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 June
30, 2008





OR





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





For the transition period
from            to            .





COMMISSION FILE NUMBER:
001-33142





Physicians Formula Holdings,
Inc.





(Exact
name of registrant as specified in its charter)





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





(626) 334-3395





(Registrant’s
telephone number, including area code)





N/A





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





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





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




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





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





The
number of shares outstanding of the registrant’s common stock, par value $.01
per share, as of August 8, 2008, was 14,096,227.















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 4.
            
            Submission of Matters to a Vote of Security
      Holders
            
            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)




June
      30,
                      
                      
                      December
      31,2008
                      
                      
                      2007ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
                      
                      $
                      3,499
                      
                      
                      $
                      -Accounts
      receivable, net of allowance for bad debts of $261 and
$436
                      
                      
                      20,021
                      
                      
                      
                      33,421Inventories
                      
                      
                      29,501
                      
                      
                      
                      31,648Prepaid
      expenses and other current assets
                      
                      
                      1,899
                      
                      
                      
                      1,781Income
      tax receivables
                      
                      
                      899
                      
                      
                      
                      -Deferred
      income taxes—net
                      
                      
                      6,108
                      
                      
                      
                      7,364Total
      current assets
                      
                      
                      61,927
                      
                      
                      
                      74,214PROPERTY
      AND EQUIPMENT—Net
                      
                      
                      4,110
                      
                      
                      
                      4,070OTHER
      ASSETS—Net
                      
                      
                      1,113
                      
                      
                      
                      1,174INTANGIBLE
      ASSETS—Net
                      
                      
                      53,664
                      
                      
                      
                      54,546GOODWILL
                      
                      
                      17,463
                      
                      
                      
                      17,463TOTAL
                      
                      $
                      138,277
                      
                      
                      $
                      151,467LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIES:Accounts
      payable
                      
                      $
                      11,563
                      
                      
                      $
                      13,043Accrued
      expenses
                      
                      
                      1,681
                      
                      
                      
                      2,134Trade
      allowances
                      
                      
                      6,620
                      
                      
                      
                      5,001Sales
      returns reserve
                      
                      
                      9,256
                      
                      
                      
                      10,396Current
      portion of long-term debt
                      
                      
                      2,813
                      
                      
                      
                      3,000Income
      taxes payable
                      
                      
                      -
                      
                      
                      
                      3,125Line
      of credit borrowings
                      
                      
                      -
                      
                      
                      
                      10,168Total
      current liabilities
                      
                      
                      31,933
                      
                      
                      
                      46,867DEFERRED
      COMPENSATION
                      
                      
                      794
                      
                      
                      
                      829DEFERRED
      INCOME TAXES—Net
                      
                      
                      19,790
                      
                      
                      
                      20,821LONG-TERM
      DEBT
                      
                      
                      9,000
                      
                      
                      
                      10,500COMMITMENTS
      AND CONTINGENCIES (NOTE 8)STOCKHOLDERS'
      EQUITY:Series A
      preferred stock, $.01 par value—10,000,000 shares authorized, no
      shares issued and outstanding at June 30, 2008 and December 31,
      2007
                      
                      
                      -
                      
                      
                      
                      -Common
      stock, $.01 par value—50,000,000 shares authorized, 14,096,227 and
      14,095,727 shares issued and outstanding at June 30, 2008 and
      December 31, 2007, respectively
                      
                      
                      141
                      
                      
                      
                      141Additional
      paid-in capital
                      
                      
                      60,447
                      
                      
                      
                      59,173Retained
      earnings
                      
                      
                      16,172
                      
                      
                      
                      13,136Total
      stockholders' equity
                      
                      
                      76,760
                      
                      
                      
                      72,450TOTAL
                      
                      $
                      138,277
                      
                      
                      $
                      151,467




See notes
to condensed consolidated financial statements.





-1-





PHYSICIANS FORMULA HOLDINGS,
INC.


CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS


(unaudited)


(dollars in thousands, except per
share data)




Three
      Months Ended June 30,
                    
                    
                    Six
      Months Ended June 30,2008
                    
                    
                    2007
                    
                    
                    2008
                    
                    
                    2007NET
      SALES
                    
                    $
                    22,876
                    
                    
                    $
                    22,102
                    
                    
                    $
                    65,537
                    
                    
                    $
                    57,825COST
      OF SALES
                    
                    
                    12,320
                    
                    
                    
                    9,920
                    
                    
                    
                    31,265
                    
                    
                    
                    25,023GROSS
      PROFIT
                    
                    
                    10,556
                    
                    
                    
                    12,182
                    
                    
                    
                    34,272
                    
                    
                    
                    32,802SELLING,
      GENERAL AND ADMINISTRATIVE EXPENSES
                    
                    
                    13,625
                    
                    
                    
                    12,458
                    
                    
                    
                    28,502
                    
                    
                    
                    25,567(LOSS)
      INCOME FROM OPERATIONS
                    
                    
                    (3,069
                    )
                    
                    
                    (276
                    )
                    
                    
                    5,770
                    
                    
                    
                    7,235INTEREST
      EXPENSE-NET
                    
                    
                    225
                    
                    
                    
                    312
                    
                    
                    
                    583
                    
                    
                    
                    716OTHER
      EXPENSE (INCOME)
                    
