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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
 
 Form 10-Q (Mark One)  [X] Quarterly Report pursuant to Section 13 or15(d)of the Securities
Exchange Act of 1934 For the quarter ended March 31, 2004 or  [   ] Transition 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
(State or other jurisdiction
of incorporation or organization)
    
    87-0482806
(I.R.S. Employer
Identification Number)
 4742 N. 24th Street, Suite 455
Phoenix, AZ 85016
(Address of principal executive offices) (602) 385-8888
(Issuers telephone number) 2375 East Camelback Road, Suite 500
Phoenix, Arizona 85016 (Former Name or Former Address, if Changed Since Last Report) 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 o NO þ There were 9,459,701 shares of the registrants common stock, $.001 par value,
outstanding as of May 13, 2004.




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MATRIXX INITIATIVES, INC.
FORM 10-Q INDEX
 PagePART I
    
    FINANCIAL INFORMATIONItem 1.
    
    Condensed Consolidated Balance Sheet as of March 31, 2004 and December 31, 2003
    
    
    1Condensed Consolidated Statements of Operations for the three months ended March 31, 2004 and 2003
    
    
    3Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and 2003
    
    
    4Notes to Condensed Consolidated Financial Statements
    
    
    5Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    9Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    21Item 4.
    
    Controls and Procedures
    
    
    22PART II
    OTHER INFORMATIONItem 1
    
    Legal Proceedings
    
    
    22Item 2
    
    Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    24Item 4
    
    Submission of Matters to a Vote of Security Holders
    
    
    24Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    24SIGNATURES
    
    
    
    
    26Exhibit 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 and
Oral Mist, Cough Mist and
RapidMelts are trademarks of our subsidiary, Zicam,
LLC. The Matrixx name and logo are trademarks of the Company.




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MATRIXX INITIATIVES, INC. AND SUBSIDIARY 
 CONDENSED CONSOLIDATED BALANCE SHEETS
  ASSETS March 31, 2004
    
    December 31, 2003Current Assets:Cash and cash equivalents
    
    $
    13,038,120
    
    
    $
    10,682,614Accounts receivable:Trade, net allowance for doubtful
accounts of $636,228 and $601,357
    
    
    4,253,933
    
    
    
    11,471,511Inventories
    
    
    4,715,562
    
    
    
    3,267,604Prepaid expenses and other
    
    
    379,236
    
    
    
    615,790Deferred tax asset
    
    
    2,450,178
    
    
    
    2,829,556Total Current Assets
    
    
    24,837,029
    
    
    
    28,867,075Property and Equipment, at cost:Office furniture and equipment
    
    
    751,509
    
    
    
    681,528Machine Tooling
    
    
    150,000
    
    
    
    150,000Leasehold improvements
    
    
    115,545
    
    
    
    37,2021,017,054
    
    
    
    868,730Less accumulated depreciation
    
    
    (262,515
    )
    
    
    (247,728
    )Net Property and Equipment
    
    
    754,539
    
    
    
    621,002Other Assets:Deposits
    
    
    348,516
    
    
    
    212,697Deferred tax asset
    
    
    4,351,810
    
    
    
    4,351,810Patents, net of accumulated amortization of $155,550
and $138,780
    
    
    968,050
    
    
    
    984,820Goodwill
    
    
    15,039,836
    
    
    
    15,039,836Total Other Assets
    
    
    20,708,212
    
    
    
    20,589,163Total Assets
    
    $
    46,299,780
    
    
    $
    50,077,240
 The accompanying notes are
an integral part of these condensed consolidated financial statements. 1




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MATRIXX INITIATIVES, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(Continued)
(Unaudited) LIABILITIES AND STOCKHOLDERS EQUITY March 31, 2004
    
    December 31, 2003Current Liabilities:Accounts payable and accrued expenses
    
    $
    4,681,883
    
    
    $
    9,552,218Sales returns and allowances
    
    
    1,928,305
    
    
    
    1,734,568Total Current Liabilities
    
    
    6,610,188
    
    
    
    11,286,786Long-Term Debt, net of current portion above:Financial institutions and other
    
    
    
    
    
    
    Less current portion above
    
    
    
    
    
    
    Total Long-Term Debt
    
    
    
    
    
    
    Commitments and contingencies
    
    
    
    
    
    
    Stockholders 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, 9,499,601 and 9,474,601 shares
issued and outstanding
    
    
    9,500
    
    
    
    9,475Additional paid in capital
    
    
    42,295,664
    
    
    
    41,993,189Accumulated deficit
    
    
    (2,376,349
    )
    
    
    (2,972,987
    )39,928,815
    
    
    
    39,029,677Less common stock held in treasury, at cost
(35,900 and 35,900 shares)
    
    
    (239,223
    )
    
    
    (239,223
    )Total Stockholders Equity
    
    
    39,689,592
    
    
    
    38,790,454Total Liabilities and Stockholders Equity
    
    $
    46,299,780
    
    
    $
    50,077,240
 The accompanying notes are
an integral part of these condensed consolidated financial statements. 2




