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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

For the quarter ended September 30, 2003

or

For the transition period from _______ to _______

Commission File number 0-27646

Matrixx Initiatives, Inc.

2375 East Camelback Road, Suite 500
Phoenix, AZ 85016
(Address of principal executive offices)

(602) 387-5353
(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 o  NO  þ

There were 9,415,851 shares of the registrant’s common stock, $.001 par value, outstanding as of October 31, 2003.

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MATRIXX INITIATIVES, INC.
FORM 10-Q
INDEX

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.

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MATRIXX INITIATIVES, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)

ASSETS

The accompanying notes are an integral part of these condensed consolidated financial statements.

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MATRIXX INITIATIVES, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(Continued)
(Unaudited)
LIABILITIES AND STOCKHOLDERS’ EQUITY

The accompanying notes are an integral part of these condensed consolidated financial statements.

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MATRIXX INITIATIVES, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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MATRIXX INITIATIVES, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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MATRIXX INITIATIVES, INC. AND SUBSIDIARY
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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MATRIXX INITIATIVES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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 nine months ended September 30, 2003 are not necessarily indicative of results of operations that may be expected for the year ending December 31, 2003. 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, 2002 previously filed with the Securities and Exchange Commission.

2.

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 schedule below summarizes the elements included in the calculation of basic and diluted net income per common share for the three and nine months ended September 30, 2003 and 2002. Options and warrants to purchase 215,000 and 197,000 shares of common stock for the three months ended September 30, 2003 and 2002, and 376,300 and 419,500 shares of common stock for the nine months ended September 30, 2003 and 2002, respectively, were not included in the computation of diluted earnings per share because their effect would be anti-dilutive.

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MATRIXX INITIATIVES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

3.

Inventories consisted of the following at September 30, 2003:

4.

Stock-Based Compensation

The Company adopted SFAS No. 123, “Accounting for Stock-Based Compensation”. 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:

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MATRIXX INITIATIVES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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

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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.

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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.

     We expect earnings in future periods will be significantly affected by the level of sales, and the timing and amount of our advertising and research and development expenses. Our expected growth in sales will depend on our success in securing additional retail distribution of our products, and in particular additional distribution of the five products that were introduced in 2002 and the three new products that we began shipping in the third quarter of 2003. In addition, sales in future periods will be affected by expanding consumer awareness and acceptance of our entire Zicam brand of products. Expenditures for advertising and research and development will vary by quarter throughout the year and could be significantly different from amounts in the same periods in prior years. We expect advertising expenses to be heaviest in our first and fourth fiscal quarters.

Results of Operations for the Three Months Ended September 30, 2003 Compared to the Three Months Ended September 30, 2002

     Certain information is set forth below for our Zicam operations expressed in dollars and as a percentage of net sales for the periods indicated:

     Net sales. Net Zicam sales for the three months ended September 30, 2003 increased to approximately $13.4 million, or approximately 163% above net sales in the third quarter of the prior year. Approximately one-third of the sales increase was attributable to sales of the three new Zicam Cold Remedy products that we began shipping in the third quarter of 2003. The

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remaining two-thirds of the increase was attributable to increased sales of our seven other Zicam products. Together, sales of these seven products grew at a combined rate of 87% above sales for the third quarter of 2002.

     Demand for our products is highly seasonal which results in significant fluctuations in our quarterly sales throughout the year. Generally, our third quarter sales are impacted by the stocking of cold products by retailers prior to the start of the cold season in October. Sales for the third quarter this year were also impacted by the initial shipments of the three new products that were introduced in 2003 as well as additional retail placement of the five products that were introduced in 2002. We expect increases in sales in future periods from continued growth, albeit at a lower growth rate than in past periods, for our Zicam Cold Remedy–pump and Zicam Allergy Relief products, and increased distribution and sales of the five products we introduced in 2002 and the three new products that we have introduced in 2003.

     Sales of our swab products during the 2002-2003 cold season were limited by the inability of our contract manufacturer, Zila Swab Technologies, Inc. (doing business as Innovative Swab Technologies) (“IST”) to meet its production obligations. Since April 2003 we have increased inventory of the current swab products and expect that we will be able to meet demand for these products through the end of 2003. We intend to introduce in the first quarter of 2004 a new, improved swab product designed to appeal more to customers and produced by a different manufacturer. We expect the new swab design will allow us to improve the gross margins for our swab products from the 2003 level and the change to a new swab manufacturer will allow us to avoid the production and backlog issues that we faced during 2002 and 2003. However, we cannot be certain that the manufacturer of the new swab will be able to meet our production expectations nor that the new swab product will attain the level of customer acceptance achieved by the current swab product. We believe that, based on initial testing, consumers will enthusiastically accept the new swabs.