                    
                    19
                    
                    
                    
                    (49
                    )
                    
                    
                    106
                    
                    
                    
                    (54
                    )(LOSS)
      INCOME BEFORE INCOME TAXES
                    
                    
                    (3,313
                    )
                    
                    
                    (539
                    )
                    
                    
                    5,081
                    
                    
                    
                    6,573(BENEFIT)
      PROVISION FOR INCOME TAXES
                    
                    
                    (1,330
                    )
                    
                    
                    (16
                    )
                    
                    
                    2,045
                    
                    
                    
                    2,794NET
      (LOSS) INCOME
                    
                    $
                    (1,983
                    )
                    
                    $
                    (523
                    )
                    
                    $
                    3,036
                    
                    
                    $
                    3,779NET
      (LOSS) INCOME PER COMMON SHARE:Basic
                    
                    $
                    (0.14
                    )
                    
                    $
                    (0.04
                    )
                    
                    $
                    0.22
                    
                    
                    $
                    0.27Diluted
                    
                    $
                    (0.14
                    )
                    
                    $
                    (0.04
                    )
                    
                    $
                    0.21
                    
                    
                    $
                    0.26WEIGHTED-AVERAGE
      COMMON SHARES OUTSTANDING:Basic
                    
                    
                    14,096,227
                    
                    
                    
                    13,927,055
                    
                    
                    
                    14,096,015
                    
                    
                    
                    13,896,890Diluted
                    
                    
                    14,096,227
                    
                    
                    
                    13,927,055
                    
                    
                    
                    14,599,127
                    
                    
                    
                    14,549,682


See notes
to condensed consolidated financial statements.





-2-





PHYSICIANS FORMULA HOLDINGS,
INC.


CONDENSED CONSOLIDATED STATEMENTS OF
CASH FLOWS


(unaudited)


(dollars in
thousands)




Six
      Months Ended June 30,2008
                    
                    
                    2007CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
                    
                    $
                    3,036
                    
                    
                    $
                    3,779Adjustments to reconcile net income to net cash provided by operating
      activities:Depreciation
      and amortization
                    
                    
                    1,441
                    
                    
                    
                    1,364Exchange
      rate loss
                    
                    
                    101
                    
                    
                    
                    -Deferred
      income taxes
                    
                    
                    225
                    
                    
                    
                    (482
                    )Provision
      for bad debts
                    
                    
                    (175
                    )
                    
                    
                    36Amortization
      of debt issuance costs
                    
                    
                    18
                    
                    
                    
                    19Recognition
      of stock-based compensation
                    
                    
                    1,219
                    
                    
                    
                    992Tax
      benefit on exercise of options
                    
                    
                    (2
                    )
                    
                    
                    -Changes
      in operating assets and liabilities:Accounts
      receivable
                    
                    
                    13,474
                    
                    
                    
                    10,009Inventories
                    
                    
                    2,202
                    
                    
                    
                    (3,998
                    )Prepaid
      expenses and other current assets
                    
                    
                    (118
                    )
                    
                    
                    490Other
      assets
                    
                    
                    8
                    
                    
                    
                    (93
                    )Accounts
      payable
                    
                    
                    (1,461
                    )
                    
                    
                    (2,684
                    )Accrued
      expenses, trade allowances and sales returns reserve
                    
                    
                    27
                    
                    
                    
                    (1,388
                    )Income
      taxes payable/receivable
                    
                    
                    (4,024
                    )
                    
                    
                    (1,945
                    )Net
      cash provided by operating activities
                    
                    
                    15,971
                    
                    
                    
                    6,099CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of property and equipment
                    
                    
                    (619
                    )
                    
                    
                    (679
                    )CASH
      FLOWS FROM FINANCING ACTIVITIES:Paydowns
      of term loans
                    
                    
                    (1,687
                    )
                    
                    
                    (750
                    )Net
      paydowns under line of credit
                    
                    
                    (10,168
                    )
                    
                    
                    (4,578
                    )Debt
      issuance costs
                    
                    
                    -
                    
                    
                    
                    (45
                    )Exercise
      of stock options
                    
                    
                    2
                    
                    
                    
                    8Net
      cash used in financing activities
                    
                    
                    (11,853
                    )
                    
                    
                    (5,365
                    )NET
      INCREASE IN CASH AND CASH EQUIVALENTS
                    
                    
                    3,499
                    
                    
                    
                    55CASH
      AND CASH EQUIVALENTS—Beginning of period
                    
                    
                    -
                    
                    
                    
                    26CASH
      AND CASH EQUIVALENTS—End of period
                    
                    $
                    3,499
                    
                    
                    $
                    81SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION—Cash paid during the period
      for:Interest,
      net of amounts capitalized
                    
                    $
                    615
                    
                    
                    $
                    716Income
      taxes
                    
                    $
                    5,843
                    
                    
                    $
                    5,221SUPPLEMENTAL
      DISCLOSURE OF NON-CASH INVESTING ACTIVITIES - The Company had accounts
      payable of $120 and $23 outstanding as of June 30, 2008 and 2007,
      respectively, 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,’’ ‘‘we’’ or ‘‘our’’), 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
Kroger.