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MATRIXX INITIATIVES, INC. AND SUBSIDIARY 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
  Three months ended March 31,2004
    
    2003Net sales
    
    $
    12,932,566
    
    
    $
    8,901,675Cost of sales
    
    
    4,099,225
    
    
    
    2,649,045Gross Profit
    
    
    8,833,341
    
    
    
    6,252,630Operating expenses
    
    
    7,416,576
    
    
    
    5,692,531Research and development
    
    
    470,469
    
    
    
    310,762Income From Operations
    
    
    946,296
    
    
    
    249,337Other Income (Expense):Interest and other income
    
    
    45,832
    
    
    
    36,959Interest and other expense
    
    
    
    
    
    
    (85,835
    )Total Other Income (Expense)
    
    
    45,832
    
    
    
    (48,876
    )Income Before Provision (Benefit) For Income Taxes
    
    
    992,128
    
    
    
    200,461Provision (benefit) for income taxes
    
    
    395,490
    
    
    
    83,107Net Income
    
    $
    596,638
    
    
    $
    117,354Net Income Per Share of Common Stock:Basic:Weighted Average Number of Common Shares Outstanding
    
    
    9,489,216
    
    
    
    9,429,397Net Income Per Share of Common Stock
    
    $
    0.06
    
    
    $
    0.01Diluted:Weighted Average Number of Common Shares Outstanding
    
    
    9,527,974
    
    
    
    9,435,712Net Income Per Share of Common Stock
    
    $
    0.06
    
    
    $
    0.01
 The accompanying notes are
an integral part of these condensed consolidated financial statements. 3




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MATRIXX INITIATIVES, INC. AND SUBSIDIARY 
 CONDENSED STATEMENTS OF CASH FLOWS
  Three months ended March 31,2004
    
    2003Cash Flows From Operating Activities:Net income
    
    $
    596,638
    
    
    $
    117,354Adjustments to reconcile net income to net cash provided
by operating activities:Depreciation
    
    
    14,787
    
    
    
    36,183Amortization
    
    
    16,770
    
    
    
    16,770Amortization of imputed interest on notes payable
    
    
    
    
    
    
    85,835Amortization of debt issuance costs
    
    
    
    
    
    
    8,750Deferred income taxes
    
    
    379,378
    
    
    
    82,155Other
    
    
    
    
    
    
    2,401Changes in assets and liabilities:Accounts receivable
    
    
    7,217,578
    
    
    
    2,676,900Inventories
    
    
    (1,447,958
    )
    
    
    (232,658
    )Prepaid expenses and other
    
    
    236,554
    
    
    
    222,926Accounts payable and accrued expenses
    
    
    (4,870,335
    )
    
    
    (2,623,463
    )Sales returns and allowances
    
    
    193,737
    
    
    
    (62,760
    )Net Cash Provided By Operating Activities
    
    
    2,337,149
    
    
    
    330,393Cash Flows From Investing Activities:Capital expenditures
    
    
    (148,324
    )
    
    
    (40,849
    )Deposits and other
    
    
    (135,819
    )
    
    
    Net Cash Provided (Used) By Investing Activities
    
    
    (284,143
    )
    
    
    (40,849
    )Cash Flows From Financing Activities:Purchase of treasury stock
    
    
    
    
    
    
    (77,512
    )Issuance of common stock
    
    
    302,500
    
    
    
    Net Cash (Used) By Financing Activities
    
    
    302,500
    
    
    
    (77,512
    )Net Increase in Cash and Cash Equivalents
    
    
    2,355,506
    
    
    
    212,032Cash and Cash Equivalents at Beginning of Period
    
    
    10,682,614
    
    
    
    12,010,091Cash and Cash Equivalents at End of Period
    
    $
    13,038,120
    
    
    $
    12,222,123Supplemental Disclosure of Cash Flow Information:Cash paid during the period for:Interest
    
    $
    
    
    
    $
    Income taxes
    
    
    222,751
    
    
    
    950
 The accompanying notes are
an integral part of these condensed consolidated financial statements. 4




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MATRIXX INITIATIVES,
INC. 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
   1.
    
    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 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, 2004 are not necessarily indicative
of results of operations that may be expected for the year ending December
31, 2004. 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, 2003 previously filed with the
Securities and Exchange Commission.2.
    
    Stock-Based CompensationThe 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 123. The
Company will continue to measure compensation expense for its stock-based
employee compensation plans using the intrinsic value method prescribed by
APB Opinion No. 25, Accounting for Stock Issued to Employees and related
interpretations in accounting for its plans and does not recognize
compensation expense for its stock-based compensation plans other than for
options granted to non-employees. 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 earnings per share
would be reduced to the following pro forma amounts: 5




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MATRIXX INITIATIVES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  Three Months EndedMarch 31,2004
    
    2003Net income (loss) applicable to common shareholders, as reported
    
    $
    596,638
    
    
    $
    117,354Less stock based employee compensation expense determined
under fair value based methods for all awards, net of
related tax effects
    
    
    361,379
    
    
    
