
      0.25%
      on any unused commitments.





Our
      senior credit agreement contains the following financial covenants: a maximum
      total leverage ratio; a minimum fixed charge coverage ratio; a minimum net
      worth
      requirement; and a limitation on capital expenditures (which may be no more
      than
      $3,000,000 per fiscal year). As of September 30, 2007, we were in compliance
      with these covenants.





Our
      senior credit agreement contains certain additional negative covenants,
      including limitations on the ability of Physicians Formula, Inc., our operating
      subsidiary, to incur other indebtedness and liens; fundamentally change its
      business through a merger, consolidation, amalgamation or liquidation; sell
      assets; pay cash dividends or pay for expenses of Physicians Formula Holdings,
      Inc., unless certain conditions are satisfied; make certain acquisitions,
      investments, loans and advances; engage in transactions with our affiliates;
      enter into certain agreements; engage in sale-leaseback transactions; incur
      certain unfunded liabilities; and change our line of business.





Our
      senior credit agreement requires us to make mandatory prepayments with the
      proceeds of certain asset dispositions and upon the receipt of insurance or
      condemnation proceeds to the extent we do not use the proceeds for the purchase
      of satisfactory replacement assets.





**Off-Balance
      Sheet Transactions**





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





-15-


**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, 2006. 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. Further, a decrease in
      the
      value of the euro and the Chinese yuan relative to the U.S. dollar could cause
      our suppliers to raise prices that would result in higher cost of sales. The
      volatility of the applicable rates and prices are dependent on many factors
      that
      cannot be forecasted with reliable accuracy. Our current sales to Canadian
      customers and reliance on foreign suppliers for many of the raw materials and
      components used to produce products make it possible that our operating results
      may be affected by fluctuations in the exchange rate of the currencies
      of our customers and suppliers. We do not have any foreign currency
      hedges.





(b)  *Interest
      Rate Risk.*





We
      are
      exposed to interest rate risks primarily through borrowings under our revolving
      loan and term loan facilities. Interest on these borrowings is based upon
      variable interest rates. Our weighted-average borrowings outstanding
      under our revolving loan and term loan facilities during the nine
      months ended September 30, 2007, was $18.2 million and the weighted-average
      interest rate in effect at September 30, 2007, was 7.75%. A hypothetical 1%
      increase or decrease in interest rates would have resulted in an $137,000 change
      to interest expense for the nine months ended September 30, 2007.





**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.





-16-




**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,
      2006.





**ITEM
      6.  EXHIBITS**





**Exhibit**
              **Number**
            
            
            
            **Description**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.





**SIGNATURES**





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





Physicians
                Formula Holdings, Inc./s/
                Ingrid JackelDate:
                November 12, 2007
            
            By:
                Ingrid JackelIts:   *Chief
                Executive Officer*
              *(principal executive officer)*/s/
                Joseph J. JaegerDate:
                November 12, 2007
            
            By:
                Joseph J. JaegerIts:   *Chief
                Financial Officer*
              *(principal financial officer)*








-17-