     As announced in a September 2003 press release, we expect that our net sales for the full year in 2003 will be at least 50% greater than the $23.5 million in net sales that we recorded for 2002.

     Cost of sales. Our cost of sales increased to $4,215,034, or 153% above the third quarter of 2002 cost of sales of $1,668,153 which largely reflects the increase in units sold.

     Gross profit. Gross profit for the third quarter of 2003 increased to approximately $9.2 million, or 169% greater than the third quarter of 2002, due largely to the substantial increase in units sold and to a lesser extent to an increase in per unit revenue. The gross margin on products sold improved slightly from 67% to 69% due to higher net revenue per unit sold achieved in the 2003 period.

     Operating expenses. Operating expenses for the third quarter of 2003 increased approximately $1.2 million, or 49%, from our operating expenses in the third quarter of 2002. The increase was largely attributable to an accrual for a portion of year-end compensation expense($675,000), higher sales commission expense ($456,000) and higher advertising expense ($1,017,000 in 2003 versus $679,000 in 2002). These increases were offset by decreases in legal expense ($72,000) and outside consulting services ($56,000). 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.

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     Research and development. Research and development expenses increased from approximately $150,000 in the third quarter of 2002 to approximately $795,000 in the third quarter of 2003. The increase reflects our previously announced commitment to expand our research and development efforts in 2003 to an amount equal to approximately 6% of annual net sales in order to establish a continuous pipeline of new product offerings in future periods.

     Interest and other income. Interest and other income for the third quarter of 2003 decreased to $45,000, approximately 26% of the amount recorded in the third quarter of 2002. The decrease is largely due to a decrease of approximately $92,000 in royalty income between the two periods. The royalty income in both periods is attributable to a dental gum product sold by the Wm. Wrigley Jr. Company (“Wrigley”) that is subject to a royalty agreement between Wrigley and us. Interest income also declined between the two periods due to a lower invested cash position and a decline in investment interest rates.

     Interest expense. Interest expense for the third quarter of 2003 decreased to approximately $44,000, nearly 66% below the level of the third quarter of 2002. Interest expense for both periods is related to the imputed interest associated with the note issued by us to Zensano, Inc. in connection with our acquisition of Zensano’s 40% interest in Zicam, LLC (then Gel Tech, L.L.C.) in December 2001. The decrease in interest is due to our repayment of three-quarters of the note in 2002 and 2003. The final required installment of $2.75 million under the note is due on November 30, 2003.

     Income before income taxes. Income before income taxes for the third quarter of 2003 increased approximately $3.8 million, or 488%, from the third quarter of 2002 due to higher net sales which offset increases in operating and research and development expenses. We expect 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 and research and development expenses.

     Provision for income tax expense. In 2003, 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. In the third quarter of 2002, we were not able to make a similar determination, and consequently, reflected a full valuation allowance on the deferred tax assets.

     Net income. We have announced that we expect earnings for the full year of 2003 to be $0.25-$0.30 per fully diluted share, as compared to $0.14 per fully diluted share that was earned in 2002, exclusive of the one-time deferred tax asset that was recorded in late 2002.

Results of Operations for the Nine Months Ended September 30, 2003 Compared to the Nine Months Ended September 30, 2002

     Certain information is set forth below for our Zicam operations expressed in dollars and as a percentage of net sales for the periods indicated:

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     Net sales. Net Zicam sales for the nine months ended September 30, 2003 increased to approximately $25.3 million, or almost 111% above net sales in the first nine months of 2002. Approximately 20% of the sales increase was attributable to sales of the three new Zicam Cold Remedy products that we began shipping in the third quarter of 2003. The remaining eighty percent of the increase was attributable to increased sales of our seven other Zicam products which grew at a combined rate of 83% above sales for the same period of 2002.

     Demand for our products is highly seasonal which results in significant fluctuations in our quarterly sales throughout the year. We expect increases in sales in future periods from continued growth, albeit at a lower growth rate than in past periods, for our Zicam Cold Remedy-pump and Zicam Allergy Relief products, and increased sales of the five products we introduced in 2002, as well as the three new products that we have introduced in the third quarter of 2003.