    158,015Pro forma Net Income (Loss)
    
    $
    235,259
    
    
    $
    (40,661
    )Net income per share of common stock:Basic:As reported
    
    $
    .06
    
    
    $
    .01Pro forma
    
    $
    .02
    
    
    $
    Diluted:As reported
    
    $
    .06
    
    
    $
    .01Pro forma
    
    $
    .02
    
    
    $
    
  During the quarter ended March 31, 2004, 50,000 options to purchase shares
of common stock of the Company were granted to non-employee board members at an exercise
price of $18.02 per share. Half of the options are vested and the second
half vest on January 2, 2005. Also during the quarter ended March 31, 2004,
240,000 options to purchase shares of common stock of the Company were
granted to officers and other employees at an exercise price of $17.90 per share. The options
granted to employees vest over three years with one-third vesting annually
on January 15, 2005, 2006, and 2007. During the quarter ended March 31,
2004, 25,000 options were exercised for total proceeds to the Company of
$302,500.3.
    
    As of December 31, 1997, Matrixx adopted 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 dilutive effect of outstanding stock options 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,
2004 and 2003. Options, warrants and other incremental shares to purchase
626,800 and 379,300 shares of common stock at March 31, 2004 and 2003,
respectively, were not included in the computation of diluted earnings per
share because their effect would be anti-dilutive. 6




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MATRIXX INITIATIVES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  Three Months Ended March 31,2004
    
    2003Net income applicable to common shareholders
    
    $
    596,638
    
    
    $
    117,354Weighted average common shares outstanding:Weighted average common shares
outstanding  Basic
    
    
    9,489,216
    
    
    
    9,429,397Dilutive securities
    
    
    38,758
    
    
    
    6,315Weighted average common shares
outstanding  Diluted
    
    
    9,527,974
    
    
    
    9,435,712Net income per common share:Basic
    
    $
    0.06
    
    
    $
    0.01Diluted
    
    $
    0.06
    
    
    $
    0.01
  4.
    
    Inventories consisted of the following at March 31, 2004: Raw materials and packaging
    
    $
    1,793,497Finished goods
    
    
    3,120,161Less reserve for obsolescence
    
    
    (198,096
    )Total
    
    $
    4,715,562
 5. Recently Issued Accounting Standards In November 2002, the FASB issued Financial Interpretation No. (FIN) 45,
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. Among other things, the
Interpretation requires guarantors to recognize, at fair value, their
obligations to stand ready to perform under certain guarantees. FIN 45 became
effective for guarantees issued or modified on or after January 1, 2003 and had
no effect on our financial position or results of operations. In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest
Entities. In general a variable entity is a corporation, partnership, trust,
or any other legal structure used for business purposes that either (a) does
not have equity investors with voting rights or (b) has equity investors that
do not provide sufficient financial resources for the entity to support its
activities. FIN 46 requires a variable interest entity to be consolidated by a
company if that company is subject to a majority of the risk of loss from the
variable interest entitys activities or entitled to receive a majority of the
entitys residual returns or both. The consolidation requirements of FIN 46
apply immediately to variable interest entities created after January 31, 2003.
The consolidation requirements apply to transactions entered into prior to
February 1, 2003 in the first fiscal year or interim period beginning after
June 15, 2003, which was subsequently delayed until the fourth quarter of 2003.
Certain of the disclosure requirements apply in all financial 7




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MATRIXX INITIATIVES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) statements issued after January 31, 2003, regardless of when the variable
interest entity was established. The adoption of the interpretation did not
have any impact on our financial statements. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities, which amends and clarifies
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities under SFAS No. 133.
The Statement is effective (with certain exceptions) for contracts entered into
or modified after June 30, 2003. The adoption of this Statement had no effect
on our financial position or results of operations. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. It requires
that an issuer classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). It is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period after June 15, 2003.
The adoption of SFAS No. 150 on July 1, 2003 had no effect on our financial
position or results of operations.  6.
    
    New insurance Program In
April 2004, the Company established a fully-funded deductible insurance program
through a product liability insurance carrier. Under the program, the
Company has
agreed to reimburse its insurer for the insurers 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 the Company to maintain an
irrevocable, evergreen letter of credit issued by a bank or other financial
institution to secure the Companys reimbursement obligations to
its insurer. The Company has arranged a $5.0 million letter of
credit with Comerica Bank and has reserved
an equal amount of cash to secure repayments of amounts that become due under
the letter of credit. 8