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





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





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




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


-4-




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




3.  NET
(LOSS) INCOME PER SHARE





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





Three
      Months Ended June 30,
                
                
                Six
      Months Ended June 30,2008
                
                
                2007
                
                
                2008
                
                
                2007Weighted-average
      number of common shares—basic
                
                
                14,096,227
                
                
                
                13,927,055
                
                
                
                14,096,015
                
                
                
                13,896,890Effect
      of dilutive employee stock options
                
                
                -
                
                
                
                -
                
                
                
                503,112
                
                
                
                652,792Weighted-average
      number of common shares—diluted
                
                
                14,096,227
                
                
                
                13,927,055
                
                
                
                14,599,127
                
                
                
                14,549,682





Stock options
for the purchase of 1,315,523 and 1,122,695 shares of common stock were
excluded from the above calculation during the three months ended June 30,
2008 and 2007, respectively, as the effect of those options was
anti-dilutive. Stock options for the purchase of 662,000
and 300,000 shares of common stock were excluded from the above calculation
during the six months ended June 30, 2008 and 2007, respectively, as the effect
of those options was anti-dilutive.





4.  INVENTORIES





Inventories
consisted of the following (dollars in thousands):





June
      30,
                  
                  
                  December
      31,2008
                  
                  
                  2007Raw
      materials and components
                  
                  $
                  13,737
                  
                  
                  $
                  17,307Finished
      goods
                  
                  
                  15,764
                  
                  
                  
                  14,341Total
                  
                  $
                  29,501
                  
                  
                  $
                  31,648





-5-




5.  PROPERTY AND
EQUIPMENT
 
 Property
and equipment consisted of the following (dollars in thousands):
 
 June
      30,
                          
                          
                          December
      31,Useful
      Lives
                          
                          2008
                          
                          
                          2007Tooling
                          3
      to 5 years
                          
                          $
                          509
                          
                          
                          $
                          479Leasehold
      improvements
                          Term
      of lease to 5 years
                          
                          
                          1,062
                          
                          
                          
                          1,054Machinery
      and equipment
                          3
      to 8 years
                          
                          
                          2,602
                          
                          
                          
                          2,493Furniture
      and fixtures
                          5
      to 8 years
                          
                          
                          334
                          
                          
                          
                          330Computer
      equipment
                          3
      years
                          
                          
                          1,961
                          
                          
                          
                          1,840Construction
      in progress
                          
                          
                          
                          1,400
                          
                          
                          
                          1,073Total
      property and equipment
                          
                          
                          
                          7,868
                          
                          
                          
                          7,269Accumulated
      depreciation
                          
                          
                          
                          (3,758
                          )
                          
                          
                          (3,199
                          )Total
                          
                          
                          $
                          4,110
                          
                          
                          $
                          4,070
 
 Depreciation
expense was $288,000 and $253,000 for the three months ended June 30, 2008
and 2007, respectively. Depreciation expense was $559,000 and $482,000 for
the six months ended June 30, 2008 and 2007,
respectively.
 
 Capitalized
interest is recorded on construction-in-progress using the average interest
rate over the construction period. Capitalized interest for the three
and six months ended June 30, 2008 and 2007 was not significant. Additionally,
the Company completed its annual impairment test of goodwill and
indefinite-lived intangible assets as of June 30, 2008 and did not record any
impairment charges as a result of this annual process.


6.  INTANGIBLE
ASSETS





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





Gross
      Carrying Amount
                    
                    
                    Accumulated
      Amortization
                    
                    
                    TotalTrade
      names
                    
                    $
                    29,500
                    
                    
                    $
                    -
                    
                    
                    $
                    29,500Patents
                    
                    
                    8,699
                    
                    
                    
                    2,706
                    
                    
                    
                    5,993Distributor
      relationships
                    
                    
                    23,701
                    
                    
                    
                    5,530
                    
                    
                    
                    18,171Total
                    
                    $
                    61,900
                    
                    
                    $
                    8,236
                    
                    
                    $
                    53,664




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





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





Amortization
expense was $441,000 in each of the three month periods ended June 30, 2008 and
2007 and $882,000 in each of the six month periods ended June 30, 2008 and 2007.
Amortization of intangible assets for the remainder of 2008 will be
approximately $883,000 and will be approximately $1,765,000 in each of the next
five years.




-6-






7.  EQUITY AND STOCK OPTION
PLANS





2006 Equity Incentive
Plan





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





2003 Stock Option
Plan





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





The 2006
Plan and 2003 Plan activity is summarized below:





Time-Vesting
      Options
                
                
                Performance-Vesting
      OptionsWeighted-Average
      Exercise Price
                
                
                Aggregate
      Intrinsic Value
                
                
                
                
                
                Weighted-Average
      Exercise Price
                
                
                Aggregate
      Intrinsic ValueOptions
      outstanding—January 1, 2008
                
                
                862,342
                
                
                $
                7.80
                
                
                
                
                
                
                136,681
                
                
                $
                0.10Options
      granted
                
                
                317,000
                
                
                
                9.54
                
                
                
                
                
                
                -
                
                
                
                -Options
      exercised
                
                
                (500
                )
                
                
                0.25
                
                
                $
                4,000
                
                
                
                -
                
                
                
                -Options
      outstanding—June 30, 2008
                
                
                1,178,842
                
                
                $
                8.27
                
                
                $
                1,273,000
                
                
                
