##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
 Form 10-Q (Mark One) þQuarterly Report pursuant to Section 13 or15(d)of the Securities Exchange Act of
1934 For the quarter ended March 31, 2005 or oTransition Report pursuant to Section 13 or15(d)of the Securities Exchange Act of
1934 For the transition period from  to Commission File number 0-27646 Matrixx Initiatives, Inc.  Delaware
    
    87-0482806(State or other jurisdiction
    
    (I.R.S. Employerof incorporation or organization)
    
    Identification Number)
 4742 N. 24thStreet, Suite 455
Phoenix, AZ 85016
(Address of principal executive offices) (602) 385-8888
(Issuers telephone number) Indicate by check mark whether the registrant (1) 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 þ NO o Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act
Rule 12b-2). YES þ NO o There were 9,511,595 shares of the registrants common stock, $.001 par value, outstanding as of
May 1, 2005.




---



MATRIXX INITIATIVES, INC.
FORM 10-Q
INDEX PagePART I
    
    FINANCIAL INFORMATIONItem 1.
    
    Condensed Consolidated Balance Sheet
as of March 31, 2005 and December 31, 2004
    
    
    1Condensed Consolidated Statements of
Operations for the three months ended
March 31, 2005 and 2004
    
    
    3Condensed Consolidated Statements of
Cash Flows for the three months ended
March 31, 2005 and 2004
    
    
    4Notes to Condensed
Consolidated Financial Statements
    
    
    5Item 2.
    
    Managements Discussion and Analysis of
Financial Condition and Results of Operations
    
    
    12Item 3.
    
    Quantitative and Qualitative Disclosures
About Market Risk
    
    
    22Item 4.
    
    Controls and Procedures
    
    
    23PART II
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    23Item 6.
    
    Exhibits
    
    
    23SIGNATURES
    
    
    
    
    25Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
  Unless otherwise indicated in this quarterly report, Matrixx, us, we, our, the Company
and similar terms refer to Matrixx Initiatives, Inc. and its subsidiaries. Zicam is a registered
trademark of our subsidiary, Zicam, LLC, and the Matrixx name and logo are trademarks of the
Company.




---



##### Table of Contents



MATRIXX INITIATIVES, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited) ASSETS March 31, 2005
    
    
    December 31, 2004Current Assets:Cash and cash equivalents
    
    $
    15,095,716
    
    
    $
    12,694,486Accounts receivable:Trade, net allowance for doubtful
accounts of $569,792 and $555,240
    
    
    8,219,822
    
    
    
    12,386,026Inventories
    
    
    5,681,042
    
    
    
    7,241,434Prepaid expenses and other
    
    
    1,302,033
    
    
    
    887,586Interest receivable
    
    
    106,053
    
    
    
    57,658Deferred tax asset
    
    
    4,532,456
    
    
    
    5,029,600Total Current Assets
    
    
    34,937,122
    
    
    
    38,296,790Property and Equipment, at cost:Office furniture and equipment
    
    
    796,447
    
    
    
    780,961Machine tooling
    
    
    150,000
    
    
    
    150,000Leasehold improvements
    
    
    179,644
    
    
    
    179,6441,126,091
    
    
    
    1,110,605Less accumulated depreciation
    
    
    (521,914
    )
    
    
    (457,718
    )Net Property and Equipment
    
    
    604,177
    
    
    
    652,887Other Assets:Deposits
    
    
    313,309
    
    
    
    220,190Restricted cash
    
    
    5,000,000
    
    
    
    5,000,000Debt issuance costs, net of accumulated amortization
of $25,000 and $18,750
    
    
    
    
    
    
    6,250Patents, net of accumulated amortization of $222,631
and $205,861
    
    
    900,969
    
    
    
    917,739Goodwill
    
    
    15,039,836
    
    
    
    15,039,836Total Other Assets
    
    
    21,254,114
    
    
    
    21,184,015Total Assets
    
    $
    56,795,413
    
    
    $
    60,133,692
 The accompanying notes are an integral part of these condensed consolidated financial statements. 1




---



##### Table of Contents



MATRIXX INITIATIVES, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(Continued)
(Unaudited) LIABILITIES AND STOCKHOLDERS EQUITY March 31, 2005
    
    
    December 31, 2004Current Liabilities:Accounts payable
    
    $
    2,284,660
    
    
    $
    4,699,316Accrued expenses
    
    
    4,885,433
    
    
    
    6,314,971Sales commissions
    
    
    642,040
    
    
    
    1,261,899Sales returns and allowances
    
    
    2,688,735
    
    
    
    2,605,260Accrued taxes
    
    
    36,678
    
    
    
    209,946Total Current Liabilities
    
    
    10,537,546
    
    
    
    15,091,392Deferred tax liability
    
    
    916,738
    
    
    
    916,738Total Liabilities
    
    
    11,454,284
    
    
    
    16,008,130Commitments and contingenciesStockholders Equity:Preferred stock: $.001 par value, 2,000,000 shares
authorized, none issued or outstanding
    
    
    
    
    
    
    Common stock: $.001 par value, 30,000,000 shares
authorized, 9,565,395 and 9,520,198 shares
issued and outstanding
    
    
    9,565
    
    
    
    9,520Additional paid in capital
    
    
    43,028,951
    
    
    
    42,527,862Unearned compensation
    
    
    (181,125
    )
    
    
    Accumulated earnings
    
    
    2,880,042
    
    
    
    1,984,48445,737,433
    
    
    
    44,521,866Less common stock held in treasury, at cost
(53,800 and 53,800 shares)
    
    
    (396,304
    )
    
    
    (396,304
    )Total Stockholders Equity
    
    
    45,341,129
    
    
    
    44,125,562Total Liabilities and
Stockholders Equity
    
    $
    56,795,413
    
    
    $
    60,133,692
 The accompanying notes are an integral part of these condensed consolidated financial statements. 2




---



##### Table of Contents



MATRIXX INITIATIVES, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited) Three months ended March 31,2005
    
    
    2004Net sales
    
    $
    14,981,590
    
    
    $
    12,932,566Cost of sales
    
    
    4,237,434
    
    
    
    4,099,225Gross Profit
    
    
    10,744,156
    
    
    
    8,833,341Operating expenses
    
    
    8,823,514
    
    
    
    7,416,576Research and development
    
    
    499,561
    
    
    
    470,469Income From Operations
    
    
    1,421,081
    
    
    
    946,296Other Income (Expense):Interest and other income
    
    
    61,155
    
    
    
    45,832Interest and other expense
    
    
    
    
    
    
    Total Other Income (Expense)
    
    
    61,155
    
    
    
    45,832Income Before Provision For Income Taxes
    
    
    1,482,236
    
    
    
    992,128Provision for income taxes
    
    
    586,678
    
    
    
    395,490Net Income
    
    $
    895,558
    
    
    $
    596,638Net Income Per Share of Common Stock:Basic:Weighted Average Number of Common Shares
Outstanding
    
    
    9,481,914
    
    
    
    9,489,216Net Income Per Share of Common Stock
    
    $
    0.09
    
    
    $
    0.06Diluted:Weighted Average Number of Common Shares
Outstanding
    
    
    9,661,113
    
    
    
    9,527,974Net Income Per Share of Common Stock
    
    $
    0.09
    
    
    $
    0.06
 The accompanying notes are an integral part of these condensed consolidated financial statements. 3




---



##### Table of Contents



MATRIXX INITIATIVES, INC. AND SUBSIDIARY
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited) Three months ended March 31,2005
    
    
    2004Cash Flows From Operating Activities:Net income
    
    $
    895,558
    
    
    $
    596,638Adjustments to reconcile net income to net cash
provided (used) by operating activities:Depreciation
    
    
    64,196
    
    
    
    14,787Amortization
    
    
    16,770
    
    
    
    16,770Amortization of debt issuance costs
    
    
    6,250
    
    
    
    Deferred income taxes
    
    
    497,144
    
    
    
    379,378Common stock issued for compensation
    
    
    320,009
    
    
    
    Changes in assets and liabilities:Accounts receivable
    
    
    4,166,204
    
    
    
    7,217,578Inventories
    
    
    1,560,392
    
    
    
    (1,447,958
    )Prepaid expenses and other
    
    
    (414,447
    )
    
    
    236,554Interest receivable
    
    
    (48,395
    )
    
    
    Accounts payable
    
    
    (2,414,656
    )
    
    
    (3,532,375
    )Accrued expenses
    
    
    (2,222,665
    )
    
    
    (1,337,960
    )Sales returns and allowances
    
    
    83,475
    
    
    
    193,737Net Cash Provided By Operating Activities
    
    
    2,509,835
    
    
    
    2,337,149Cash Flows From Investing Activities:Capital expenditures
    
    
    (15,486
    )
    
    
    (148,324
    )Deposits and other
    
    
    (93,119
    )
    
    
    (135,819
    )Restricted cash
    
    
    
    
    
    
    Net Cash (Used) By Investing Activities
    
    
    (108,605
    )
    
    
    (284,143
    )Cash Flows From Financing Activities:Issuance of common stock
    
    
    
    
    
    
    302,500Net Cash Provided By Financing Activities
    
    
    
    
    
    
    302,500Net Increase in Cash and Cash Equivalents
    
    
    2,401,230
    
    
    
    2,355,506Cash and Cash Equivalents at Beginning of
Period
    
    
    12,694,486
    
    
    
    10,682,614Cash and Cash Equivalents at End of Period
    
    $
    15,095,716
    
    
    $
    13,038,120Supplemental Disclosure of Cash Flow Information:Cash paid during the period for:Interest
    
    $
    
    
    
    $
    Income taxes
    
    
    262,801
    
    
    
    222,751
 The accompanying notes are an integral part of these condensed consolidated financial statements. 4