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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 the third quarter of 2003 we began
shipping three new Zicam Cold Remedy products  Oral Mist, Chewables and
RapidMelts. At our annual meeting of shareholders held on April 28, 2004, we
announced 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, Cough Mist Kids Plus Decongestant  that we
intend to begin shipping to retailers in the third quarter of 2004. Executive Summary Net sales for the first quarter of fiscal 2004 increased 45% to $12.9
million compared to $8.9 million for the first quarter of fiscal 2003.
Approximately 56% of the increase was attributable to sales of our three new
Zicam oral delivery products introduced in the third quarter of 2003. Net
income for the first quarter of fiscal 2004 increased 408% to $597,000 compared
to $117,000 for the first quarter of last year. 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 litigation. Our expected growth in annual sales
will depend on our success in securing additional retail distribution of our
products, including the six new Zicam Cough Mist products that we plan to begin
shipping in the third quarter of 2004, and upon expanding consumer awareness
and acceptance of our entire line of Zicam products. Expenditures for
advertising, research and development and legal expenses will vary by quarter
throughout the year and could be significantly different from amounts incurred
in the same periods in prior years. We expect advertising expenses to be
heaviest in our first and fourth fiscal quarters in conjunction with the cough
and cold season. Management reviews several key performance indicators. First, we compare
our annual sales and net income performance against our stated goal of 30%
annual growth for each. For the quarter ended March 31, 2004, we exceeded both
goals. We also monitor our share of the cough and cold market. For the
quarter ended March 31, 2004, sales of our products (as measured by three
outlet syndicated scanner data, excluding Wal-Mart) increased 41% over the
comparable period a year ago while the entire cough and cold market industry
experienced a 4% decline from the same period. We also measure our ability to
maintain strong gross margins on our products. During the first quarter of
fiscal 2004, our products averaged a gross margin of 68%, which was slightly
below our target of 70% due to the higher cost of the old swab product and the
mix of products sold. In the first quarter of fiscal 2003, our gross margin
was 70%. In addition, 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 first quarter of fiscal 2004, 9




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our operating expenses were 57% of our net sales compared to 64% for the
first quarter of fiscal 2003. Finally, we review the distribution of our
products by key national retailers. In the first quarter of fiscal 2004, our
15 largest customers carried, on average, 7.6 of our 10 Zicam products,
compared to 4.3 of our 7 products in the first quarter of fiscal 2003. We
expect to expand the distribution of our existing products and add distribution
of our new products among these retailers during the balance of fiscal 2004. Critical Accounting Policies and Estimates Our consolidated financial statements and accompanying notes have been
prepared in accordance with generally accepted accounting principles applied on
a consistent basis. The preparation of financial statements in conformity with
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,
accounting for returns and allowances associated with our products 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 142, goodwill must be tested
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 evaluation of goodwill
was completed in the third quarter of 2003 by an independent valuation firm and
no impairment was found. Accounting for 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 10




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expense of approximately $3.4 million in 2002. In 2003 and the first
quarter of 2004, we recorded income tax expense based on our estimated
effective income tax rate 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 on a
quarterly basis. Should there be a significant change in our expectations of
future income, the impact of adjusting the deferred tax valuation allowance
could be significant which would negatively impact our earnings. Accounting for Customer Returns and Allowances:We recognize revenues on
the sale of our products when they are shipped from our warehouse facility, and
at that time record a provision for estimated product 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 the liability associated
with product returns. To date, our sales returns experience has been
consistent with our estimate for returns, except for returns of outdated
products arising from excess production during the introduction of Zicam Cold
Remedy in the 1999-2000 cold season, which resulted in out-of-date product two
years later. Currently, we are recording a provision of 3% of gross sales for
the seven Zicam products introduced in 2002 or earlier for potential returns
and allowances. In establishing the appropriate reserve level for the three
new Zicam products introduced in the third quarter of 2003, we reviewed the
similarities and differences of the three products relative to the seven Zicam
products for which we now have several years of product return experience.
Based on that review, we 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 in the future for the six new Zicam Cough Mist products that we intend
to being shipping to retailers in the third quarter of fiscal 2004 and 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
over 168 individuals in 12 different lawsuits (two of which have not yet been
served against us) generally alleging that our Zicam Cold Remedy product caused
damage to the sense of smell and/or taste. A class action lawsuit has also
been filed (but not yet served) against us, our President and Chief Executive
Officer, Carl Johnson, and our Executive Vice President and Chief Financial
Officer, William J. Hemelt, alleging violation of federal securities laws.
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. 11




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Results of Operations for the Three Months Ended March 31, 2004 Compared to the
Three Months Ended March 31, 2003 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 31,2004
    
    2003Net sales
    
    $
    12,932,566
    
    
    
    100
    %
    
    $
    8,901,675
    
    
    
    100
    %Cost of sales
    
    
    4,099,225
    
    
    
    32
    
    
    
    2,649,045
    
    
    
    30Gross profit
    
    
    8,833,341
    
    
    
    68
    
    
    
    6,252,630
    
    
    
    70Operating expenses
    
    
    7,416,576
    
    
    
    57
    
    
    
    5,692,531
    
    
    
    64Research and development
    
    
    470,469
    
    
    
    4
    
    
    
    310,762
    
    
    
    3Income from operations
    
    
    946,296
    
    
    
    7
    
    
    
    249,337
    
    
    
    3Interest and other income
    
    
    45,832
    
    
    
    
    
    
    
    36,959
    
    
    
    Interest expense
    
    
    0
    
    
    
    
    
    
    
    85,835
    
    
    
    1Income before income taxes
    
    
    992,128
    
    
    
    8
    
    
    