                136,681
                
                
                $
                0.10
                
                
                $
                1,264,000Vested
      and expected to vest—June 30, 2008
                
                
                1,178,842
                
                
                $
                8.27
                
                
                $
                1,273,000
                
                
                
                136,681
                
                
                $
                0.10
                
                
                $
                1,264,000





The fair
value of options granted during the six months ended June 30, 2008 and
2007 totaled $1.6 million and $3.2 million, respectively. The Company
utilized the Black-Scholes option valuation model to calculate the fair value of
these options using the following assumptions:




Six
      Months Ended June 30,2008
                
                
                2007Risk-free
      interest rate
                
                
                3.3
                %
                
                
                4.9
                %Volatility
                
                
                50.7
                %
                
                
                52.2
                %Dividend
      rate
                
                None
                
                
                NoneLife
      in years
                
                
                6.5
                
                
                
                5.0





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




-7-


The
vesting activity for the 2006 Plan and 2003 Plan is summarized
below:
 
 Time-Vesting
      Options
                
                Performance-Vesting
      OptionsWeighted-Average
                
                
                
                
                
                
                Weighted-AverageVested
      and Exercisable
                
                Aggregate
      Exercise Price
                
                Exercise
      Price
                
                Remaining
      Contractual Life
                
                Aggregate
      Intrinsic Value
                
                Vested
      and Exercisable
                
                Aggregate
      Exercise Price
                
                Exercise
      Price
                
                Remaining
      Contractual Life
                
                Aggregate
      Intrinsic ValueJanuary
      1, 2008
                475,572
                
                $
      1,393,000
                
                
                
                
                
                
                
                136,681
                
                $   14,000Vesting
      during period
                150,838
                
                1,224,000
                
                
                
                
                
                
                
                -
                
                -Options
      exercised
                (500)
                
                -
                
                
                
                
                
                
                
                -
                
                -June
      30, 2008
                625,910
                
                $
      2,617,000
                
                $   4.18
                
                7.5
      years
                
                $3,236,000
                
                136,681
                
                $   14,000
                
                $   0.10
                
                5.3
      years
                
                $
      1,264,000




As
of June 30, 2008, the options outstanding under the 2003 Plan and 2006
Plan had exercise prices between $0.10 and $20.75 and the weighted-average
remaining contractual life for all options was 7.3 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 ValueJanuary
      1, 2008
                    
                    
                    386,770
                    
                    
                    $
                    10.24Vested
                    
                    
                    (150,838
                    )
                    
                    
                    8.70Granted
                    
                    
                    317,000
                    
                    
                    
                    5.13June
      30, 2008
                    
                    
                    552,932
                    
                    
                    $
                    7.73





The total
fair value of options that vested during the six months ended June 30, 2008
and 2007 was $1.3 million and $1.0 million, respectively.





As of
June 30, 2008, total unrecognized estimated compensation cost related to
non-vested stock options was approximately $4.2 million, which is expected to be
recognized over a weighted-average period of approximately 2.7 years. The
Company recorded cash received from the exercise of stock options of $125 during
the six months ended June 30, 2008. Upon option exercise, the Company
issues new shares of stock.





The
Company incurred $1.3 million of pre-tax non-cash share-based compensation
expense for each of the six
month periods ended June 30, 2008 and 2007.  Non-cash share-based
compensation cost of $55,000 was a component of cost of sales and $1.2
million was a component of selling, general and administrative
expenses in the accompanying condensed consolidated statement of operations for
the six months ended June 30, 2008. Non-cash share-based compensation cost
of $349,000 was a component of cost of sales and $1.0 million was a
component of selling, general and administrative expenses in the
accompanying condensed consolidated statement of operations for
the six months ended June 30, 2007. The tax benefit recognized of $554,000
and $573,000 was recorded for the six months ended June 30, 2008 and 2007,
respectively.  The Company capitalized non-cash share-based
compensation expense of $58,000 and $40,000 in inventory for the six
months ended June 30, 2008 and 2007, respectively.





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







-8-


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





The
facility is located within an area of regional groundwater contamination known
as the Puente Valley “operable unit” (“PVOU”) of the San Gabriel Valley
Superfund Site. The Company, along with many others, was named a potentially
responsible party (“PRP”) for the regional contamination by the United States
Environmental Protection Agency (“EPA”). The Company entered into a settlement
with another PRP at the site, pursuant to which, in return for a payment the
Company has already made and that was fully indemnified and paid by a second
company, the other PRP indemnified the Company against most claims for PVOU
contamination. The Company 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 the Company 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
that the indemnifying private company is financially able to pay the liability.
Because the Company believes it is not probable that it will be held liable for
any of these expenses, the Company has not recorded a liability for such
potential claims for alleged contamination of the area’s potable water
supply.





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.