---



##### Table of Contents



MATRIXX INITIATIVES,
INC. 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 1. Financial Statements The accompanying financial information of Matrixx Initiatives, Inc. is prepared in accordance
with the rules prescribed for filing condensed interim financial statements and, accordingly, does
not include all disclosures that may be necessary for complete financial statements prepared in
accordance with U.S. generally accepted accounting principles. The disclosures presented are
sufficient, in managements opinion, to make the interim information presented not misleading. All
adjustments, consisting of normal recurring adjustments, which are necessary so as to make the
interim information not misleading, have been made. Results of operations for the three months
ended March 31, 2005 are not necessarily indicative of results of operations that may be expected
for the year ending December 31, 2005. The products we market are seasonal in nature, and sales at
retail generally increase as the level of population suffering from colds rises. The Company
records sales when we ship products from our warehouse facilities. During the third quarter the
Company usually realizes increased sales volume as retailers stock our products and order displays
to prepare for the upcoming cough and cold season. Retail consumption of our products is highest
during the cough and cold season, which usually runs from September through April. The second
quarter of each year generally accounts for less than 10% of annual sales. It is recommended that
this financial information be read with the complete financial statements included in Matrixxs
Annual Report on Form 10-K for the year ended December 31, 2004 previously filed with the
Securities and Exchange Commission (SEC). 2. Stock-Based Compensation The Company adopted the disclosure provisions of Statement of Financial Accounting Standard
(SFAS) No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148,
Accounting for Stock-Based Compensation  Transition and
Disclosure  an Amendment to SFAS No. 123",
which prefers that companies apply a fair-value-based method of accounting for share-based payment
transactions with employees. However, SFAS No. 123 permits entities the option of continuing to
apply the guidance of Accounting Principles Board (APB) Opinion 25, Accounting for Stock Issued
to Employees, as long as the footnotes to the financial statements disclose what net income would
have been had the preferable fair-value-based method been used.The Company currently measures
compensation expense for its stock-based employee compensation plans using the intrinsic value
method prescribed by APB No. 25 and related interpretations in accounting for its stock based
compensation plans and does not recognize compensation expense for its stock-based compensation
plans other than for options granted to non-employees. The Companys ability to utilize the
alternative guidance of APB Opinion 25, however, will cease as of January 2006. Beginning in January 2006, the Company will be required to measure the cost of services
received in exchange for equity instruments based on the grant-date fair value of the award and
that cost will be recognized to expense over the requisite service, or vesting period. On February
7, 2005, the Companys Compensation Committee approved the immediate vesting of all outstanding
stock options previously granted under the Companys option plans, including those granted to
executive officers and directors, for which the option exercise price was above the closing price
on February 7, 2005 (refer to the Companys Form 8-K filed with the SEC on February 11, 2005). The immediate vesting of
these options will avoid the compensation expense in future periods
for these options, which were
granted prior to the implementation of SFAS No. 123R (see Note 5), and reflects the expectation of
fewer option grants in future periods. If the Company had elected to recognize compensation expense
based upon the fair value at the grant date for awards under its stock-based compensation plans
consistent with the methodology prescribed by SFAS No. 123, the Companys net income and net income
per share would be reduced to the following pro forma amounts: - 5 -




---



##### Table of Contents



MATRIXX INITIATIVES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Three Months EndedMarch 31,2005
    
    
    2004Net income applicable to common shareholders, as
reported
    
    $
    895,558
    
    
    $
    596,638Less stock based employee compensation expense
determined under fair value based methods for all awards,
net of related tax effects
    
    
    1,379,438
    
    
    
    361,379Proforma Net Income (Loss)
    
    $
    (483,880
    )
    
    $
    235,259Net income (loss) per share of common stock:Basic:As reported
    
    $
    0.09
    
    
    $
    0.06Pro forma
    
    $
    (0.05
    )
    
    $
    0.02DilutedAs reported
    
    $
    0.09
    
    
    $
    0.06Pro forma
    
    $
    (0.05
    )
    
    $
    0.02
 During the quarter ended March 31, 2005, 60,000 options to purchase shares of common stock of
the Company were granted to board members at an exercise price of $11.50 per share and were
immediately vested. Also during the quarter ended March 31, 2005, 128,000 options to purchase
shares of common stock of the Company were granted to employees at an exercise price of $10.73 per
share. The options granted to employees vested immediately. During the quarter ended March 31,
2005, no options were exercised. 3. Basic and Diluted Earnings Per Share The Company follows the provisions of Statement of Financial Accounting Standards (SFAS) No.
128, Earnings Per Share, which specifies the method of computation, presentation and disclosure
of earnings per share. SFAS No. 128 requires the presentation of two earnings per share amounts,
basic and diluted. Basic earnings per share is calculated using the average number of common
shares outstanding. Diluted earnings per share is computed on the basis of the average number of
common shares outstanding plus the effect of dilutive securities. The Companys stock options are
included using the treasury stock method. The table below summarizes the elements included in the calculation of basic and diluted net
income per common share for the three months ended March 31, 2005 and 2004. Options, warrants and
other incremental shares to purchase 334,343 and 626,800 shares of common stock at March 31, 2005
and 2004, respectively, were not included in the computation of diluted earnings per share because
their effect would be anti-dilutive. - 6 -




---



##### Table of Contents



MATRIXX INITIATIVES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Three Months EndedMarch 31,2005
    
    
    2004Net income applicable to common shareholders
    
    $
    895,558
    
    
    $
    596,638Weighted
average common shares outstanding - Basic
    
    
    9,481,914
    
    
    
    9,489,216Dilutive Securities
    
    
    179,199
    
    
    
    38,758Weighted
average common shares outstanding - Diluted
    
    
    9,661,113
    
    
    
    9,527,974Net Income per common share:Basic
    
    $
    0.09
    
    
    $
    0.06Diluted
    
    $
    0.09
    
    
    $
    0.06
 4. Inventory Inventories are stated at the lower of cost or market. The Company uses first-in, first-out
(FIFO) to value inventory. Inventories consisted of the following at March 31, 2005 and December
31, 2004: March 31,
    
    
    December 31,2005
    
    

2004Raw materials and packaging
    
    $
    1,879,551
    
    
    $
    2,140,915Finished goods
    
    
    4,109,896
    
    
    
    5,580,974Less reserve for obsolescence
    
    
    (308,405
    )
    
    
    (480,455
    )Total
    
    $
    5,681,042
    
    
    $
    7,241,434
 5. Recently Issued Accounting Standards The Financial Accounting Standards Board (FASB) issued SFAS No. 123 (Revised 2004),
Share-Based Payment, which was originally scheduled to take effect for reporting periods beginning
after June 15, 2005 (third quarter adoption for the Company). SFAS No. 123R replaces SFAS No. 123,
Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board (ABP) Opinion
No. 25, Accounting for Stock Issued to Employees. SFAS No. 123, as originally issued in 1995,
established as preferable a fair-value-based method of accounting for share-based payment
transactions with employees. However, the statement permitted entities the option of continuing to
apply the guidance in APB Opinion No. 25, as long as the footnotes to the financial statements
disclosed what net income would have been had the preferable fair-value-based method been used.
Currently, in accordance with APB Opinion No. 25, the Company records the intrinsic value of stock
based compensation as expense. Accordingly, no compensation expense is currently recognized for
fixed stock plans as
the exercise price equals the stock price on the date of grant. Under
SFAS No. 123R, effective January 1, 2006, the
Company will be required to measure the cost of services received in exchange for equity
instruments based on the grant-date fair value of the award and that cost will be recognized to
expense over the requisite service, or vesting period. SFAS No. 123R allows for the use of the
Black-Scholes or a lattice option-pricing model to value such equity instruments. The Company has
not determined which option-pricing model will be used in valuing such equity instruments. Upon
adoption of SFAS No. 123R, the Company can elect either Modified Prospective Application (MPA) or
the Modified Retrospective Application (MRA). The MPA applies SFAS No. 123R to new awards and
awards modified after the effective date, and to that portion of outstanding awards for which the
requisite service will be rendered on or after the effective date. The MRA applies SFAS No. 123R
to either all prior years for which SFAS No. 123 was effective or only to prior interim periods in
the year of adoption. The Company has chosen to apply the MPA method. Note 2 of the Condensed
Consolidated Financial Statements illustrates the effects on net income and earnings per share if
the Company had adopted SFAS No. 123R using the Black-Scholes option-pricing model. - 7 -




