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  • 10-Q (Nov 6, 2009)
  • 10-Q (Aug 10, 2009)

 
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Matrixx Initiatives 10-Q 2010

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-32.1
  4. Ex-32.1
e10vq
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
(Mark One)
     
þ   Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarter ended September 30, 2010
or
     
o   Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File number 001-31404
Matrixx Initiatives, Inc.
(Name of registrant as specified in its charter)
     
Delaware   87-0482806
(State or other jurisdiction
of incorporation or organization)
  (I.R.S. Employer
Identification Number)
8515 E. Anderson Drive
Scottsdale, AZ 85255

(Address of principal executive offices)
(602) 385-8888
(Issuer’s telephone number)
     Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO o
     Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large accelerated filer o   Accelerated filer þ   Non-accelerated filer o   Smaller reporting company o
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). YES o NO þ
There were 9,398,587 shares of the registrant’s common stock, $.001 par value, outstanding as of November 1, 2010.
 
 

 


 

MATRIXX INITIATIVES, INC.
FORM 10-Q
INDEX
             
PART I FINANCIAL INFORMATION     Page   
 
           
  Condensed Consolidated Balance Sheets as of September 30, 2010 (Unaudited) and March 31, 2010     3  
 
           
 
  Condensed Consolidated Statements of Income for the three months ended September 30, 2010 and 2009 (Unaudited)     4  
 
           
 
  Condensed Consolidated Statements of Operations for the six months ended September 30, 2010 and 2009 (Unaudited)     5  
 
           
 
  Condensed Consolidated Statements of Cash Flows for the six months ended September 30, 2010 and 2009 (Unaudited)     6  
 
           
 
  Notes to Condensed Consolidated Financial Statements (Unaudited)     7  
 
           
  Management’s Discussion and Analysis of Financial Condition and Results of Operations     19  
 
           
  Quantitative and Qualitative Disclosures About Market Risk     31  
 
           
  Controls and Procedures     31  
 
           
PART II OTHER INFORMATION        
 
           
  Legal Proceedings     32  
 
           
  Risk Factors     32  
 
           
  Exhibits     32  
 
           
SIGNATURES     33  
 EX-31.1
 EX-32.1
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 SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
                 
    September 30,     March 31,  
    2010     2010  
ASSETS
               
 
               
Current Assets:
               
Cash and cash equivalents
  $ 24,023,702     $ 26,482,499  
Certificates of deposit
          3,736,525  
Accounts receivable:
               
Trade, net of allowance for doubtful accounts of $178,345 and $169,720
    13,656,188       5,386,044  
Inventories
    9,468,573       6,166,809  
Prepaid expenses
    1,378,898       2,230,116  
Interest receivable
    648       3,443  
Income tax receivable
    4,491,704       5,661,554  
Current deferred tax asset
    4,785,614       5,071,475  
     
Total Current Assets
    57,805,327       54,738,465  
     
 
               
Property and Equipment, at cost:
               
Office furniture and computer equipment
    1,578,751       1,722,176  
Machine tooling and manufacturing equipment
    4,865,248       4,415,352  
Laboratory furniture and equipment
    381,079       486,459  
Leasehold improvements
    423,442       562,738  
     
 
    7,248,520       7,186,725  
Less accumulated depreciation
    (4,104,598 )     (3,865,302 )
     
 
               
Net Property and Equipment
    3,143,922       3,321,423  
     
 
               
Other Assets:
               
Deposits
    192,806       636,924  
Other assets
    40,043       40,043  
Patents, net of accumulated amortization of $349,312 and $311,209
    755,704       793,807  
Non-current deferred tax asset
    1,738,059       1,934,686  
     
 
               
Total Other Assets
    2,726,612       3,405,460  
     
 
               
Total Assets
  $ 63,675,861     $ 61,465,348  
     
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
 
               
Current Liabilities:
               
Accounts payable
  $ 1,381,714     $ 1,007,886  
Accrued expenses
    4,843,507       7,026,708  
Sales commissions
    362,810       188,433  
Sales returns and allowances
    1,316,461       1,420,600  
Deferred insurance proceeds
    942,000        
Legal liability
    522,500       740,000  
     
 
               
Total Current Liabilities
    9,368,992       10,383,627  
     
 
               
Total Liabilities
    9,368,992       10,383,627  
 
               
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, 9,398,587 and 9,455,620 shares issued and outstanding
    9,399       9,455  
Additional paid-in capital
    39,024,721       38,657,444  
Retained earnings
    15,272,749       12,414,822  
     
Total Stockholders’ Equity
    54,306,869       51,081,721  
     
Total Liabilities and Stockholders’ Equity
  $ 63,675,861     $ 61,465,348  
     
The accompanying notes are an integral part of these consolidated financial statements.