9.  GEOGRAPHIC
INFORMATION





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





Three
      Months Ended June 30,
                  
                  
                  Six
      Months Ended June 30,Customer
                  
                  2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007United
      States
                  
                  $
                  20,498
                  
                  
                  $
                  20,143
                  
                  
                  $
                  56,182
                  
                  
                  $
                  51,318Canada
                  
                  
                  2,228
                  
                  
                  
                  1,872
                  
                  
                  
                  9,042
                  
                  
                  
                  6,294Other
                  
                  
                  150
                  
                  
                  
                  87
                  
                  
                  
                  313
                  
                  
                  
                  213$
                  22,876
                  
                  
                  $
                  22,102
                  
                  
                  $
                  65,537
                  
                  
                  $
                  57,825




10.  SUBSEQUENT
EVENT
 
 On July
8, 2008, the Company entered into an amendment to the Company's senior
credit agreement, which reduced the applicable interest rates on borrowings
under the term loan and revolving credit facilities by 0.25% and no other terms
of the senior credit agreement were modified as a result of the
amendment.


-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, 2007.





Overview of the
Business





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





We sell
our products to mass market retailers such as Wal-Mart, Target, CVS, Walgreens
and Kroger. Our products provide above-average profitability for retailers due
to their higher price points and sales per linear foot. Our products are
currently sold in approximately 27,000 of the 49,000 stores in which we estimate
our masstige
competitors’ products are sold. We seek to be first-to-market with new products
within this channel, and are able to take new products from concept development
to shipment in less than 12 months. New products, which are primarily
introduced during the first and fourth quarters, are a very important
part of our business and have contributed, on average, approximately 45.2% of
our net sales for the last three years.





Overview of U.S. Market Share
Data





Based on
retail sales data provided by ACNielsen, our approximate share of the masstige market, as we define
it, was 8.1% for the 52 weeks ended July 12, 2008, or a gain of 8.0%
when compared to 7.5% for the same period in the prior year. We define the masstige market as products
sold in the mass market channel under the following premium-priced brands:
Physicians Formula, Almay, L’Oreal, Max Factor, Neutrogena, Revlon and Vital
Radiance. AC Nielsen is an independent research entity and its data does not
include retail sales from Wal-Mart and Canada.




Seasonality





Our business,
similar to others in the cosmetic industry, is subject to seasonal variation due
to the annual “sell-in” period when retailers decide how much retail space will
be allotted to each supplier and the number of new and existing products to be
offered in their stores. For us, this period has historically been from
December through April. Sales during these months are typically greater due
to the shipments required to fill the inventory at retail stores and retailers’
warehouses. Retailers typically reset their retail selling space during these
months to accommodate changes in space allocation to each supplier and to
incorporate the addition of new products and the removal of slow-selling
items. For example, our net sales for the three months ended June 30, 2008
were lower than our net sales for the first quarter of 2008
and fourth quarter of 2007, as a result
of this seasonality. Our quarterly results of operations may also fluctuate as a
result of a variety of other reasons including the timing of new product
introductions, general economic conditions or consumer 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, 2007. There have been
no material changes to these policies as of this Quarterly Report on
Form 10-Q for the three and six months ended June 30,
2008.





-10-




Results of
Operations





The
following table sets forth our condensed consolidated statements
of operations for the three and six months ended June 30 , 2008
and 2007:





Three
      Months Ended June 30,
                      
                      
                      Six
      Months Ended June 30,2008
                      
                      
                      2007
                      
                      
                      2008
                      
                      
                      2007(dollars
      in thousands, except per share data)Statement
      of Operations Data:Net
      sales
                      
                      $
                      22,876
                      
                      
                      $
                      22,102
                      
                      
                      $
                      65,537
                      
                      
                      $
                      57,825Cost
      of sales
                      
                      
                      12,320
                      
                      
                      
                      9,920
                      
                      
                      
                      31,265
                      
                      
                      
                      25,023Gross
      profit
                      
                      
                      10,556
                      
                      
                      
                      12,182
                      
                      
                      
                      34,272
                      
                      
                      
                      32,802Selling,
      general and administrative expenses
                      
                      
                      13,625
                      
                      
                      
                      12,458
                      
                      
                      
                      28,502
                      
                      
                      
                      25,567(Loss)
      income from operations
                      
                      
                      (3,069
                      )
                      
                      
                      (276
                      )
                      
                      
                      5,770
                      
                      
                      
                      7,235Interest
      expense-net
                      
                      
                      225
                      
                      
                      
                      312
                      
                      
                      
                      583
                      
                      
                      
                      716Other
      expense (income)
                      
                      
                      19
                      
                      
                      
                      (49
                      )
                      
                      
                      106
                      
                      
                      
                      (54
                      )(Loss)
      income before income taxes
                      
                      
                      (3,313
                      )
                      
                      
                      (539
                      )
                      
                      
                      5,081
                      
                      
                      
                      6,573(Benefit)
      provision for income taxes
                      
                      
                      (1,330
                      )
                      
                      
                      (16
                      )
                      
                      
                      2,045
                      
                      
                      
                      2,794Net
      (loss) income
                      
                      $
                      (1,983
                      )
                      
                      $
                      (523
                      )
                      
                      $
                      3,036
                      
                      
                      $
                      3,779Net
      (loss) income per common share:Basic
                      
                      $
                      (0.14
                      )
                      
                      $
                      (0.04
                      )
                      
                      $
                      0.22
                      
                      
                      $
                      0.27Diluted
                      
                      $
                      (0.14
                      )
                      
                      $
                      (0.04
                      )
                      
                      $
                      0.21
                      
                      
                      $
                      0.26Weighted-average
      common shares outstanding:Basic
                      