---



##### Table of Contents



MATRIXX INITIATIVES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) On February 7, 2005, the Companys Compensation Committee approved the immediate vesting
of all outstanding stock options previously granted under the Companys option plans, including
those granted to executive officers and directors, for which the option exercise price was above
the closing price on February 7, 2005 (refer to the Company's
Form 8-K filed with the SEC on February 11, 2005). The
immediate vesting of these options will avoid the compensation expense in future periods for these
options, which were granted prior to the implementation of SFAS No. 123R, and reflects the
expectation of fewer option grants in future periods. On April 15, 2005 the Securities and Exchange Commission issued Release No. 33-8568, Amendment
to Rule 4-01(a)of Regulation S-X Regarding the Compliance Date for Statement of Financial
Accounting Standards No. 123 (Revised 2004), Share-Based Payment. The amended Rule permits calendar
year registrants subject to oversight by the SEC to implement SFAS No. 123R by the beginning of
their next fiscal year. The Company will implement SFAS No. 123R at the beginning of its next
fiscal year (January 1, 2006). We are evaluating the requirements under SFAS No. 123R and expect the adoption will result in
additional compensation expense in our consolidated statements of income. The pro forma impact of
recognizing compensation expense for options previously issued is
included in Note 2 of the
Condensed Consolidated Financial Statements. In December 2004, the FASB issued FASB Staff Position FAS 109-1, Application of FASB Statement
No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities
Provided by the American Jobs Creation Act of 2004 (AJCA). The AJCA was signed into law in October
2004 and includes a tax deduction of up to 9 percent (when fully phased-in) of the lesser of a)
qualified production activities income as defined in the Act, or b) taxable income (after the
deduction for the utilization of any net operating loss carryforwards). The FASB concluded that
the tax relief (special tax deduction for domestic manufacturing) from this legislation should be
accounted for as a special deduction instead of a tax rate reduction. The Company will be able
to start claiming this tax benefit in 2005. The Company expects the adoption of FAS 109-1 will not
have a material impact on the Companys financial position or results of operations. In November 2004, the FASB issued SFAS No. 151, Inventory Costs  An amendment of ARB No. 43,
Chapter 4. SFAS No. 151 clarifies that abnormal amounts of idle facility expense, freight,
handling costs and spoilage should be expensed as incurred and not included in overhead. The
provisions in SFAS No. 151 are effective for inventory costs incurred during fiscal years beginning
after June 15, 2005 and companies must apply the standard prospectively. The Company expects the
adoption of SFAS No. 151 will not have a material impact on the Companys financial position or
results of operations. 6. Insurance Program In April 2004, we established a fully-funded deductible insurance program through a product
liability insurance carrier. Under the program, we have agreed to reimburse our insurer for its
claims administration expenses and for amounts paid out by it in settlement of product liability
claims filed after the initial date of the program and which are not covered by insurance programs
from prior years. The terms of the program require us to maintain an irrevocable, evergreen letter
of credit issued by a bank or other financial institution to secure our reimbursement obligations
to our insurer. We have a $5.0 million letter of credit with Comerica Bank and have reserved an
equal
amount of cash to secure repayments of amounts that become due under the letter of credit.
The $5.0 million reserve is classified as Restricted Cash on the consolidated balance sheet and has
been placed in an interest-bearing certificate of deposit. The Company may need to commit an
additional $5 million to the fully-funded insurance program during the year. - 8 -




---



##### Table of Contents



MATRIXX INITIATIVES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) 7. Legal Proceedings Litigation The Company is involved in various product liability claims and other legal proceedings. The
Companys legal expense continues to have a significant impact on the results of operations as the
Company defends itself against the various claims. Net income and earnings per share for the first
quarter of 2005 reflect the effect of a pretax reimbursement of $800,000 from our principal
insurance carrier for legal expenses previously incurred by the Company in defense of the product
liability lawsuits. First quarter 2005 legal expense was
approximately $2.1 million, reduced by the
$800,000 reimbursement from our principal insurance carrier for legal expense previously incurred,
resulting in net legal expense of approximately $1.3 million compared to $434,000 in the first
quarter of 2004.The Company will continue to seek reimbursement from its insurance carriers but
cannot predict the level and timing of any future reimbursements if any. Litigation is inherently unpredictable, and excessive verdicts do occur. Although the Company
believes it has valid defenses in these matters, the Company could incur, in the future, judgments
or enter into settlements of claims that could have a material adverse affect on the Companys
financial position or results of operations in any particular period.While we intend to defend
ourselves vigorously in each of these proceedings, the outcome of these and any other proceedings
that may arise cannot be predicted with certainty. Therefore, loss provisions arising from such
matters will be recorded when a loss outcome is probable and can be reasonably estimated, to the
extent not provided for through insurance. At present, we have not been able to determine the
probability of a loss outcome in any of the litigation to which we are currently subject.
Accordingly, we have not recorded any loss provisions related to such litigation. Among the principal matters pending to which the Company is a party are the following: Product Liability Matters Litigation relating to Zicam Cold Remedy nasal gel arises from claims that the product causes
the permanent loss of taste and smell, or anosmia. The Company believes the studies that have been
conducted and reviewed by independent medical experts and other evidence support our contention
that these claims are unfounded. From late 2003 through April 2005, we have been sued by approximately 350 individuals in 36
different lawsuits generally alleging that our Zicam Cold Remedy product caused damage to the sense
of smell and/or taste. Two of these lawsuits were filed as class action lawsuits covering named
and unnamed plaintiffs, but one of the class action lawsuits has been dismissed, as have the claims
of several individual plaintiffs. The current cases that have been filed against the Company are: Abramsen et al. vs. Matrixx
Initiatives, Inc., et al., filed March 8, 2004, in the Superior Court of Arizona (Maricopa County),
Case No. CV2004-04415; Adams, et al., vs. Matrixx Initiatives, Inc., et al., filed May 6, 2004, in
the Superior Court of Arizona (Maricopa County), Case No. CV2004-008929; Adamson, et al. vs.
Matrixx Initiatives, Inc., et al., filed February 1, 2005, in the Superior Court of Arizona
(Maricopa County), Case No. CV2005-001880; Akers, et al. vs. Matrixx Initiatives, Inc., et al.,
filed August 20, 2004, in the Superior Court of Arizona (Maricopa County), Case No. CV2004-016010;
Benkwith, et al. vs. Matrixx Initiatives, Inc., et al., filed May 3, 2004, in the Circuit Court for
Montgomery County, Alabama, Case No. CV04-1180 CNP; removed to United States District Court for the
Middle District of Alabama, Case No.
2:04 CV-00623-F; Bentley et al. vs. Matrixx Initiatives, Inc., et al., filed January 23, 2004,
in the Superior Court of Arizona (Maricopa County), Case No. CV2004-001338; Bryant vs. Matrixx
Initiatives, Inc., et al., filed June 9, 2004, in the District Court, Boulder County, Colorado,
Case No. 04-MK-2317 (BNB); Cappy, et al. vs. Matrixx Initiatives, Inc., et al., filed November 17,
2004, in the Superior Court of Arizona (Maricopa County), Case No. CV2004-021668; Cash, Katie and
David vs. Matrixx Initiatives, Inc., et al., filed January 13, 2005, in the Superior Court of
California (Fresno County, Central Division), Case No. 05 CE CG 00124; Cheney, Sharon vs. Matrixx
Initiatives, Inc., et al., filed April 20, 2005, in Maricopa County Superior Court, Case No.
CV2005-050458; Connolly, Gay vs. Matrixx Initiatives, Inc., et al., filed October 22, 2004, in the
State Court of Georgia (Cobb County), Case No. 2004A 9564-5; Douillard, John R. vs. Matrixx
Initiatives, Inc., et al., filed May 6, 2004, in the Superior Court of Arizona (Maricopa County),
Case No. CV2004-008950; Flores vs. Matrixx Initiatives, Inc., et al., filed on December 30, 2004,
in Santa Clara County, Case No. 1:04-CV033194; removed to United States District Court Northern
District of California (San Jose Division), Case No. C05 01090 PVT; Gillespie, Julie vs. Matrixx - 9 -




---



##### Table of Contents



MATRIXX INITIATIVES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Initiatives, Inc., et al., filed December 8, 2004, in the Superior Court of California (Orange
County), Case No. 04CC11976; removed to United States District Court Central District of California
(Southern Division), Case No. SACV 05-0047-DOC(ANx); Hans, et al. vs. Matrixx Initiatives, Inc., et
al., filed September 13, 2004, in the United States District Court, Western District of Kentucky,
Case No. 3:04CV540-R; Hilton, Heather vs. Matrixx Initiatives, Inc., et al., filed June 17, 2004,
in the State of Texas District Court, Tarrant County, Case No. 048-206162-04; removed to the United
States District Court for the Northern District of Texas Fort Worth Division, Case No. 04CV-519-Y;
Hood, Michael and Terri vs. Matrixx Initiatives, Inc., et al., filed April 14, 2004, in the Circuit
Court of the 17th Judicial Circuit in and for Broward County, Florida, General Jurisdiction
Division, Case No. 04006193; Horvat, Diane vs. Matrixx Initiatives, Inc., et al., filed February
28, 2005, in Circuit Court of Cook County, Illinois County Department, Law Division, Case No.
2005L02324; Hudson, et al. vs. Matrixx Initiatives, Inc., et al., filed February 11, 2005, in the
Superior Court of Arizona (Maricopa County), Case No. CV2005-002569; Hunter, et al. vs. Matrixx
Initiatives, Inc., et al., filed June 4, 2004, in the Superior Court of Arizona (Maricopa County),
Case No. CV2004-010830; Kalfian, Carol A. vs. Matrixx Initiatives, Inc., et al., filed April 20,
2004, in the United States District Court for the District of Rhode Island, Case No. 04-119-ML;
Lusch, Barbara A. vs. Matrixx Initiatives, Inc., et al., filed January 14, 2005, in the Circuit
Court of the State of Oregon, Case No. 0501-00588; removed to the United States District Court for
the District of Oregon, Case No. 3:05-CV-292-HA;Lutche, Lucy B. vs. vs. Matrixx Initiatives, Inc.,
et al., filed May 7, 2004, in the Superior Court of Arizona (Maricopa County), Case No.
CV2004-008704; Mayo, Derek vs. Matrixx Initiatives, Inc., et al., filed May 26, 2004, in the
Superior Court of New Jersey, Law Division: Essex County, Docket No. ESX-L-3551-04; removed to the
United States District Court for the District of New Jersey, Case No. 2:04-cv-3197; Nelson vs.
Matrixx Initiatives, Inc., et al., filed December 8, 2003, in the Superior Court of the Sate of
California for the County of Los Angeles, Case No. YC048136; Nelson, Tommy Ray and Sherry vs.
Matrixx Initiatives, Inc., et al., filed February 28, 2005, in the Circuit Court for Roane County,
Tennessee, Case No. 13328; removed to the United States District Court for the Eastern District of
Tennessee Northern Division, Case No. 3:05-CV-193; OHanlon, Dennis and Bonnie vs. Matrixx
Initiatives, Inc., et al., filed October 29, 2004, in the Superior Court of California (Los Angeles
County), Case No. BC322039; removed to United States District Court Central District of California
(Los Angeles), Case No. CV04-10391 AHM(JTLx); Ringbauer et al. vs. Matrixx Initiatives, Inc., et
al., filed February 11, 2004, in the Superior Court of Arizona (Maricopa County), Case No.
CV2004-002822; removed to the United States District Court for the District of Arizona, Case No.
04-CV-513; remanded to the Superior Court of Arizona (Maricopa County); Rostron, et al. vs. Matrixx
Initiatives, Inc., et al., filed November 4, 2004, in the United States District Court for the
Northern District of Alabama, Middle Division, Case No. CV-04-AR-3136-M, originally involving
plaintiffs Rostron and McCune, was severed; Rostron was transferred to the United States District
Court for the District of New Jersey by Order filed on March 15, 2005, and McCune continues in the
United States District Court for the Northern District of Alabama, Middle Division, under Case No.
CV-04-AR-3136-M; Sutherland, Janie vs. Matrixx Initiati
ves, Inc., et al., filed December 18, 2003,
in the Circuit Court of Etowah, Alabama, Case No. CV-2003-1635-WHR; removed to United States
District Court for the Northern District of Alabama, Middle Division, Case No. CV-04-AR-0129-M;
Swanbeck, Steven vs. Matrixx Initiatives, Inc., et al., filed November 18, 2004, in the Superior
Court of New Jersey Law Division: Morris County, Dock No. L-3096-04; Wagner, Nicole vs. Matrixx
Initiatives, Inc., et al., filed February 24, 2005, in Superior Court of California, County of San
Diego, Case No. GIC 843335; Williams, Rose Mary et al. vs. Matrixx Initiatives, Inc., et al., filed
December 29, 2004, in the United States District Court for the Northern District of Alabama, Middle
Division, Case No. 4:04cv-3548-UWC; Wyatt, Susan vs. Matrixx Initiatives, Inc., et al., filed June
15, 2004, in the United States District Court for the Northern District of Alabama, Southern
Division, Case No. CV-04-AR-1230-S; Bourgeois, Deborah vs. Matrixx Initiatives, Inc., et al., filed
February 22, 2005, in the United States District Court for the Northern District of Alabama, Middle
Division, Case No. CV-05-PT-0393-M; and Orlansky, Robin vs. Matrixx Initiatives, Inc., et al.,
filed February 9, 2005, in the Superior Court of California (San Diego County), Case No. GIC
842519. Generally, the cases filed in the Superior Court of Arizona have been or we expect will be
consolidated under In Re Consolidated Zicam Product Liability Cases, Case No. CV 2004-001338.
Various defendants in the lawsuits, including manufacturers and retailers, have sought
indemnification or other recovery from us for damages related to the lawsuits. These cases are all
in the early stages and we expect the first trial to begin in the second half of 2005. Also,
plaintiffs law firms continue to solicit potential claimants through the Internet and other media.
As a result, we expect additional lawsuits to be filed against us. - 10 -