     Sales of our swab products during the 2002-2003 cold season were limited by the inability of our contract manufacturer, Zila Swab Technologies, Inc. (doing business as Innovative Swab Technologies) (“IST”) to meet its production obligations. Since April 2003 we have increased inventory of the current swab products and expect that we will be able to meet demand for these products through the end of 2003. We intend to introduce in the first quarter of 2004 a new, improved swab product designed to appeal more to customers and produced by a different manufacturer. We expect the new swab design will allow us to improve the gross margins for our swab products from the 2003 level and the change to a new swab manufacturer will allow us to avoid the production and backlog issues that we faced during 2002 and 2003. However, we cannot be certain that the manufacturer of the new swab will be able to meet our production expectations nor that the new swab product will attain the level of customer acceptance achieved by the current swab product. We believe that, based on initial testing, consumers will enthusiastically accept the new swabs.

     As announced in a September 2003 press release, we expect that our net sales for 2003 will be at least 50% greater than the $23.5 million in net sales that we recorded for 2002.

     Cost of sales. Our cost of sales in the first nine months of 2003 increased to approximately $8.0 million, or 133% greater than the approximately $3.4 million cost of sales in

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the first nine months of 2002. This largely reflects the increase in units sold. The cost of goods was also affected by the mix of products sold, including the higher cost of the swabs that we agreed to pay in connection with our settlement with IST. Our swab products cost more per unit than our other products. Consequently, the increasing percentage of sales from swab products has resulted in a higher total unit cost. We expect that the unit cost of goods sold will continue to be affected by the relative mix of products sold. We also expect that the new swab product to be introduced in the first quarter of 2004 will result in a decrease in the unit cost of our swab products.

     Gross profit. Gross profit for the first nine months of 2003 increased to approximately $17.3 million, or 102% greater than the first nine months of 2002, due to the substantial increase in units sold. However, the gross margin on products sold declined from 71% to 68% for the periods due primarily to the higher per unit cost of the swab products sold in 2003.

     Operating expenses. Operating expenses for the first nine months of 2003 increased to $11.6 million, more than 52% above our operating expenses for the first nine months of 2002. The increase was primarily due to an increase in advertising expenses of $2.9 million during the first nine months of 2003 ($5.3 million in 2003 versus $2.4 million in 2002). Also contributing to the increase in operating expenses was an increase in sales commission expense of approximately $500,000 due to higher sales, and an accrual for year end compensation expense($675,000). Partially offsetting these increased expenses was the absence of a royalty payment of approximately $296,000 which we incurred in the first quarter of 2002. Expenses in future periods will vary largely in relation to the level of our advertising expenditures, which are the heaviest in the first and fourth quarters.

     Research and development. Research and development expenses increased more than $1.4 million from approximately $272,000 in the first nine months of 2002. The increase reflects our previously announced commitment to expand our research and development efforts in 2003 to an amount equal to approximately 6% of annual net sales in order to establish a continued pipeline of new product offerings in future periods.

     Interest and other income. Interest and other income for the first nine months of 2003 decreased to $140,000, approximately $459,000 (77%) below the level recorded in the first nine months of 2002. The decrease is largely due to a decrease of approximately $282,000 in royalty income between the periods. The royalty income in both periods is attributable to a dental gum product sold by Wrigley that is subject to a royalty agreement between Wrigley and us. The higher royalty amount received in the 2002 period reflects higher level of shipments during the product’s introductory period. Interest income also declined between the two periods due to a lower invested cash position and a decline in investment interest rates.

     Interest expense. Interest expense for the first half of 2003 decreased to approximately $217,000, or 55% below the level of the first nine months of 2002. Interest expense for both periods is primarily related to the imputed interest associated with the note issued by us to Zensano, Inc. in connection with our acquisition of Zensano’s 40% interest in Zicam, LLC (then Gel Tech, L.L.C.) in December 2001. The decrease in interest is due to our repayment of three-fourths of the note in 2002 and 2003. The final required installment of $2.75 million under the note is due on November 30, 2003.

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     Income before income tax. Income before income taxes for the first nine months of 2003 increased approximately $3.1 million, or 411%, from the first nine months of 2002 due to the higher net sales which offset increases in operating and research and development expenses. We expect 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 and research and development expenses.

     Provision for income tax expense. In 2003, 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. In 2002, we were not able to make a similar determination and consequently reflected a full valuation allowance on the deferred tax assets. The reduction in income tax expense recorded in the first half of 2002 reflects a refund of a tax payment made in connection with the sale of our gum assets in late 2001.

     Net income. We have announced that we expect earnings for the full year of 2003 to be $0.25-$0.30 per fully diluted share, as compared to $0.14 per diluted share that was earned in 2002, exclusive of the one-time deferred tax asset that was recorded in late 2002.