    200,461
    
    
    
    2Provision for income taxes
    
    
    395,490
    
    
    
    3
    
    
    
    83,107
    
    
    
    1Net Income
    
    $
    596,638
    
    
    
    5
    %
    
    $
    117,354
    
    
    
    1
    %
 Net Sales.Net sales for the three months ended March 31, 2004 increased
to approximately $12.9 million, or almost 45% above net sales in the first
quarter of the prior year. Approximately 56% of the increase in net sales was
attributable to sales of the three new Cold Remedy products that we began
shipping in the third quarter of 2003, in particular, Zicam Cold Remedy Oral
Mist, Zicam Cold Remedy Chewables, and Zicam Cold Remedy Rapid Melts.
Approximately 24% of the increase in net sales was attributable to increased
sales of our Zicam Allergy Relief product. The remainder of the increase was
attributable to increased sales of our six other Zicam products. Together,
sales of these six products grew at a combined rate of 19% above sales for the
first quarter of 2003. We continue to expect sales growth for the full 2004
fiscal year of 30% above our 2003 sales levels. During the first half of the quarter ended March 31, 2004, we experienced
a backlog for Zicam Cold Remedy Swabs  Adult Size due to the inability of our
original contract manufacturer, Innovative Swab Technologies, to meet its
production obligations. The backlog situation was relieved in mid-February
2004 when our new contract manufacturer began shipping the redesigned Zicam
Cold Remedy Swabs  Adult size. We believe that the new contract manufacturer
of our redesigned swab product will be able to meet our requirements for the
2004-2005 cold season. Demand for our products is highly seasonal which
results in significant fluctuations in our quarterly sales throughout the year.
Generally, sales in the second quarter are significantly weaker than in other
quarters of the year. We expect increases in sales beginning in the third and
fourth quarters of 2004 from the six new Cough Mist products that we expect to
begin shipping in the third quarter of 2004, as well as continued growth in the
sales of our existing Zicam products. 12




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Cost of Sales.Our cost of sales increased to approximately $4.1 million,
or 55% above the first quarter 2003 cost of sales of approximately $2.7
million. Approximately 75% of the increase is due to the higher sales volume
and the remaining 25% is due to the mix of products sold. Our swabs and oral
delivery Cold Remedy products cost more per unit to manufacture than the nasal
gel product. Consequently, an increasing percentage of sales from swabs and
oral delivery Cold Remedy products results in a higher total unit cost. We
expect the unit cost of goods sold will continue to be affected by the relative
mix of products sold. Gross Profit.Gross profit for the first quarter of 2004 increased to
approximately $8.8 million, or 41% greater than the first quarter of 2003, due
to the substantial increase in units sold. However, the gross margin on
products sold declined from 70% to 68% due to the higher per-unit cost of the
swab products sold in 2004 and the relative mix of products sold. With the
introduction of the redesigned swab product, we expect to improve the gross
margin on the swabs. Operating Expenses.Operating expenses for the first quarter of 2004
increased to $7.4 million, or more than $1.7 million above the first quarter of
2003. The increase is primarily due to a $520,000 increase in advertising
expense ($4.3 million for the quarter ended March 31, 2004 versus $3.8 million
for the quarter ended March 31, 2003), and a $286,000 increase in expenses for
consumer research and public relations. Administrative expenses also increased
during the first quarter of 2004 compared to the same quarter in 2003 with
increases in legal fees of $293,000, audit fees of $73,000 and quality control
testing fees of $121,000. Labor and benefit expenses increased $144,000, along
with increased sales expense of $97,000, and insurance expense of $82,000. We
expect that legal expenses will increase in the second quarter of fiscal 2004
and, potentially, throughout the balance of fiscal 2004 as a result of the
Zicam Cold Remedy product liability and other related litigation in which we
are engaged (see Part II, Item 1  Legal Proceedings, in this Report on Form
10-Q). We expect that operating expenses in future periods will vary largely
in connection with the level of our advertising and
legal expenditures. Research and Development.Research and development expenses increased
from approximately $311,000 in the first quarter of 2003 to approximately
$470,000 in the first quarter of 2004. The increase reflects our previously
announced commitment to expand our research and development efforts to an
amount equal to approximately 6% of annual net sales. We intend to continue to
maintain research and development efforts at this rate in 2004 and for the
foreseeable future. Interest Expense.Interest expense for the first quarter of 2004
decreased to zero, $86,000 below the level of the first quarter of 2003. The
decrease is entirely attributable to the repayment of the debt that we incurred
in connection with the acquisition of the 40% interest in Zicam, LLC in
December 2001. This debt was fully repaid in November 2003. We currently have
no debt outstanding. Income Before Income Tax.Income before income tax in the first quarter
of 2004 increased to $992,128, or 395%, from $200,461 in the first quarter of
2003, primarily as a result of the higher level of sales. We expect that
earnings in future periods will continue to be significantly impacted by the
seasonality of our sales, revenues and expenses associated with 13