---



##### Table of Contents



MATRIXX INITIATIVES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) We believe the allegations relating to Zicam Cold Remedy are unfounded. Zicam Cold
Remedy has been studied in two independent, placebo-control studies. In those studies, there was
no statistically significant difference in adverse events between the placebo and non-placebo
group, and there was no indication in either group of impairment to the sense of smell. Further,
the incidence of smell disorders is reported at 1-2% of the population on average, and is very
common in those over age 50. Upper respiratory infections are among the most common causes of
impairment to sense of smell. Therefore, any product such as Zicam Cold Remedy designed to treat
upper respiratory illnesses may be mistakenly associated with distortion of sense of smell. The
rate of reported complaints of distortion of sense of smell associated with Zicam Cold Remedy is
well below these national incidence levels. We convened a two-day meeting of our Scientific Advisory Board in September 2004 to review the
findings of studies initiated in the first quarter of fiscal 2004. The Scientific Advisory Board
is comprised of medical doctors and researchers that are independent of the Company. Matrixx
provided honorariums for members attendance at meetings, travel expenses, and funded grants to
design and perform research studies investigating the contention that Zicam Cold Remedy zinc
gluconate nasal gel is associated with disorders of smell. Members of the Scientific Advisory Board
presented the results of their studies on the epidemiology, anatomy, and physiology of smell
disorders. It was the unanimous opinion of the Scientific Advisory Board that the cumulative
scientific evidence does not support the contention that Zicam Cold Remedy zinc gluconate nasal gel
is associated with disorders of smell. The Scientific Advisory Board plans to do further testing
of the zinc gluconate nasal gel on human volunteers and animal models. Panel members are expected
to reconvene in the first half of 2005 to review the findings of the additional research. We have submitted all of the existing lawsuits to our insurance carriers. In April 2004, we
established a fully-funded deductible insurance program through a product liability insurance
carrier. If the fully-funded program were to incur any liability, the Companys financial results
could be materially impacted. We cannot predict the outcome of the litigation, but we will defend
ourselves vigorously. If any liability were to result from one or more of these or future
lawsuits, we believe our financial results could be materially impacted. Our financial results
could also be materially impacted by the adverse publicity that may result from the lawsuits. Securities Litigation Matters Two class action lawsuits were filed in April and May 2004 against the Company, our President
and Chief Executive Officer, Carl J. Johnson, and our Executive Vice President and Chief Financial
Officer, William J. Hemelt, alleging violations of federal securities laws. On January 18, 2005,
the cases were consolidated and the court appointed James V. Sircusano as lead plaintiff. The
amended complaint also includes our Vice President of Research and Development, Timothy L. Clarot
as a defendant and was filed March 4, 2005. The consolidated case is Sircusano, et al. vs. Matrixx
Initiatives, Inc., et al., in the United States District Court, District of Arizona, Case No.
CV04-0886 PHX DKD. Among other things, the lawsuit alleges that between October 2003 and February
2004, we made materially false and misleading statements regarding our Zicam Cold Remedy product,
including failing to adequately disclose to the public the details of allegations that our products
caused damage to the sense of smell and
of certain of the product liability lawsuits described above. We believe the claims made in
this matter are without merit. We intend to vigorously defend ourselves in these matters. In
accordance with and subject to the provisions of the Companys Certificate of Incorporation,
Messrs. Johnson, Hemelt, and Clarot will be indemnified by the Company for their expenses incurred
in defending these lawsuits and for any other losses which they may suffer as a result of these
lawsuits. The Company has submitted this matter to its insurance carriers, and may incur charges
up to the deductible amount of $1 million. If any liability were to result from these lawsuits, not
covered by insurance, we believe our financial results could be materially impacted. - 11 -




---



##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations Overview Through our 100%-owned subsidiary, Zicam LLC, we are engaged in the development, production
and sale of over-the-counter pharmaceutical products. In 2002, we introduced five new Zicam nasal
gel products, improved package graphics for our entire Zicam product line and engaged a new sales
team to represent our products to retailers. In 2003, we began shipping three new Zicam Cold
Remedy products (Oral Mist, Chewables and RapidMelts). In the third quarter of fiscal 2004, we
began shipping our six new Zicam Cough Mist products (Cough Mist Adult Cherry, Cough Mist Adult
Honey Lemon, Cough Mist Adult Plus Decongestant, Cough Mist Adult Night Time, Cough Mist Kids
Cherry, and Cough Mist Kids Plus Decongestant). The Company currently markets 16 products within the $3.5 billion overall cough and cold
category at retail. The products we market are seasonal in nature, and sales at retail generally
increase as the level of population suffering from colds rises. The Company records sales when we
ship products from our warehouse facilities. During the third quarter, the Company usually realizes
increased sales volume as retailers stock our products and order displays to prepare for the
upcoming cough and cold season. Additional sales (re-orders) to retailers are highly dependent upon
the incidence of illness within the population. Retail sales of our products is highest during the
cough and cold season, which usually runs from September through April. The Company begins
extensive advertising campaigns to coincide with the cough and cold season and generally realizes
higher advertising expense in the fourth and first quarters of each year. The second quarter of
each year generally accounts for less than 10% of annual sales. Our products are currently
available at all of the major food, drug, and mass merchant retailers. Net sales for the first quarter of fiscal 2005 increased 16% to approximately $15.0 million
compared to approximately $12.9 million for the first quarter of 2004. The increased sales in the
first quarter of 2005 were primarily due to sales of the new Zicam Cough Mist products, which were
introduced in the second half of 2004, along with increased sales of the Zicam Cold Remedy oral
products. Net income for the first quarter of 2005 increased 50% to approximately $896,000
compared to $597,000 in the first quarter of 2004. The increase in net income is primarily related
to the increased sales for the quarter as well as a pretax reimbursement of $800,000 from our
principal insurance carrier for legal expenses previously incurred by the Company in defending the
product liability lawsuits. We expect net income in future periods will be significantly affected by the level of sales,
the timing and amount of our advertising and research and development expenses, and the timing and
amount of expenses incurred in the defense of product liability and securities litigation matters.
Expenditures for advertising and research and development will vary by quarter throughout the year
and could be significantly different in 2005 than the amounts incurred in the same periods in
earlier years. We expect that advertising expenses will be highest in the fourth and first quarters
in conjunction with the cough and cold season. We anticipate quarterly earnings will continue to
vary along with the seasonality of sales. As in prior years, we believe the second quarter of 2005
will result in a loss and expect this loss will be greater than our loss in the second quarter of
2004 due to increased research and development expense and continued high levels of legal expense. Since the introduction of our new Zicam Cough Mist products, we now market Zicam products in
the cold (3 nasal delivery products and 3 oral delivery products), allergy/sinus (4 nasal delivery
products), and cough (6 oral delivery products) market groups of the overall cough and cold
category. We expect that our mix of products sold will change due to seasonality and varying
growth rates within the market groups. For the quarter ended March 31, 2005, our mix of products
sold (units) was cold (nasal and oral) - 61%, allergy/sinus -
25%, and cough - 14%, compared to
cold - 70% and allergy/sinus - 30% for the quarter ending March 31, 2004. In February 2005, the Company announced Nasal Comfort, a new brand and product for nasal
health. The initial offering under the new brand is a unique product designed to help maintain the
critical functions of the nasal cavity and its role in the respiratory process. Nasal Comfort is a
preservative free, sterile, hyper-tonic aqueous solution with essential salts and oils that
cleanses and moisturizes the nose. The new product will be packaged in a pharmaceutical grade
dispenser, employing a patented one-way, micro-filtration pump. The Company previously anticipated
shipments of this product to commence in the second quarter of 2005; however, due to refinements in
the manufacturing process, we now expect shipments to begin in the third quarter of 2005. We do not
expect the change - 12 -