Liquidity and Capital Resources

     Our working capital increased from approximately $10.2 million at December 31, 2002 to approximately $15.0 million at September 30, 2003. During the nine-month period ended September 30, 2003, we experienced a decrease in cash from operating activities of approximately $2.5 million due primarily to an increase in accounts receivable of approximately $2.6 million, an increase in inventory of approximately $2.2 million and a decrease in accounts payable of approximately $2.3 million. These cash decreases were offset by pre-tax net income of approximately $4.0 million and other non-cash amortization and depreciation charges of $0.4 million.

     Investing activities used approximately $0.2 million of cash for deposits and capital expenditures while $2.7 million of cash was used for financing activities to pay the third installment on the note to Zensano, Inc. in late June 2003 ($2.75 million, including imputed interest). An additional $177,000 of cash was used to repurchase our common stock in the open market between January and July 2003.

     In July 2003, we renewed our $2.5 million credit facility with Comerica Bank for two years through July 2005. The interest rate on borrowings under the renewed facility was decreased from Prime plus 1.5% (under the prior credit facility) to Prime plus 0.75%. Additionally, unlike the prior facility, borrowings under the new facility are not limited to specified percentages of accounts receivable and inventory. Due to our current cash position and our expected cash flows from operations, we do not expect to borrow under the credit facility in the immediate future.

     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.

Critical Accounting Policies and Estimates

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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, and accounting for returns and allowances associated with our products.

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. The goodwill was evaluated 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 have 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. In subsequent periods, we will record income tax expense based on our estimated effective income tax rate for each period. 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

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our estimate for returns, except for returns of outdated products arising from excessive production during the introduction of Zicam Cold Remedy in the 1999-2000 cold season. Currently, we are recording a provision of 3% of gross sales for our original Zicam Cold Remedy and Zicam Allergy Relief products for potential returns and allowances. In establishing the appropriate reserve level for the five new Zicam products introduced in the third quarter of 2002, we reviewed the similarities and differences of the five products relative to our original Zicam Cold Remedy and Zicam Allergy Relief products for which we now have almost three years of product return experience. Based on that review, effective July 1, 2003 we are now recording a 3% provision of gross sales for these products. Similarly, we are recording a provision of 7% of gross sales on the three products that we introduced in 2003. We will review the return provision regularly on all of our products 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 any other new products that we introduce, until such products achieve market acceptance.

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 plans to introduce a new, improved swab product in the first quarter of 2004, and our expectation that the new product will result in a decrease in the unit cost of our swab products and allow us to improve our gross margins;

•

our expectation that consumers will enthusiastically accept our new swab product and that our change of swab manufacturers will allow us to avoid the production and backlog issues that we faced during 2003 and 2003.

•

our expectation regarding increases in sales in future periods of our current and new Zicam products;

•

our belief that sales, expense levels and earnings in future periods will be primarily affected by timing and amounts of advertising, research and development expenses, costs of introduction of new products, our success in securing additional retail distribution, expanding consumer awareness and acceptance of our entire Zicam brand of products;

•

our expectation regarding the seasonality of our quarterly sales, and our expectation that future earnings will be impacted by the seasonality and timing of certain expenditures;

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•

our expectation regarding the growth rates for future sales of products;

•

our expectation that expenditures for advertising and research and development will vary by quarter throughout the year, with advertising expenses being heaviest in the first and fourth fiscal quarters and our expectation that future operating expenses will vary largely in relation to the level of advertising expenditures;

•

our expectation that we will be able to meet demand for our swab products through the end of 2003;

•

our expectation that the cost of goods sold will continue to be affected by the relative mix of products sold and the planned introduction of a new swab product will result in a decrease in the unit cost of our swab products;

•

our previously announced commitment to expand our research and development efforts in 2003 to an amount equal to approximately 6% of annual net sales;

•

our expectation that our net sales for fiscal 2003 will be at least 50% greater than the $23.5 million in net sales that we recorded for fiscal 2002;

•

our expectation that net income for 2003 will be $0.25 to $0.30 per fully diluted share;

•

our belief that our settlement with IST will help facilitate an orderly transition to the new swab product that we intend to introduce in early 2004, allowing us to provide appropriate levels of service to our retail customers until the transition is complete;

•

our expectation that we will not borrow under our credit facility with Comerica Bank in the immediate future;

•

our expectation of continuing profitability in future years;

•

our intention to continue outsourcing all of our product manufacturing and packaging for the foreseeable future;

•

our intention to evaluate our 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;

•

our belief that our current capital resources and credit line are sufficient to fund the Company for the next 12 months; 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

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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 Form 10-Q, including those set forth in the sections 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 cause actual results to differ materially from our expectations. Other such factors include (i) less than anticipated demand for our current and future products or a weak cold season, (ii) lack of market acceptance for or uncertainties concerning the efficacy of our current and future products, including our new swab, (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 and difficulties in establishing adequate manufacturing arrangements for our new swab products, (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, (vi) oversupply of product inventory to retailers resulting in unsold product returns, and (vii) material litigation involving patent and contractual claims, product liabilities or consumer issues.