                      
                      14,096,227
                      
                      
                      
                      13,927,055
                      
                      
                      
                      14,096,015
                      
                      
                      
                      13,896,890Diluted
                      
                      
                      14,096,227
                      
                      
                      
                      13,927,055
                      
                      
                      
                      14,599,127
                      
                      
                      
                      14,549,682





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




-11-


Three Months Ended June 30, 2008
Compared to Three Months Ended June 30, 2007





Net Sales.Net
sales increased $0.8 million, or 3.6%, to $22.9 million for the three months
ended June 30, 2008, from $22.1 million for the three months ended June 30,
2007.  The increase was primarily attributable to growth in sales of
our face makeup products due to new products as well as higher promotional
programs related to our new products, as we continued to broaden our total
distribution. Total distribution represents the number of stores in which we
sell products multiplied by our number of stock keeping units per store. Unit
sales for our face makeup increased by 0.3 million units, or
7.7%, to 4.2 million units for the three months ended June 30, 2008,
from 3.9 million units for the same period a year ago. New
products, which are primarily introduced during the first and fourth
quarters, represented 37% of our net sales for the three months ended June
30, 2008, 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
three months ended June 30, 2008, was a decrease in sales of our eye makeup
products and higher returns from our retailers.  Unit sales
for our eye makeup decreased by 0.1 million units, or 6.6%, to 1.4
million units for the three months ended June 30, 2008, from 1.5 million
units for the same period a year ago. Our provision for returns increased
by $5.3 million, or 165.6%, to $8.5 million for the three months ended June
30, 2008, from $3.2 million for the three months ended June 30, 2007 due
primarily to lower than anticipated retail sell-through on higher-priced
promotional kits. During the three months ended June 30, 2008, our
results included net sales of $2.4 million from our international customers,
compared to $2.0 million for the three months ended June 30, 2007.





Cost of
Sales.Cost of sales increased $2.4 million, or 24.2%, to
$12.3 million for the three months ended June 30, 2008, from $9.9 million
for the three months ended June 30, 2007. The increase in cost of sales resulted
primarily from an increase in product cost of $2.8 million due to an increase in
face makeup units sold and 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 53.9% of net sales for the three months
ended June 30, 2008, compared to 44.9% for the three months ended June 30, 2007.
The increase in cost of sales, as a percentage of net sales, was primarily due
to an increase in product costs and an increase in our provision for
returns from retailers for the three months ended June 30, 2008.





Selling, General and Administrative
Expenses.Selling, general and administrative expenses
increased $1.1 million, or 8 .8%, to
$13.6 million for the three months ended June 30, 2008, from $12.5 million for
the three months ended June 30, 2007. The increase was primarily due to a $0.8
million increase in marketing spending, a $0.8 million increase in
freight and warehouse costs and a $0.1 million increase in realized and
unrealized foreign currency exchange losses.  The variance was offset by a
$0.2 million decrease in bad debts expense, a $0.2 million decrease in legal
expense and a $0.2 million decrease in corporate administration
expense.





Interest
Expense-Net.Interest expense-net decreased $0.1 million, or
33.3%, to $0.2 million for the three months ended June 30, 2008, from $0.3
million for the three months ended June 30, 2007. The slight decrease in
interest expense was due to the decrease in average borrowings outstanding under
our credit facility and the associated interest rate.





Other Expense
(Income).Other expense for the three months
ended June 30, 2008 was $19,000 compared to other income
of $49,000 for the three months ended June 30, 2007. Other expense for
the three months ended June 30, 2008 and other income for the three months ended
June 30, 2007 were attributable to realized and unrealized gains and losses
related to investments held as part of our non-qualified deferred compensation
plan.





(Benefit) Provision for Income
Taxes.The (benefit) provision for income taxes represents
federal, state and local income taxes.  For the three months ended June 30,
2008, the income tax benefit was $1.3 million, representing an
effective income tax rate of 40.1%, compared to the income tax benefit
of $16,000 for the
three months ended June 30, 2007, representing an effective income tax rate of
3.0%. The 3.0% rate was primarily the result of certain non-deductible
transaction fees associated with the secondary public offering, which was
completed in the second quarter of 2007.




-12-


Six Months Ended June 30, 2008
Compared to Six Months Ended June 30, 2007
  Net Sales.Net
sales increased $7.7 million, or 13.3%, to $65.5 million for the six months
ended June 30, 2008, from $57.8 million for the six months ended June 30,
2007.  The increase was primarily attributable to growth in sales of
our face and other makeup products due to new products as well as higher
promotional programs related to new products, as we continued to broaden our
total distribution. Total distribution represents the number of stores in which
we sell products multiplied by our number of stock keeping units per store. Unit
sales for our face and other makeup increased by 1.3 million units, or
12.7%, to 11.5 million units for the six months ended June 30,
2008, from 10.2 million units for the same period a year ago. New
products, which are primarily introduced during the first and fourth
quarters, represented 44% of our net sales for the six months ended June
30, 2008, 1% higher than the same period a year ago, when new products
contributed 43% of net sales. Partially offsetting our net sales growth for
the six months ended June 30, 2008 was a decrease in sales of our eye
makeup products, an increase in our provision for returns and an
increase in trade spending.  Unit sales for our eye makeup decreased
by 1.0 million units, or 25.6%, to 2.9 million units for the six
months ended June 30, 2008, from 3.9 million units for the same period a
year ago. Our provision for returns increased $4.7 million when
compared to the same period a year ago due to higher returns from our retailers
due primarily to lower than anticipated retail sell-through on
higher-priced promotional kits. Trade spending with retailers increased by
$1.6 million, which includes an increase in cooperative advertising expense of
$2.2 million and an increase in provision for markdowns of $0.2 million, which
was offset by a decrease in our provision for coupon expense of $0.8
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 six months
ended June 30, 2008, our results included net sales of $9.4 million from our
international customers, compared to $6.5 million for the six months ended
June 30, 2007.
 