---



##### Table of Contents



of initial sales to the third quarter will have a material affect on our
previously announced sales and earnings guidance for 2005. The Company also expects to
introduce additional Zicam product extensions and several improvements to existing products later
this year. The Companys management reviews several key performance indicators. First, we compare our
year to date sales and net income performance against our stated annual goal for each. For fiscal
2005, our goal is to grow sales 25% - 35% and net income 10% - 20% above the level realized in
2004. For the three months ended March 31, 2005 net sales have increased 16% and net income is up
50% over the same period in 2004. Second, we monitor our share of the cough and cold market. For
the 12 weeks ended March 20, 2005, retail sales of our products (as measured by three outlet
syndicated scanner data, not including our customer Wal-Mart) increased approximately 50% over the
comparable period in the previous year, while the entire cough and cold category increased
approximately 26% over the same period. The increased sales of our products achieved a share of
approximately 2.6% of the entire cough and cold market compared to a share of 2.2% in the previous
year. Third, we measure our ability to maintain strong gross margins on our products. We achieved
an average gross margin of 72% for the first quarter of 2005, which is above our goal of 70%, and
above the gross margin of 68% achieved in the first quarter of 2004 (gross margins on our current
products vary between 65% and 80%). The increased gross margin is primarily due to the lower cost
of our redesigned swab product that we introduced in 2004. Fourth, we evaluate our operating
performance by reviewing, over time, our ability to decrease administrative and general costs as a
percentage of net sales. For the three months ended March 31, 2005, our operating expenses were
approximately 59% of our net sales compared to 57% for the first quarter in 2004. Operating
expenses for the first quarter have been negatively impacted by an increase in legal expense ($1.3
million in Q1 2005 (after giving effect to the $800,000 insurance reimbursement discussed in Note 7
of the Consolidated Financial Statements) compared to $0.4 million in Q1 2004) primarily related to
the product liability lawsuits which have been filed against the Company (see Part II, Item 1-
Legal Proceedings). Finally, we review the distribution of our products by key national
retailers. In the first quarter of 2005, our ten largest retail customers carried, on average, 12
of our 16 Zicam products compared to seven of our ten products in 2004. Those customers accounted
for approximately 74% of net sales in the first quarter 2005, and 67% of net sales for the first
quarter 2004. We expect to expand the distribution of products among these retailers during the
year as we introduce new products. Critical Accounting Policies and Estimates Our consolidated financial statements and accompanying notes have been prepared in
accordance with U.S. generally accepted accounting principles applied on a consistent basis. The
preparation of financial statements in conformity with U.S. generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported amounts
of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during the reporting
periods. We regularly evaluate the accounting policies and estimates that we use to prepare our
consolidated financial statements. In general, managements estimates are based on historical
experience, on information from third party professionals, and on various other assumptions that
are believed to be reasonable under the facts and circumstances. Actual results could differ from
those estimates made by management. We believe that our critical accounting policies and estimates include the accounting for
intangible assets and goodwill, accounting for income taxes, revenue recognition, accounting for
returns associated with our products, accounting for sales discounts and promotional programs, and
accounting for legal contingencies. Intangible Assets and Goodwill:We recorded approximately $15.0 million in goodwill in
connection with the 40% Zicam, LLC interest that we acquired from Zensano, Inc. in December 2001.
Under SFAS No. 142, goodwill must be tested when a triggering event occurs or at least annually to
identify a potential impairment and the amount of any impairment loss. Factors that could affect
this analysis would be significant loss of market share, a general decline in Zicam product sales,
higher than expected increases in expenses and various other matters. Any change in key
assumptions about the business or prospects of Zicam, LLC, or any change in market conditions or
other externalities affecting Zicam, LLC, could result in an impairment charge, and such a charge
could have a material adverse effect on our financial condition and results of operations. Our
annual evaluation of goodwill was completed in the third quarter of 2004 and no impairment was
identified. Management has not identified any triggering events since that evaluation was
completed. - 13 -




---



##### Table of Contents



Income Taxes:Due to our significant operating losses prior to 2001, we possess a sizeable
tax loss carry-forward which can be used to reduce our taxable income in future periods. Due to
our history of operating losses, we recorded a deferred tax valuation allowance in 2001 and prior
years to offset the entire deferred tax asset arising from our tax loss carry-forward. However,
due to the significant improvement in our net income in 2002, together with our expectation of
continuing profitability in future years, we determined that we are more likely than not to realize
the tax benefit associated with our tax loss carry-forward. Consequently, we reduced the deferred
tax valuation allowance and recorded a large portion of the deferred tax asset in 2002. The effect
of this change was a decrease in our income tax expense of approximately $3.4 million in 2002. In 2004 and the first quarter of 2005, we recorded income tax expense based on our estimated
effective income tax rate of 40% for the year and will continue to do so in future periods. In
addition, we will continue to evaluate the deferred tax valuation allowance regularly and adjust
the amount to reflect our expectation of our ability to realize the tax benefit arising from our
tax loss carry-forward and other deferred tax items on a quarterly basis. Should there be a
significant change in our expectations of future income or the ability to realize the deferred tax
asset, the impact of increasing the deferred tax valuation allowance could be significant, which
would negatively impact our earnings. Revenue Recognition:The Company recognizes revenue from product sales when earned, that is,
when the risks and rewards of ownership have transferred to the customer, which is considered to
have occurred upon shipment of the finished project. Sales incentives, promotional allowances, and
returns are estimated and recognized at the date of shipment based upon historical activity and
current agreements with customers. The Company evaluates these estimates on a monthly basis and
revises them as necessary. Customer Returns:The estimate for product returns is based on our historical experience of
sales to retailers and is reviewed regularly to ensure that it reflects potential product returns.
Our sales returns experience has been consistent with our estimate for returns. In July 2004, we
reviewed the return provision for the three oral delivery Cold Remedy products that were introduced
in the third quarter of 2003. Based on our product return experience we reduced the return
provision from 7% to 3% on sales of these three products in mid 2004. Currently, we are recording
a returns provision of 3% of gross sales for the ten Zicam products introduced in 2003 or earlier.
In establishing the appropriate reserve level for the six new Zicam Cough Mist products, that began
shipping in July 2004, we reviewed the similarities and differences of the six products relative to
the ten Zicam products for which we have longer product return experience. Based on that review,
we believe that our past experience is a good indicator of the estimate of returns to be expected
from the new products and are recording a provision of 7% of gross sales for these products. We
will review the return provision at least quarterly and adjust these reserve amounts as actual
product return experience continues to develop. Should the actual level of product returns vary
significantly from our estimates, our operating and financial results would be materially affected.
In addition, we expect that a higher sales returns allowance will be recorded for any other new
products that we introduce until such products achieve market acceptance. Legal Contingencies:We are subject to lawsuits, investigations and claims arising out of the
normal conduct of our business. We are being sued by approximately 350 individuals in 36 different
lawsuits generally alleging that our Zicam Cold Remedy nasal products caused damage to their sense
of smell and/or taste. Two of these lawsuits have been filed as class action lawsuits, although
one has been dismissed. Various defendants in the lawsuits, including manufacturers and retailers,
have sought indemnification or other recovery from us for damages related to the lawsuits. In
addition, two class action lawsuits (which have been consolidated) have been filed against Matrixx,
our President and Chief Executive Officer, Carl J. Johnson, our Executive Vice President and Chief
Financial
Officer, William J. Hemelt, and our Vice President of Research and Development, Timothy L.
Clarot, alleging violation of federal securities laws (see Note 7 of the Condensed Consolidated
Financial Statements). While we intend to defend ourselves vigorously in each of these
proceedings, the outcome of these and any other proceedings that may arise cannot be predicted with
certainty. Therefore, loss provisions arising from such matters will be recorded when a loss
outcome is probable and can be reasonably estimated, to the extent not provided for through
insurance or otherwise. At present, we have not been able to determine the probability of a loss
outcome in any of the litigation to which we are currently subject. Accordingly, we have not
recorded any loss provisions related to such litigation. - 14 -




---



##### Table of Contents



Results of Operations for the Three Months Ended March 31, 2005 Compared to the Three Months
Ended March 31, 2004 Certain information is set forth below for our Zicam operations expressed in dollars and
as a percentage of net sales for the periods indicated: Three
Months Ended March 31,2005

    
    

2004Net sales
    
    $
    14,981,590
    
    
    
    100
    %
    
    $
    12,932,566
    
    
    
    100
    %Cost of sales
    
    
    4,237,434
    
    
    
    28
    
    
    
    4,099,225
    
    
    
    32Gross profit
    
    
    10,744,156
    
    
    
    72
    
    
    
    8,833,341
    
    
    
    68Operating expenses
    
    
    8,823,514
    
    
    
    59
    
    
    
    7,416,576
    
    
    
    57Research & development
    
    
    499,561
    
    
    
    3
    
    
    
    470,469
    
    
    
    4Income from operations
    
    
    1,421,081
    
    
    
    9
    
    
    
    946,296
    
    
    
    7Interest and other income
    
    
    61,155
    
    
    