     Forward-looking statements contained in this Form 10-Q speak only as of the date of this 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 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 studies have indicated that Zicam Cold Remedy can significantly reduce the duration and severity of the common cold, we cannot be certain that this product (including our new swab formats) will achieve widespread acceptance by the market. To date, Zicam Allergy Relief has not achieved the market success presently enjoyed by Zicam Cold Remedy. In addition, given their recent introduction in late 2002, our five new Zicam products have not yet reached the level of market recognition achieved by the original Zicam Cold Remedy. While we are working to

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increase the market presence of Zicam Allergy Relief and our five new Zicam products, we cannot be certain that demand for these products will grow. It is too soon to determine how the market will respond to the three new Zicam products that we began shipping in the third quarter of 2003 or the new swab products that we plan to begin shipping in the first quarter of 2004. If any unanticipated problem arises concerning the efficacy of Zicam Cold Remedy, Zicam Allergy Relief or any of our other new products, or if any of these 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

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:

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we may experience unanticipated or otherwise negative research and development results;

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existing or proposed products may be found to be ineffective or unsafe, or may otherwise fail to receive required regulatory clearances or approvals;

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we may find that existing or proposed products, while effective, are uneconomical to commercialize or market;

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we may be unable to produce sufficient product inventories to meet customer demand or may encounter other manufacturing difficulties involving our new products and our new swabs;

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existing or proposed products do not achieve broad market acceptance; or

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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 certain 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 and the related Zicam swab products) and controlling allergy symptoms (in the case of Zicam Allergy Relief). Under the Federal 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. Although we have neither provided nor been requested to provide any scientific data to the FDA in support of claims regarding our Zicam products, we have obtained necessary scientific data to support our product claims. 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

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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 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

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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. Although we carry product liability insurance, there can be no assurance 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. A product liability claim, even one 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 a claim, 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 has occurred to date with our new 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 2002, we had approximately $1.3 million in backlog of swab orders, which continued at reduced levels until the end of March 2003. We have since increased our inventory of swab products in order to prevent a similar backlog from occurring in the 2003-2004 cold season. We expect our new swab manufacturer to provide products beginning in the first quarter of 2004. However, we cannot be certain that these efforts will be sufficient to prevent a backlog of these swab products from repeating itself in the 2003-2004 cold season 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.

The large number of shares eligible for immediate and future sales may depress the price of our stock

Sales of substantial amounts of our common stock in the open market or the availability of a large number of additional shares for sale could adversely affect the market price of our common stock. Substantially all of our outstanding shares of common stock, as well as the shares underlying vested but as yet unexercised warrants and options, have either been registered for public sale or may be sold under Rule 144 promulgated under the Securities Act of 1933, as amended. Therefore, all of these shares may be immediately sold by the holders. A substantial increase in sales of our common stock could depress the price of our common stock.

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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:

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voting rights, including the right to vote as a class on particular matters;

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preferences as to dividends and liquidation rights;

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conversion rights;

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anti-dilution protections; and

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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 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 many small capitalization companies, like Matrixx, that are not yet profitable or that experience low or inconsistent earnings. Often, the effect on the price of such securities is disproportionate to the operating performance of such companies. In our case, such broad market 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.

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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 nine months of fiscal 2003 did we have any outstanding balance against this line of credit. During fiscal 2002, the average outstanding balance on our prior line of credit on a daily basis was approximately $100,000. Assuming future borrowings in line with our average borrowings in 2002, a hypothetical interest rate change of 1% would increase our interest expense approximately $1,000 per year from the expense levels that we experienced in 2002. 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 September 30, 2003 and December 31, 2002, 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 $5.0 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 currency exchange risk or foreign customer purchases (of which there were none in the first nine months of fiscal 2003 or in all of 2002) 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 under 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 has materially affected, or is 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.

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PART II

OTHER INFORMATION

Item 1. Legal Proceedings

     The Company is subject to legal proceedings and claims that arise in the ordinary course of business. In the opinion of management, the amount of ultimate liability with respect to these actions will not materially affect the Company’s financial position or results of operations.

Item 6. Exhibits and Reports on Form 8-K

A.   Exhibits