Table of Contents

MATRIXX INITIATIVES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009
(Unaudited)
                 
    2010     2009  
Net sales
  $ 21,310,960     $ 25,626,789  
Cost of sales
    5,590,076       6,829,913  
     
 
               
Gross Profit
    15,720,884       18,796,876  
 
               
Selling, general and administrative expenses
    6,764,319       10,150,409  
Research and development
    354,257       418,749  
     
 
               
Income From Operations
    8,602,308       8,227,718  
 
               
Interest and other income
    6,427       38,190  
     
 
               
Income Before Income Taxes
    8,608,735       8,265,908  
 
               
Income taxes
    3,317,800       3,187,521  
     
 
               
Net Income
  $ 5,290,935     $ 5,078,307  
     
 
               
Net Income Per Share of Common Stock:
               
Basic and Diluted:
               
Weighted Average Number of Common Shares Outstanding
    9,301,924       9,228,970  
Net Income Per Share of Common Stock
  $ 0.57     $ 0.55  
The accompanying notes are an integral part of these consolidated financial statements.


Table of Contents

MATRIXX INITIATIVES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE SIX MONTHS ENDED SEPTEMBER 30, 2010 AND 2009
(Unaudited)
                 
    2010     2009  
Net sales
  $ 24,518,358     $ 32,543,026  
Cost of sales
    6,922,654       9,622,975  
     
 
               
Gross Profit
    17,595,704       22,920,051  
     
 
               
Selling, general and administrative expenses
    12,078,217       26,639,046  
Research and development
    884,485       1,353,142  
Goodwill impairment
          15,039,836  
Asset impairments
          8,827,322  
     
 
               
Income (Loss) From Operations
    4,633,002       (28,939,295 )
 
               
Interest and other income
    22,825       85,470  
     
 
               
Income (Loss) Before Income Taxes
    4,655,827       (28,853,825 )
 
               
Income taxes
    1,797,900       (11,099,960 )
     
 
               
Net Income (Loss)
  $ 2,857,927     $ (17,753,865 )
     
 
               
Net Income (Loss) Per Share of Common Stock:
               
Basic and Diluted:
               
Weighted Average Number of Common Shares Outstanding
    9,294,791       9,199,561  
Net Income (Loss) Per Share of Common Stock
  $ 0.31     $ (1.93 )
The accompanying notes are an integral part of these consolidated financial statements.


Table of Contents

MATRIXX INITIATIVES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED SEPTEMBER 30, 2010 AND 2009
(Unaudited)
                 
    2010     2009  
Cash Flows From Operating Activities
               
Net income (loss)
  $ 2,857,927     $ (17,753,865 )
Adjustments to reconcile net income (loss) to net cash used by operating activities:
               
Depreciation
    666,281       395,682  
Amortization
    38,103       56,672  
Deferred income taxes
    482,488       (11,535,585 )
Common stock issued for compensation
    521,041       1,490,342  
Asset impairments and abandonments
          24,287,130  
Changes in assets and liabilities:
               
Accounts receivable
    (8,270,144 )     (8,198,496 )
Insurance receivable
          (25,386 )
Interest and other receivables
    2,795       (308,099 )
Income tax receivable
    1,169,850       (108,474 )
Inventories
    (3,301,764 )     (1,336,989 )
Prepaid expenses and other
    851,218       (1,508,659 )
Accounts payable
    373,828       (1,220,642 )
Accrued expenses
    (2,008,824 )     1,191,266  
Legal liability
    (217,500 )     (45,000 )
Deferred insurance proceeds
    942,000        
Sales returns and allowances
    (104,139 )     307,719  
     
 
               
Net Cash Used By Operating Activities
    (5,996,840 )     (14,312,384 )
     
 
               
Cash Flows From Investing Activities
               
Purchases of certificates of deposit
          (3,736,525 )
Maturities of certificates of deposit
    3,736,525       7,371,439  
Capital expenditures
    (44,662 )     (42,371 )
Deposits and other
          (2,252,563 )
     
 
               
Net Cash Provided By Investing Activities
    3,691,863       1,339,980  
     
 
               
Cash Flows From Financing Activities:
               
Issuance of common stock
          1,362,219  
Purchase of treasury stock
    (153,820 )     (1,187,906 )
     
 
               
Net Cash Provided (Used) By Financing Activities
    (153,820 )     174,313  
     
 
               
Net Decrease in Cash and Cash Equivalents
    (2,458,797 )     (12,798,091 )
 
               
Cash and Cash Equivalents at Beginning of Period
    26,482,499       25,144,088  
     
 
               
Cash and Cash Equivalents at End of Period
  $ 24,023,702     $ 12,345,997  
     
 
               
Supplemental Disclosure of Cash Flow Information:
               
Cash paid for income taxes
  $     $ 8,000  
Supplemental Disclosure of Non-cash Financing Activities:
               
Retirement of treasury stock
  $ 153,820     $ 1,187,906  
Manufacturing equipment placed in service
    444,118        
The accompanying notes are an integral part of these consolidated financial statements.