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new products and the timing and amount of advertising, research and
development and legal expenses. Based on our expectation of seasonally reduced
sales in the second quarter of fiscal 2004, we expect to record a loss for the
second quarter of fiscal 2004. Provision for Income Tax Expense.In 2004, we recorded a provision for
income tax expense based on an estimate of our effective income tax rate for
the full year. This reflects the determination that we made at the end of
fiscal 2002 that we would more likely than not be able to realize the benefit
of tax losses accumulated in prior years to offset taxable income in 2003 and
future years. Net Income. Net income increased $480,000 to approximately $597,000 for
the quarter ended March 31, 2004 compared to net income for the first quarter
2003 of $117,000. Based on our expectation of seasonally reduced sales in the
second quarter of fiscal 2004, we expect net income to be negative for the
second quarter of fiscal 2004, but continue to expect 30% net income growth for
the full 2004 fiscal year compared to fiscal 2003. Liquidity and Capital Resources Our working capital increased from approximately $17.6 million at December
31, 2003 to approximately $18.2 million at March 31, 2004. During the
three-month period ended March 31, 2004, we experienced an increase in cash
from operating activities of approximately $2.3 million. The increase in cash
from operations was due to net income of approximately $597,000 and various
non-cash charges to income of approximately $411,000. Also contributing to the
increase in cash from operations was a decrease in accounts receivable of $7.2
million, which is partially offset by a decrease in accounts payable of $4.9
million and an increase of inventories of $1.4 million. Investing activities used cash of approximately $284,000 primarily for
capital expenditures and leasehold improvements, as well as prepayments for
production of our redesigned swab product. Cash flows from financing
activities provided approximately $303,000 from the issuance of common stock
related to the exercise of options. 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
arranged 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. Currently we do not have any debt outstanding. We have a $2.5 million
credit facility with Comerica Bank which was renewed for a two-year term in May
2003. We do not currently have any borrowings outstanding under the facility
and do not presently anticipate borrowing under the facility to meet our
working capital requirements. We are in compliance with the earnings and
financial covenants contained in our credit agreement. We believe that our
existing 14




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capital resources and our credit line will be sufficient to fund our
operations and capital requirements for the next 12 months. CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS AND RISK FACTORS Forward Looking Statements This 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 belief that expected growth in sales will depend on our success
in securing additional retail distribution of our products, including
the three new Cold Remedy products that we began shipping in the third
quarter of 2003 and the six new Cough Mist products that we plan to
begin shipping in the third quarter of 2004;  
    
    our belief that sales in future periods will be affected by
expanding consumer awareness and acceptance of our entire Zicam brand
of products;  
    
    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 intention to review our product return reserve provision
regularly and adjust these 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 our six new
Zicam Cough Mist products and any other new products that we introduce
until such products achieve market acceptance;  
    
    our expectation that sales growth and net income for the full 2004
fiscal year will be 30% above our 2003 sales and net income levels;  
    
    our belief that our new contract manufacturer of our redesigned
swab product will be able to meet our requirements for the 2004-2005
cold season;  
    
    our belief that the unit cost of goods sold will continue to be
affected by the relative mix of products sold;  
    
    our expectation that the introduction of the redesigned swab
product, will improve the gross margin on the swab products.  
    
    our expectation that legal expenses will increase in the second
quarter of fiscal 2004 and, potentially, throughout the balance of
fiscal 2004 as a result of the Zicam Cold Remedy product liability and
other related litigation in which we are engaged; 15




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
    
    our expectation that operating expenses in future periods will vary
largely in connection with the level of our advertising and legal expenditures;  
    
    our expectation of continuing to commit 6% of net sales to research
and development efforts in 2004 and for the foreseeable future;  
    
    our expectation regarding increases in sales beginning in the third
and fourth quarters of 2004 from the six new Cough Mist products, as
well as continued growth in the sales of our existing Zicam products;  
    
    our expectation that earnings in future periods will continue to be
significantly impacted by the seasonality of our sales, revenues and
expenses associated with new products and the timing and amount of
advertising, research and development and legal expenses;  
    
    our expectation that we will record a loss in the second quarter of
fiscal 2004;  
    
    our intention to vigorously defend the Zicam Cold Remedy product
liability and other related lawsuits that have been filed against us,
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 related publicity, could
materially impact our financial results;  
    
    our belief that we will not need to borrow on our credit facility
to meet our working capital requirements;  
    
    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 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 Securities and Exchange Commission 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 below entitled Risk
Factors, describe factors that could contribute to or 16