    
    
    
    
    45,832
    
    
    
    Interest expense
    
    
    0
    
    
    
    
    
    
    
    0
    
    
    
    Income before income taxes
    
    
    1,482,236
    
    
    
    10
    
    
    
    992,128
    
    
    
    8Provision for income taxes
    
    
    586,678
    
    
    
    4
    
    
    
    395,490
    
    
    
    3Net income
    
    $
    895,558
    
    
    
    6
    %
    
    $
    596,638
    
    
    
    5
    %
 Net Sales Net sales for the three months ended March 31, 2005 increased to approximately $15.0 million,
or 16% above net sales of $12.9 million for the first three months in 2004. Approximately 76% of
the increase in net sales was attributable to sales of the six new Zicam Cough Mist products
introduced in the third quarter of 2004 and approximately 21% of the increase was due to increased
sales of our Zicam Cold Remedy products, principally the oral products introduced in 2003. We
believe the sales increase of Zicam products is primarily due to greater brand awareness and
marketing efforts. Cost of Sales For the first quarter 2005, our cost of sales increased approximately $138,000 or 3% over the
cost of sales for the first quarter in 2004. The increase is due to the higher number of units sold
in the first quarter 2005. The cost per unit sold in the first quarter 2005 decreased approximately
14% compared to the cost per unit sold during the first quarter 2004. The lower cost per unit sold
is primarily due to the lower cost of our redesigned swab product that we introduced in 2004. Gross Profit Gross profit for the three months ended March 31, 2005 increased to approximately $10.7
million, or 22%, versus gross profit of $8.8 million for the same period in 2004. The increase is
primarily due to the increase in sales and the lower cost per unit sold. The gross margin achieved
during the quarter increased to 72% from 68% in the first quarter of 2004. The gross margins on our
current products vary between 65% and 80%. Gross margin will continue to be affected by the
relative mix of products sold and changes in product costs that may occur. Operating Expenses Operating expense for the first quarter 2005 increased to approximately $8.8 million from $7.4
million in the first quarter 2004. The increase is primarily due to an increase of approximately
$0.8 million in legal expense associated with product liability and securities litigation claims.
First quarter 2005 legal expense was approximately $2.1 million, reduced by an $800,000
reimbursement from our principal insurance carrier for legal expense previously incurred, resulting
in net legal expense of approximately $1.3 million compared to $434,000 in the first quarter of
2004. Also contributing to the higher operating expenses in the first quarter of 2005 were increases
in advertising expense of $0.1 million (approximately $4.4 million in 2005 compared to $4.3 million
in 2004); an increase in non- - 15 -




---



##### Table of Contents



advertising marketing expense of $0.2 million (primarily related to
consumer research as well as public relations expense associated with the anosmia claims); and
higher labor expense of approximately $0.3 million. We expect expenses in future periods will vary largely in relation to the level of our
advertising expenditures, which are heaviest in the first and fourth quarters. We anticipate that
we will continue to incur approximately $1.0 million to $1.5 million in legal expense each quarter
as a result of the Zicam Cold Remedy product liability and securities litigation matters in which
we are engaged (see Part II, Item 1 - Legal Proceedings), which is generally consistent with our
legal expenses during the second through fourth quarters of fiscal 2004. The Company will continue
to seek reimbursement from its insurance carriers but cannot predict the level and timing of any
future reimbursements if any. Research and Development Research and development expense increased from approximately $470,000 in the first quarter of
2004 to approximately $500,000 in 2005. We expect to invest 4% - 6% of 2005 annual net sales on
research and development efforts. We continue to invest in research and development efforts and
remain focused on developing new products and anticipate introducing new products in 2005 as well
as several improvements to existing products. Interest & Other Income Other income increased to approximately $61,000 in the first quarter of 2005 from $45,000 in
the first quarter 2004. The increase is due to interest earned on the Companys increased cash
position. Income Before Income Taxes Income before income tax for the three months ending March 31, 2005 increased 49%, to
approximately $1.5 million, from almost $1.0 million for the first three months of 2004. The
increase is due to an increase in sales volume and gross margin, partially offset by an increase in
operating expenses. We expect that net income in future periods will be significantly impacted by
the success of our 16 current products, new product introductions (including new products we plan
to introduce in 2005), and year over year changes in our advertising, research and development, and
legal expenses. We anticipate quarterly earnings will continue to vary along with the seasonality
of sales. We believe the second quarter of 2005 may result in a significant loss due to increased
research and development expense and continued high levels of legal expense. Provision for Income Tax Expense We recorded a provision for income tax expense at our combined federal and state estimated,
effective tax rates. Due to operating income recorded in the first quarter of 2005, we recognized
income tax expense of approximately $587,000 compared to $395,000 in the first quarter of 2004. Net Income Net income increased approximately $300,000, or 50%, to approximately $896,000 in the first
quarter of 2005 compared to net income for the first quarter of 2004 of approximately $597,000. Liquidity and Capital Resources Our working capital increased to $24.4 million as of March 31, 2005 from $23.2 million as
of December 31, 2004, an increase of approximately $1.2 million. During the first quarter of 2005,
we experienced an increase in available cash of approximately $2.4 million. The increase in cash
stems from cash generated by operations of $2.5 million being offset by $0.1 million used by
investing activities. The increase in cash from operations was driven by higher sales during the
first quarter of 2005 and cash receipts of those sales. The Companys principal source of liquidity
is cash generated from sales of our products to retailers and distributors. The majority of sales
are given 30 day credit terms; however, payment terms are occasionally extended, as retailers begin
to increase inventory of our products prior to the onset of the cough and cold season. The Company
records an allowance as an estimate for potentially uncollectible accounts. The allowance for
potentially uncollectible accounts is reviewed on a monthly basis and we believe our allowance is
adequate. The change in accounts receivable, inventory, accounts payable and accrued expenses largely
reflects the increase in the Companys business and the number of new products. On a quarterly
basis, changes in these items reflect the seasonal nature of the Companys business. The Company
records the bulk of its sales, which is reflected - 16 -




---



##### Table of Contents



in higher accounts receivable, in the third,
fourth and first quarters; builds inventory during the second through fourth quarter periods; and
advertises its products, which is the largest component of accrued expenses, in the fourth and
first quarters. Although affected by the build-up of inventory in the second through fourth
quarters, accounts payable and accrued expenses are more significantly affected by advertising
spending which largely occurs in the fourth and first quarters. Generally, to the extent our
operations are profitable, our business is cash-flow positive. Additionally, due to our sizeable
tax loss carryforward, we have not incurred sizeable income tax payments. We expect that we will
not incur large tax payments through 2005. We do have working capital requirements arising from the
increase of inventory and accounts receivable in excess of the increase in accounts payable, but
these vary throughout the year reflecting the seasonal nature of our business. The Company has historically had very low capital expenditures since we rely on contract
manufacturers to produce our products. Typical capital expenditures include investments in
technology, office furniture, and leasehold improvements. The Company occasionally provides
deposits and prepayments to our manufacturers to improve and increase manufacturing capabilities
for our products. In April 2004, we established a fully-funded deductible insurance program through a product
liability insurance carrier. Under the program, we have agreed to reimburse our insurer for its
claims administration expenses and for amounts paid out by it in settlement of product liability
claims filed after the initial date of the program and which are not covered by insurance programs
from prior years. The terms of the program require us to maintain an irrevocable, evergreen letter
of credit issued by a bank or other financial institution to secure our reimbursement obligations
to our insurer. We have a $5.0 million letter of credit with Comerica Bank and have reserved an
equal amount of cash to secure repayments of amounts that become due under the letter of credit.
The $5.0 million reserve is noted as Restricted Cash on the consolidated balance sheet and has been
placed in an interest-bearing certificate of deposit. The Company may need to commit an additional
$5 million to the self-funded insurance program during the year. We have a $4.0 million credit facility with Comerica Bank which was renewed for a two-year
term in May 2003. The credit facility includes interest at 0.75% above prime (or 6.5% at March 31,
2005). We are in compliance with the earnings and financial covenants contained in our credit
agreement. We expect to renew the credit facility in July 2005. We believe that our existing
capital resources and our credit line will be sufficient to fund our operations and capital
requirements for the next 12 months. Contractual Obligations We have entered into certain long-term contractual obligations that will require various
payments over future periods as follows: Contractual Cash Obligations(In thousands of dollars)Payments due by Period as of March 31, 2005Less than
    
    
    
    
    
    
    
    
    
    
    AfterTotal
    
    
    1 year
    
    
    1-3 years
    
    
    3-5 years
    
    
    5 yearsLong-Term Debt
Obligations
    
    $
    0
    
    
    $
    0
    
    
    $
    0
    
    
    $
    0
    
    
    $
    0Capital Lease Obligations
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0Operating Lease Obligations
    
    
    336
    
    
    
    119
    
    
    
    217
    
    
    
    0
    
    
    
    0Purchase Obligations
    
    
    1,496
    
    
    
    1,496
    
    
    
    0
    
    
    
    0
    
    
    
    0Other Long-Term Liabilities
Reflected on the
Companys Balance Sheet under
GAAP
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0Total
    