 Cost of
Sales.Cost of sales increased $6.3 million, or 25.2%, to
$31.3 million for the six months ended June 30, 2008, from $25.0 million
for the six months ended June 30, 2007. The increase in cost of sales
resulted primarily from an increase in product cost of $6.8 million due to an
increase in face makeup units sold and 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 47.7% of net sales for
the six months ended June 30, 2008, compared to 43.3% for the six
months ended June 30, 2007. The increase in cost of sales, as a percentage of
net sales, was primarily due to an increase in product costs, an increase in
trade spending with retailers and an increase in our provision for returns
from retailers for the six months ended June 30, 2008.
 
 Selling, General and Administrative
Expenses.Selling, general and administrative expenses
increased $2.9 million, or 11.3%, to $28.5 million for the six months ended
June 30, 2008, from $25.6 million for the six months ended June 30, 2007.
The increase was primarily due to a $1.5 million increase in marketing
spending, a $0.8 million increase in freight and warehouse costs, a $0.7 million
increase in distribution costs related to our growth, a $0.5 million increase in
realized and unrealized foreign currency exchange losses and a $0.2 million
increase in expense for stock option awards.  The increase was offset
by a $0.7 million decrease in transaction fees that were associated with the
secondary public offering in the second quarter of 2007 and a $0.2 million
decrease in professional service fees.
 
 Interest
Expense-Net.Interest expense decreased $0.1 million, or
14.3%, to $0.6 million for the six months ended June 30, 2008, from $0.7 million
for the six months ended June 30, 2007.  The slight decrease in
interest expense was due to the decrease in average borrowings outstanding under
our credit facility and the associated interest rate.
 
 Other Expense
(Income).Other expense for the six months
ended June 30, 2008 was $106,000 compared to other income
of $54,000 for the six months ended June 30, 2007. Other expense for
the six months ended June 30, 2008 and other income for the six months
ended June 30, 2007 were attributable to realized and unrealized gains and
losses related to investments held as part of our non-qualified deferred
compensation plan.
 
 (Benefit) Provision for Income
Taxes.The provision for income taxes represents federal,
state and local income taxes.  For the six months ended June 30, 2008,
income tax expense was $2.1 million, representing an effective income
tax rate of 40.2%, compared to income tax expense of $2.8
million for
the six months ended June 30, 2007, representing an effective income tax
rate of 42.5%. The effective rates differed from the statutory rates due to the
effect of varying state and local taxes and certain permanent items such
as research and development credits.




-13-




Liquidity and Capital
Resources





Cash Flows





As of
June 30, 2008, we had $3.5 million in cash and cash equivalents compared to no
cash and cash equivalents as of December 31, 2007. The increased level of
cash reflects higher cash inflows provided by our operating
activities. As of June 30, 2008, we had $20.0 million of availability under our
revolving credit facility. The significant components of our working capital are
accounts receivable and inventories, reduced by accounts payable, accrued
expenses, line of credit borrowings and the current portion of
our long-term debt.





Operating
activities.Cash provided by operating activities increased by
$9.9 million, or 162.3%, to $16.0 million for the six months ended June 30,
2008, from $6.1 million for the six months ended June 30, 2007. The net
increase in cash provided by operating activities resulted primarily from
favorable changes in deferred income taxes, accounts receivable, inventories,
accrued expenses and trade allowances. The net increase in cash provided by
operating activities was offset by unfavorable changes in accounts payable,
sales return reserve and income taxes
payable/receivable.  Inventories decreased by $2.2 million when
compared to prior year end due to increased sales. Our inventory turnover rate
increased to an annualized 1.9 times per year for the six months ended
June 30, 2008, from an annualized 1.8 times per year for the six
months ended June 30, 2007. Days sales outstanding decreased by 0.2 days,
to 39.4 days for the six months ended June 30, 2008 from 39.6
days for the six months ended June 30, 2007.





Investing
activities.Cash used in investing activities for the six
months ended June 30, 2008 was $0.6 million, which was related to capital
expenditures for the replacement of machinery and equipment, the automation
of the assembly line to accommodate future growth and improvements to our
warehouse distribution systems. Cash used in investing activities for
the six months ended June 30, 2007 of $0.7 million was related to capital
expenditures for the replacement of machinery and equipment and the automation
of the assembly line.





Financing
activities.Cash used in financing activities was $11.9
million for the six months ended June 30, 2008 compared to cash used
in financing activities of $5.4 million for the six months ended June
30, 2007. The increase in cash used in financing activities between periods
primarily resulted from higher paydowns on our term loan and revolving credit
facilities.