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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) lack of market acceptance for or uncertainties concerning
the efficacy or safety of our current and future products or regulatory actions
involving our products, (iii) difficulties in increasing production or
maintaining sufficient inventories to meet unexpectedly high demand in the
short term, including our inability to resolve product backlog and product
pricing issues, (iv) financial difficulties encountered by one or more of our
principal customers, (v) difficulties in obtaining additional capital for
marketing, research and development, and other expenses, and (vii) material
litigation involving patent and contractual claims, product liability, consumer
issues and securities law claims. 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 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 Zicam products do not gain widespread market acceptance, our anticipated
sales and results of operations will suffer Although we believe that each of our products, and in particular our Zicam
Cold Remedy nasal products, offer unique benefits to consumers, we cannot be
certain that any of these products will achieve widespread acceptance by the
market. In addition, given their recent introduction in late 2003, our three
new oral Zicam products have not yet reached the level of market recognition
achieved by the original Zicam Cold Remedy nasal gel pump or swab products.
While we are working to increase the market presence of all of our products,
including our new Cough Mist products, we cannot be certain that demand for
these products will grow. If problems arise concerning the efficacy or safety
of any of our products, 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. Unanticipated problems associated with product development and
commercialization could adversely affect our operating results 17




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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; 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 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 FDA and FTC rules, we are required to obtain
scientific data to support any health claims we make concerning our products.
Although we have neither provided nor been requested to provide any scientific
data to the FDA or FTC in support of claims regarding our Zicam products, we
have obtained scientific data for our products. We cannot be certain, however,
that the scientific data we have obtained in support of our claims will be
deemed acceptable to the FDA or FTC, should either agency request any such data
in the future. If the FDA or the FTC requests any supporting information, and
we are unable to provide support that is acceptable to the FDA or the FTC,
either agency could force us to stop making the claims in question or restrict
us from selling the affected products. 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, 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. 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 18




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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, causing our business
and operating results to suffer The consumer health products industry is highly competitive. We compete
with companies in the United States and abroad 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
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 may incur significant costs resulting from product liability claims We are subject to significant liability should use or consumption of our
products cause injury, illness or death. Presently, we are being sued by over
168 individuals in 12 different product liability lawsuits (two of which have
not yet been served against us) relating to our Zicam Cold Remedy product.
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 on reasonable terms.
Product liability claims, such as those described in our Report on Form 10-K
for our 2003 fiscal year and in this Report on Form 19




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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. This in turn
could materially adversely affect our results of operations and financial
condition. 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 continue to experience product backlogs At the end of fiscal 2003, we had approximately $0.4 million in backlog of
swab orders. This backlog continued into the first half of the first quarter
of fiscal 2004. We have undertaken significant measures to remedy the
manufacturing problems that led to these backlogs, including replacing our swab
manufacturer and redesigning our swab product to permit higher volume
production. We also intend to build a substantial inventory of swab products
to reduce the likelihood of any backlog of swab products occurring in the
2004-2005 cough and cold season. However, we cannot be certain that these
measures will be sufficient to prevent future backlog of these products 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. 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; 20




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
    
    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, litigation against the
Company, and general economic and stock market conditions. Since the Spring of
2000, the stock market has experienced, and it may continue to experience,
significant price and volume fluctuations. These fluctuations have
particularly affected 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 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. In addition, we believe our stock price has
been impacted by a sizeable short position and resulting covering by investors
holding short positions in our stock. 
 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 2004 did we have any outstanding balance against this line of credit.
At no time during fiscal 2003 or the first quarter of fiscal 2004 did we have
any outstanding balance against this line of credit. 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, 2004 and December 31, 2003, 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 presently hold approximately $5.4 million in short-term U.S.
treasury securities which are not subject to material risk. We believe that we
are not subject in any material way to other forms of market risk, such as
foreign 21




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currency exchange risk or foreign customer purchases (of which there were
none in the first quarter of fiscal 2004 or in any of 2003) 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 We are subject, from time to time, to legal proceedings and claims
regarding adverse reactions to our products. From late 2003 through May 2004,
we were sued by over 168 named individuals in 12 different lawsuits (including
two lawsuits which have not yet been served on the Company) generally alleging
that our Zicam Cold Remedy product caused damage to the sense of smell and/or
taste. One of these lawsuits is a class action suit covering both named and
unnamed plaintiffs. In addition to the six lawsuits previously disclosed in
our From 10-K for our fiscal year ended December 31, 2003, the new cases are
Kalfian vs. Matrixx Initiatives, Inc. et al., filed April 6, 2004 in the United
States District Court for the District of Rhode Island, Case No. 04-119ML; Hood
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, Case No.
04006193; Powell et al. vs. Matrixx Initiatives, Inc. et al., filed March 29,
2004 in the Superior Court of the State of Arizona (Maricopa County), Case No.
CV2004-006062; Lutche vs. Matrixx Initiatives, Inc. et al., filed May 6, 2004
in the Superior Court of the State of Arizona (Maricopa County), Case No.
CV2004-008704; Adams et al., vs. Matrixx Initiatives, Inc. et al., filed May 6,
2004 in the Superior Court of the State of Arizona (Maricopa County), Case No.
CV2004-008929; and Douillard vs. Matrixx Initiatives, Inc. et al., filed May 6,
2004 in the Superior Court of the State of Arizona (Maricopa County), Case No.
CV2004-008950. An investigative news report by a national network program that was
subsequently featured by several local stations across the country, which
suggested the possibility of Zicam Cold Remedy negatively impacting a persons
sense of smell and/or taste appears to be related to the filing of the
lawsuits. Also, we are aware that plaintiffs law firms are actively
soliciting potential claimants through the internet and other media. As a
result, we expect additional lawsuits to be filed against us. It is very early
in the discovery phase of the 12 lawsuits, so it is 22