    $
    1,832
    
    
    $
    1,615
    
    
    $
    217
    
    
    $
    0
    
    
    $
    0
 - 17 -




---



##### Table of Contents



CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS AND RISK FACTORS Forward Looking Statements This Report on Form 10-Q, including documents incorporated herein by reference, contains
forward-looking statements within the meaning of the Private Securities Litigation Reform Act of
1995. The words believe, expect, estimate, anticipate, intend, may, might, will,
would, could, project and predict, or similar words and phrases generally identify
forward-looking statements. Forward looking statements contained herein and in documents
incorporated by reference herein include, but are not limited to statements regarding:  
    our anticipation that we will continue to incur approximately $1.0 to $1.5 million in
legal expense each quarter as a result of the Zicam Cold Remedy product liability and
securities litigation in which we are engaged;
    our intention to vigorously defend the Zicam Cold Remedy product liability and
securities litigation claims, our expectation that additional product liability lawsuits
will be filed against us, and our belief that any liability resulting from these or other
lawsuits, including any adverse publicity, could materially impact our financial results;
    our expectations regarding 2005 net sales and net income and our expectations for the
second quarter of 2005;
    our belief that new advertising approaches and public relations efforts will continue to
build brand awareness;
    our expectation that the trend of growth in sales in future periods will continue as we
expand consumer awareness and acceptance of our entire Zicam brand of products, increase
distribution, introduce new products, and avoid additional adverse publicity;
    our expectation regarding future net income, our belief that expenditures for
advertising and research and development will vary by quarter throughout the year, and our
expectation that advertising expenses will be heaviest in our first and fourth fiscal
quarters;
    our anticipation that initial sales and shipments of the Nasal Comfort brand will begin
in the third quarter of 2005;
    our belief that our new brand, Nasal Comfort, will gain consumer acceptance and retail distribution;
    our expectation of the effect of recently issued accounting standards;
    our expectation that our mix of products sold will change due to seasonality and varying
growth rates within our three market categories;
    our expectation of expanding distribution of our products among our 10 largest retailers;
    our expectation of continuing profitability in future years;
    our intention to review our product return reserve provision monthly and adjust the
reserve amounts as actual product return experience continues to develop, and our
expectation that a higher sales returns allowance will be recorded in the future for new
products that we introduce until such products achieve market acceptance;
    our intention to evaluate and adjust as appropriate the deferred tax valuation allowance
and expectation of realizing the tax benefit arising from our tax loss carryforward;
    our expectation that the average unit cost of goods sold and gross margin will continue
to be affected by the relative mix of products sold;
    our expectation of achieving a 70% gross margin for the year;
    our expectation that our net income and operating expenses in future periods will vary
largely in connection with the level of our advertising, research and development, and
legal expenses;
    our expectation that research and development spending will be between 4-6% of net sales
for 2005 and in subsequent years; - 18 -




---



##### Table of Contents




    our expectation that earnings in future periods will be significantly impacted by the
seasonality of our sales, the severity of the cold season, the revenues and expenses
associated with new products, and the timing and amount of advertising, research and
development, and legal expenses;
    our Scientific Advisory Boards plan to do further testing of the zinc gluconate nasal
gel on human volunteers and animal models, and our expectation that members of the
Scientific Advisory Board will reconvene in the first half of 2005 to review the findings
of such research;
    our belief that our existing capital resources and our credit line will be sufficient to
fund our operations and capital requirements for the next 12 months;
    our belief that we may need to commit an additional $5 million to the self-funded insurance program;
    our belief that our insurance coverage is adequate;
    our having no plans to directly manufacture and store our products; and
    our belief that moderate interest rate increases will not have a material adverse impact
on our results of operations or financial position in the foreseeable future. We may make additional written or oral forward-looking statements from time to time in filings
with the SEC or in public news releases. Such additional statements
may include, but not be limited to, projections of revenues, income or loss, capital expenditures,
acquisitions, plans for future operations, financing needs or plans, the impact of inflation and
plans relating to our products or services, as well as assumptions relating to the foregoing.
Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot
be predicted or quantified. Future events and actual results could differ materially from those
set forth in, contemplated by, or underlying our forward-looking statements. Statements in this Report on Form 10-Q, including those set forth in the section entitled
Managements Discussion and Analysis of Financial Condition and Results of Operations, and under
the subheading Risk Factors, describe factors that could contribute to or cause actual results to
differ materially from our expectations. Other such factors include (i) less than anticipated
demand for our current and future products, (ii) a weak cough and cold season, (iii) lack of market
acceptance for or uncertainties concerning the efficacy or safety of our current and future
products or regulatory actions involving our products, (iv) difficulties in increasing production
or maintaining sufficient inventories to meet unexpectedly high demand in the short term, (v)
financial difficulties encountered by one or more of our principal customers, (vi) difficulties in
obtaining additional capital for marketing, research and development, and other expenses, (vii)
material litigation involving patent and contractual claims, product liability claims, consumer
issues and securities violation claims, and (viii) adverse publicity regarding our products or
advertising restrictions. Forward-looking statements contained in this Report on Form 10-Q speak only as of the date of
this Report on Form 10-Q or, in the case of any document incorporated by reference, the date of
that document. We do not
undertake, and we specifically disclaim any obligation, to publicly update or revise any
forward-looking statement contained in this Report on Form 10-Q or in any document incorporated
herein by reference to reflect changed assumptions, the occurrence of unanticipated events or
changes to future operating results over time. Risk Factors We may continue to incur significant costs resulting from product liability claims or
securities litigation We are subject to significant liability should use or consumption of our products cause
injury, illness or death. Presently, we are being sued by approximately 350 individuals in 36
different product liability lawsuits (two of which have been filed as class action lawsuits,
although one of the class action suits has been dismissed) relating to our Zicam Cold Remedy
product. Various defendants in the lawsuits, including manufacturers and retailers, have sought
indemnification or other recovery from us for damages related to the lawsuits. Although we carry
product liability insurance, we cannot be sure that our insurance will be adequate to protect us
against product liability claims or that insurance coverage will continue to be available. Product
liability claims, such as those described in our Annual Report on
Form 10-K for the year end December 31, 2004 fiscal
year and in this Report on Form 10-Q, even if without merit or for which we have substantial
coverage, could result in significant legal defense costs, thereby increasing our expenses and
lowering our earnings. Such claims, whether or not proven to be valid, could have a material
adverse effect on our product branding and goodwill, resulting in reduced market acceptance of our
products. In addition, any adverse decision in such litigation could require significant damages
to be paid or result in adverse publicity, either of which could materially adversely affect our
results of operations and financial condition. Separately, the Company and three of its officers
are also subject to two class action lawsuits (which have been consolidated) - 19 -




---



##### Table of Contents



alleging violations of
securities laws. In accordance with and subject to the provisions of
our Certificate of Incorporation, we have agreed to indemnify these
officers for their expenses incurred in defending these lawsuits and
for any other losses which they may suffer as a result of these
lawsuits. Any adverse decision in such litigation could materially adversely affect our
results of operations and financial condition. Our new business focus means we have a limited operating history on which to assess our current and
prospective performance Although we have been in operations for a number of years, the significant change of direction
and focus in our business that we made in 2001 by exiting the chewing gum business and refocusing
entirely on the development, production and sale of over-the-counter pharmaceutical products
presents a limited operating history upon which you may evaluate our current and prospective
performance. The possibility of our future success must be considered relative to the problems,
challenges, complications and delays frequently encountered in connection with the development and
operation of a new business, and the development and marketing of relatively new products such as
the Zicam products. If our products do not gain widespread market acceptance or receive additional adverse publicity,
our anticipated sales and results of operations will suffer Although we believe that each of our products offers unique benefits to consumers, we cannot
be certain that any of the products will achieve or continue to enjoy widespread acceptance by the
market. While we are working to increase the market presence of all of our products, including new
products, we cannot be certain that demand for our products will grow. If problems arise
concerning the efficacy or safety of any of our products, or if any of our products receives
additional adverse publicity, or if any of our products fails to achieve widespread market
acceptance for any other reason, our operating results and prospects would be materially adversely
affected. Our results could also be affected by fluctuations in buying patterns and inventory
levels of major customers. Unanticipated problems associated with product development and commercialization could adversely
affect our operating results Our successful development of existing and new products is subject to the risks of failure and
delay inherent in the development and commercialization of products based on innovative
technologies. These risks include the possibilities that:  
    we may experience unanticipated or otherwise negative research and development results;
    existing or proposed products may be found to be ineffective or unsafe, or may otherwise
fail to receive required regulatory clearances or approvals;
    we may find that existing or proposed products, while effective, are uneconomical to
commercialize or market;
    we may be unable to produce sufficient product inventories to meet customer demand;
    existing or proposed products do not achieve broad market acceptance;
    existing or proposed products do not attain broad distribution or retail shelf space; or
    proprietary rights held by third parties preclude us from developing or marketing
existing or proposed products. Our inability to develop and commercialize our existing products or any new products,
including our Nasal Comfort product, on a timely basis and within our financial budgets could have
a material adverse effect on our operating results and future prospects. Our inability to provide scientific proof for product claims may adversely affect our sales The marketing of our Zicam products involves claims that these products assist in reducing the
duration and severity of the common cold (in the case of Zicam Cold Remedy products) and
controlling allergy symptoms (in the case of Zicam Allergy Relief). Under Food and Drug
Administration (FDA) and Federal Trade Commission (FTC) rules, we are required to obtain
scientific data to support any health claims we make concerning our products. We have obtained
scientific data for our product claims, however, we cannot be certain that the scientific data we
have obtained in support of our claims will be deemed acceptable to the FDA, FTC or other
regulatory bodies. If any regulatory body requests supporting information and we are unable to
provide support that is acceptable, either the FDA or FTC could force us to stop making the claims
in question or restrict us from selling the affected products. - 20 -