Future Liquidity and Capital
Needs.Net working capital requirements increased by $7.1
million, or approximately 31.0%, to $30.0 million for the six months ended
June 30, 2008, from $22.9 million for the six months ended June 30,
2007. We
anticipate that working capital will remain materially consistent during the
third quarter and increase during the fourth quarter of 2008, when we typically
experience higher inventory levels as we produce new products for shipment in
the first quarter of the following year. We have
budgeted capital expenditures of $2.1 million for 2008 for several key projects,
including investment in our information technology infrastructure and
improvements to our manufacturing and distribution equipment. Capital
requirements related to manufacturing include a major project undertaken in 2007
to automate a product assembly line that is used to assemble products that
represented approximately 36.9% of our total sales in 2007. We expect the
aggregate capital requirements of this project to total $1.7 million, of which
$1.3 million was incurred as of June 30, 2008. In addition to an estimated
$0.4 million in new equipment for the automated assembly line project, we expect
to need to make improvements to other manufacturing and distribution equipment
at a cost of approximately $0.8 million, improvements to our leasehold
facilities of approximately $0.2 million and improvements to our
information technology infrastructure at a cost of approximately $0.1
million in 2008. We incurred $0.6 million of capital expenditures
for the six months ended June 30, 2008. We believe that our cash flows
from operations and funds from our revolving credit facility will provide
adequate funds for our working capital needs and planned capital expenditures
for at least the next twelve months. No assurance can be given, however, that
this will be the case.





-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 June 30, 2008, we had $20.0 million of availability under the revolving
credit facility. The availability under the revolving credit facility is
reduced by outstanding letters of credit.





Borrowings
under the senior credit agreement are guaranteed by Physicians
Formula Holdings, Inc. and the domestic subsidiaries of Physicians Formula,
Inc., and are secured by liens on substantially all of the assets of
Physicians Formula, Inc., including the assets of its subsidiaries. Amounts
outstanding under the term loan facility totaled $11.8 million at June 30, 2008.
There were no outstanding letters of credit as of June 30, 2008. The interest
rate on the term loan was 4.7% at June 30, 2008. Payments under the
term loan facility are due quarterly, increasing from initial quarterly payments
of $375,000 to $562,500 as of December 31, 2007, $750,000 as of December 31,
2008, $937,500 as of December 31, 2009 and $1,125,000 as of December 31, 2010.
Quarterly payments of $375,000 were made on January 1, 2007, April 2, 2007, July
16, 2007 and October 2, 2007 and quarterly payments of $562,500 were made on
January 2, 2008, March 31, 2008 and June 30, 2008.





On July
8, 2008, we entered into an amendment to our senior credit agreement,
which reduced the applicable interest rates on borrowings under the term
loan and revolving credit facilities by 0.25%. The revolving credit facility is
also subject to a commitment fee of 0.25% on any unused
commitments.





The senior
credit agreement contains the following financial covenants: a maximum total
leverage ratio; a minimum fixed charge coverage ratio; a minimum net worth
requirement; and a limitation on capital expenditures (which may be no more than
$3,000,000 per fiscal year). As of June 30, 2008, we were in compliance with
these covenants.





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





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





Off-Balance Sheet
Transactions





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





-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, 2007. 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 six months ended June 30, 2008, was $17.7 million and the
weighted-average interest rate in effect at June 30, 2008, was 4.7%. A
hypothetical 1% increase or decrease in interest rates would have resulted in a
$88,000 change to interest expense for the six months ended June 30,
2008.





ITEM
4.  CONTROLS AND PROCEDURES





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





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





-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,
2007.





ITEM 4.SUBMISSION OF MATTERS TO
A VOTE OF SECURITY HOLDERS
  The
Company’s 2008 annual meeting of stockholders was held on June 3, 2008. At the
annual meeting, our stockholders elected five directors to the Company’s
Board of Directors and ratified the Audit Committee’s appointment of
Deloitte & Touche LLP as the Company’s independent registered public
accounting firm for the year ending December 31, 2008. Following are the results
of the election:
  Proposal I:   Election
of five directors to the Board of Directors
  Votes
For
                
                
                Votes
      WithheldIngrid
    Jackel
                
                
                13,039,439
                
                
                
                316,639Sonya
      T. Brown
                
                
                13,131,780
                
                
                
                224,298Jeffrey
      P. Rogers
                
                
                12,837,800
                
                
                
                518,278Zvi
      Eiref
                
                
                13,336,254
                
                
                
                19,824Jeff
      M. Berry
                
                
                13,336,554
                
                
                
                19,524
  Proposal II:   Ratification
of the Audit Committee’s appointment of Deloitte & Touche LLP
as independent registered public accounting firm for the year
ending December 31, 2008
 
 Votes for
                
                
                13,326,486Votes
    against
                
                
                25,511Abstentions
                
                
                4,081




ITEM
6.  EXHIBITS





Exhibit
              Number
            
            
            
            Description31.1
            
            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.




-17-


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:
      August 11, 2008
            
            By:
      Ingrid JackelIts:   Chief Executive
      Officer
              (principal executive officer)/s/
      Joseph J. JaegerDate:
      August 11, 2008
            
            By:
      Joseph J. JaegerIts:   Chief Financial
      Officer
              (principal financial officer)








-18-