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unlikely than any of the cases will proceed to trial before the first
quarter of 2005. It appears that the lawsuits, as well as the above-noted news
media reports, are based on research and allegations regarding a connection
between zinc sulfate and loss of sense of smell. Zicam Cold Remedy contains
zinc gluconate, not zinc sulfate, which has very different properties than zinc
sulfate. We believe the allegations relating to Zicam Cold Remedy are inappropriate
and misleading. 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 an impairment to 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 cause 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 have submitted 11 of the 12 lawsuits to our insurance carrier. The
above-noted Hood vs. Matrixx case has not been submitted to our insurance
carrier as we have not yet been served with the complaint in this case. 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,
as well as by the adverse publicity that may result. In April 2004, a class action lawsuit was filed against the Company, our
President and Chief Executive Officer, Carl Johnson, and our Executive Vice
President and Chief Financial Officer, William J. Hemelt, alleging violation of
federal securities laws. The case is Sved vs. Matrixx Initiatives, Inc., Carl
J. Johnson and William J. Hemelt, filed April 27, 2004 in the United States
District Court for the District of Arizona, Case No. CV04-0886PHX. As of the
time of filing this Report on Form 10-Q, this lawsuit has not been served on
the Company, Mr. Johnson or Mr. Hemelt. 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 certain of the
product liability lawsuits described above. We believe the claims made in this
lawsuit are without merit and represent the actions of opportunistic
plaintiffs law firms seeking to take advantage of existing Zicam Cold Remedy
litigation. We intend to vigorously defend ourselves in this matter. In
accordance with and subject to the provisions of the Companys Certificate of
Incorporation, Messrs. Johnson and Hemelt will be indemnified by the Company
for their expenses incurred in defending this lawsuit and for any other losses
which they may suffer as a result of this lawsuit. If any liability were to
result from this lawsuit, we believe our financial results could be materially
impacted. 23




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##### Table of Contents



Item 2.
    Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities The Company did not repurchase any shares of its stock in the first
quarter of fiscal 2004, nor did it have any share repurchase plan or program in
effect during the first quarter of fiscal 2004. 
 Item 4. Submission of Matters to a Vote of Security Holders At our 2004 annual meeting of stockholders held on April 28, 2004, our
stockholders elected Edward J. Walsh and Michael A. Zeher to our Board of
Directors for terms of three years each. Of the 9,463,801 shares entitled to
vote in such election, the votes cast were as follows: Director
    
    Votes For
    
    Votes WithheldEdward J. Walsh
    
    
    8,457,334
    
    
    
    464,305Michael A. Zeher
    
    
    8,476,934
    
    
    
    444,705
 
 Item 6. Exhibits and Reports on Form 8-K  A.
    
    Exhibits Exhibit No.
    
    Title3.01
    
    Articles of Incorporation and Amendments thereto of the Company (1)3.02
    
    Bylaws of the Company (1)4.01
    
    Rights Agreement dated as of July 22, 2002 by and between the
Company 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.(1)
    
    Incorporated by reference to the Companys Amendment No. 1
to Form 8-A, filed June 18, 2002, file number 000-27646.(2)
    
    Incorporated by reference to the Companys registration
statement on Form 8-A, filed July 23, 2002, file number 000-27646. 24




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B.
    
    Reports on Form 8-K  On January 8, 2004, the Company filed a report on Form 8-K upwardly
revising guidance for fiscal 2003.On February 11, 2004, the Company filed a report on Form 8-K relating
to the issuance of two press releases in response to media reports about
the safety of intranasal Zicam cold remedy.On February 17, 2004, the Company filed a report on Form 8-K
announcing earnings for fiscal 2003 and the fourth quarter of 2003.On February 27, 2004, the Company filed a report on Form 8-K
announcing the findings of a panel of physicians and scientists convened
by the Company to address allegations linking Zicam intranasal cold
remedy to the loss of smell.On April 28, 2004, the Company filed a report on Form 8-K announcing
its preliminary earnings results for the first quarter of fiscal 2004.On April 30, 2004, the Company filed a report on Form 8-K announcing
the election of two directors at the Companys 2004 annual meeting of
shareholders and the introduction at such annual meeting of six new Zicam
products. 25




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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. Johnson  
 /s/ William J. Hemelt 
 
 May 14, 2004 26




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EXHIBIT INDEX Exhibit No.
    
    Title3.01
    
    Articles of Incorporation and
Amendments thereto of the Company (1)3.02
    
    Bylaws of the Company (1)4.01
    
    Rights Agreement dated as of July 22, 2002 by and between the
Company 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.(1)
    
    Incorporated by reference to the Companys Amendment No. 1
to Form 8-A, filed June 18, 2002, file number 000-27646.(2)
    
    Incorporated by reference to the Companys registration
statement on Form 8-A, filed July 23, 2002, file number 000-27646. 27