---



##### Table of Contents



FDA and other government regulation may restrict our ability to sell our products We are subject to various federal, state and local laws and regulations affecting our
business. Our Zicam products are subject to regulation by the FDA, including regulations with
respect to labeling of products, approval of ingredients in products, claims made regarding the
products, and disclosure of product ingredients. If we do not comply with these regulations or if
these regulations change in the future, the FDA could force us to stop selling the affected
products or require us to incur substantial costs in adopting measures to maintain compliance with
these regulations. If the FDA came to believe that any of our products caused harm to consumers, we
could be required to stop selling that product or subject the product to a recall. Our advertising
claims regarding our products are subject to the jurisdiction of the FTC as well as the FDA. In
both cases we are required to obtain scientific data to support any advertising or labeling health
claims we make concerning our products, although no pre-clearance or filing is required to be made
with either agency. If we are unable to provide the required support for such claims, the FTC may
stop us from making such claims or require us to stop selling the affected products. We may fail to compete effectively, particularly against, larger more established pharmaceutical
and health products companies, or low cost generic drug manufacturers, causing our business and
operating results to suffer The consumer health products industry is highly competitive. We compete with companies with
sales in the United States that are engaged in the development of both traditional and innovative
healthcare products. Many of these companies have much greater financial and technical resources
and production and marketing capabilities than we do. As well, many of these companies have
already achieved significant product acceptance and brand recognition with respect to products that
compete directly with our Zicam and new products. Our competitors may successfully develop and
market superior or less expensive products which could render our Zicam and other future products
less valuable or unmarketable. If we are unable to protect our intellectual property or if we infringe the intellectual property
of others, our financial condition and future prospects could be materially harmed We rely significantly on the protections afforded by patent and trademark registrations that
we routinely seek from the U.S. Patent and Trademark Office (USPTO) and from similar agencies in
foreign countries. We cannot be certain that any patent or trademark application that we file will
be approved by the USPTO or other foreign agencies. In addition, we cannot be certain that we will
be able to successfully defend any trademark, trade name or patent that we hold against claims
from, or use by, competitors or other third parties. No consistent policy has emerged from the
USPTO or the courts regarding the breadth of claims allowed or the degree of protection afforded
under biotechnology and similar patents. Our future success will depend on our ability to prevent
others from infringing on our proprietary rights, as well as our ability to operate without
infringing upon the proprietary rights of others. We may be required at times to take legal action
to protect our proprietary rights and, despite our best efforts, we may be sued for infringing on
the patent rights of others. Patent litigation is costly and, even if we prevail, the cost of such
litigation could adversely affect our financial condition. If we do not prevail, in addition to
any damages we might have to pay, we could be required to stop the infringing activity or obtain a
license. We cannot be certain that any required license would be available to us on acceptable
terms, or at all. If we fail to obtain
a license, our business might be materially adversely affected. In addition to seeking patent
protection, we rely upon a combination of non-disclosure agreements, other contractual restrictions
and trade secrecy laws to protect proprietary information. There can be no assurance that these
steps will be adequate to prevent misappropriation of our proprietary information or that our
competitors will not independently develop technology or trade secrets that compete with our
proprietary information. We do not have manufacturing capabilities of our own We currently do not have the physical or human resources to independently manufacture our
Zicam products or any other products that we may develop. We currently outsource all of our
product manufacturing and packaging operations and intend to continue this outsourcing for the
foreseeable future. If we are unable to enter into cost-effective or otherwise suitable
arrangements for manufacturing of our Zicam products or any other products, or if our third-party
contractors fail to adequately perform their manufacturing operations (as occurred with our old
swab products), our sales and related financial results could be materially adversely affected.
If, in the future, we decide to establish our own manufacturing facilities, we will require
substantial additional funds and significant additional personnel to undertake such operations. We
cannot be certain that such funding or a sufficient number of such qualified persons will be
available for such an undertaking. We may experience product backlogs At the end of fiscal 2003, we had approximately $0.4 million in backlog of swab orders. This
backlog continued into March of fiscal 2004. We have undertaken significant measures to remedy the
manufacturing - 21 -




---



##### Table of Contents



problems that led to this backlog, including replacing our swab manufacturer and
redesigning our swab product to permit higher volume production. We have established inventory
plans to support sales expectations for all of our products. However, we cannot be certain that
these measures will be sufficient to prevent future backlog of the swab product or that other
product backlogs will not occur in the future. Any such future backlogs will potentially result in
higher production costs, higher freight costs to expedite shipment of raw materials and finished
goods, fines from certain retailers, cancelled orders and lost opportunity costs. These in turn
could materially affect our results of operations and financial condition. Loss of key personnel Our success depends on the continued services of our senior management and key employees as
well as our ability to attract additional members to our management team with experience in the
consumer health products industry. The unexpected loss of the services of any of our management or
other key personnel, or our inability to attract new management when necessary, could have a
material adverse effect upon our operations. Our board of directors is authorized to issue shares of preferred stock that could have rights
superior to our outstanding shares of common stock, and, if issued, could adversely impact the
value of our common stock Our certificate of incorporation permits our board of directors, in its sole discretion, to
issue up to 2,000,000 shares of authorized but unissued preferred stock. These shares may be
issued by our board without further action by our shareholders, and may include any of the
following rights (among others) as our board may determine, which rights may be superior to the
rights of our outstanding common stock:  
    voting rights, including the right to vote as a class on particular matters;
    preferences as to dividends and liquidation rights;
    conversion rights;
    anti-dilution protections; and
    redemption rights Since our board of directors has the authority to determine, from time to time, the terms of
our authorized preferred stock, there is no limit on the amount of common stock that could be
issuable upon conversion of any future series of preferred stock that may be issued. The rights of
holders of our common stock will be subject to, and may be adversely affected by, the rights of the
holders of any series of preferred stock that may be issued in the future. In addition, the market
price of our common stock may be adversely affected by the issuance of any series of preferred
stock with voting or other rights superior to those of our common stock. The issuance of any
series of preferred stock could also have the effect of making it more difficult for a third party
to acquire a majority of our outstanding common stock. The price of our stock may continue to be volatile The market price of our common stock, which is quoted for trading on the Nasdaq National
Market, has been highly volatile and may continue to be volatile in the future. Any or a
combination of the following factors could cause the market value of our common stock to decline
quickly: operating results that differ from market expectations, negative or other unanticipated
results of clinical trials or other testing, delays in product development, technological
innovations or commercial product introductions by our competitors, changes in government
regulations, developments concerning proprietary rights, including pending or threatened patent
litigation, public concerns regarding the safety of any of our products, the outcome of litigation
against the Company, and general economic and stock market conditions. The stock market has
experienced, and it may continue to experience, significant price and volume fluctuations.
Historically, these fluctuations particularly affect the market prices of equity securities of
small capitalization companies, like Matrixx. Often, the effect on the price of such securities is
disproportionate to the operating performance of such companies. In addition, we believe our stock
price may fluctuate as investors increase and cover short positions in the stock. In our case, such
fluctuations may adversely affect our stockholders ability to dispose of their shares of Matrixx
at a price equal to or above the price at which they purchased such shares. 
 Item 3. Quantitative and Qualitative Disclosures about Market Risk Our primary market risk exposure relates to our variable rate revolving line of credit
with Comerica Bank. At no time during the first quarter of fiscal 2005 did we have any outstanding
balance against this line of credit. In July - 22 -




---



##### Table of Contents



2004, we borrowed $2 million against our credit
facility with Comerica Bank. The primary purpose for the borrowing was to provide additional
liquidity as we built inventory for expected increases in sales during the second half of 2004. We
generally extend payment terms for customers during the third quarter as customers purchase new
products and build inventory for the upcoming cough and cold season. We repaid the debt in the
fourth quarter of 2004 and ended fiscal 2004 with no debt. Consequently, we believe that moderate
interest rate increases will not have a material adverse impact on our results of operations or
financial position in the foreseeable future. As of March 31, 2005 and December 31, 2004, we did not participate in any market
risk-sensitive commodity instruments for which fair value disclosure would be required under
Statement of Financial Accounting Standards No. 107. We believe that we are not subject in any
material way to other forms of market risk, such as foreign currency exchange risk or foreign
customer purchases (of which there were none in fiscal 2004 or the period ended March 31, 2005) or
commodity price risk. 
 Item 4. Controls and Procedures We carried out an evaluation, under the supervision and with the participation of our
Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and
operation of our disclosure controls and procedures pursuant to Rules 13a-15 and 15d-15 of the
Securities Exchange Act of 1934. Based upon that evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that, as of the end of the period covered by this report, our
disclosure controls and procedures are effective in timely alerting them to material information
relating to the Company and required to be included in our periodic SEC filings. There were no
significant changes in our internal controls over financial reporting during our most recently
completed quarter that have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting, or other factors that could significantly affect these
controls subsequent to the date of their evaluation, and there were no corrective actions taken
with regard to significant deficiencies or material weaknesses in our controls. 
 PART II OTHER INFORMATION 
 Item 1. Legal Proceedings See Note 7 of the Condensed Consolidated Financial Statements for a discussion of the
principal legal proceedings to which the Company or its officers are
parties. 
 Item 6. Exhibits Exhibit No.
    
    Title3.01
    
    Articles of Incorporation and Amendments thereto of the registrant (1)3.02
    
    Bylaws of the registrant (1)4.01
    
    Rights Agreement dated as of July 22, 2002 by and between the registrant and
Corporate Stock Transfer, Inc. (2)31.1*
    
    Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2*
    
    Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 200232.1*
    
    Certification of CEO pursuant to 18 U.S.C. Section 135032.2*
    
    Certification of CFO pursuant to 18 U.S.C. Section 1350
   *Filed with this Report on Form 10-Q. - 23 -




---



##### Table of Contents



(1)
    Incorporated by reference to the registrants Amendment No. 1 to Form 8-A,
filed June 18, 2002, file number 000-27646.(2)
    Incorporated by reference to the registrants registration statement on Form
8-A, filed July 23, 2002, file number 000-27646. - 24 -




---



##### Table of Contents



SIGNATURES In accordance with the requirements of the Securities Exchange Act of 1934, the
registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized. Matrixx Initiatives, Inc./s/ Carl J. JohnsonCarl J. JohnsonPresident andChief Executive Officer/s/ William J. HemeltWilliam J. HemeltExecutive Vice President,Chief Financial Officer, &Treasurer
 May 10, 2005 - 25 -