Table of Contents

MATRIXX INITIATIVES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Description of Business and Basis of Presentation
     Matrixx Initiatives, Inc. markets and sells over-the-counter healthcare products with an emphasis on those that utilize unique or novel delivery systems. Through our subsidiaries, we market and sell products under the Zicam® brand.
     The accompanying condensed consolidated balance sheet as of March 31, 2010, which has been derived from audited consolidated financial statements, and the unaudited interim condensed consolidated financial statements of Matrixx Initiatives, Inc. as of and for the three and six months ended September 30, 2010 have been prepared in accordance with the rules prescribed for filing condensed interim financial statements and, accordingly, do not include all disclosures that may be necessary for complete financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The disclosures presented are sufficient, in management’s opinion, to make the interim information presented not misleading. All adjustments, consisting of normal recurring adjustments that are necessary so as to make the interim information not misleading, have been made. All references made in this Report to “Note” or “Notes” refer to these Notes to the Condensed Consolidated Financial Statements (“Financial Statements”). Results of operations for the three and six months ended September 30, 2010 are not necessarily indicative of results of operations that may be expected for the fiscal year ending March 31, 2011. The products we market are seasonal in nature. We record sales when products are shipped from our warehouse facilities to customers. Generally, the Company realizes fluctuations in sales volume as retailers stock our products and order displays to prepare for the cough and cold season, which usually runs from October through March. Consumer purchases of our products at retail are highest during the cough and cold season. It is recommended that this financial information be read in conjunction with the complete financial statements included in Matrixx’s Annual Report on Form 10-K for the fiscal year ended March 31, 2010 previously filed with the Securities and Exchange Commission (“SEC”).
2. Recently Issued Authoritative Guidance
     In April 2010 we adopted the FASB’s guidance on the Consolidation Topic of the Codification (ASC Topic 810-10). This updated guidance requires an enterprise to determine whether its variable interest or interests give it a controlling financial interest in a variable interest entity; to require ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity; to eliminate the quantitative approach previously required for determining the primary beneficiary of a variable interest entity; to add an additional reconsideration event for determining whether an entity is a variable interest entity when any changes in facts and circumstances occur such that holders of the equity investment at risk, as a group, lose the power from voting rights or similar rights of those investments to direct the activities of the entity that most significantly impact the entity’s economic performance; and to require enhanced disclosures that will provide users of financial statements with more transparent information about an enterprise’s involvement in a variable interest entity. The adoption of this guidance did not impact our Financial Statements.
     In October 2009, the FASB issued Accounting Standards Update (“ASU”) No. 2009-13, Revenue Recognition (ASC Topic 605) — Multiple-Deliverable Revenue Arrangements, a consensus of the FASB Emerging Issues Task Force. This guidance modifies the fair value requirements of ASC subtopic 605-25 Revenue Recognition-Multiple Element Arrangements by allowing the use of the “best estimate of selling price” in addition to VSOE and VOE (now referred to as TPE standing for third-party evidence) for determining the selling price of a deliverable. A vendor is now required to use its best estimate of the selling price when VSOE or TPE of the selling price cannot be determined. In addition, the residual method of allocating arrangement consideration is no longer permitted. This update requires expanded qualitative and quantitative disclosures and is effective for fiscal years beginning on or after June 15, 2010. This update may be applied either prospectively from the beginning of the fiscal year for new or materially modified arrangements or retrospectively. The adoption of this guidance will not impact our Financial Statements.

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MATRIXX INITIATIVES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)
3. Stock-Based Compensation
     The Company measures the cost of services received in exchange for equity instruments based on the grant-date fair value of the award and recognizes that cost in expense over the requisite service period. The Company uses the Black-Scholes option-pricing model in valuing option grants.
     The Company did not recognize any compensation expense for option awards during the three or six months ended September 30, 2010 or 2009. There were no options exercised in the three or six months ended September 30, 2010. There were 144,700 options exercised in the six months ended September 30, 2009; however, no options were exercised in the three months ended September 30, 2009. No options were granted during the three or six months ended September 30, 2010 or 2009.
     The Company has granted restricted stock to directors, officers, and employees as part of its overall compensation plan. Compensation expense is based on the closing stock price on the grant date, and is amortized on a straight-line basis over the requisite service period. Stock-based compensation expense recognized in the quarter ended September 30, 2010, for restricted stock awards was approximately $271,000, or $167,000 after tax, compared to approximately $371,000, or $225,000 after tax, for the quarter ended September 30, 2009. During the six months ended September 30, 2010, the Company recognized approximately $377,000, or $232,000 after tax, compared to $718,000, or $434,000 after tax, for the six months ended September 30, 2009.
4. Basic and Diluted Income (Loss) Per Share
     Basic earnings (loss) per share is calculated using the weighted average number of common shares outstanding. Diluted earnings (loss) per share are computed on the basis of the weighted average number of common shares outstanding plus the effect of dilutive securities. The Company’s stock options and unvested restricted stock are considered dilutive securities and are included in the computation of diluted earnings (loss) per share using the “treasury stock” method.
     The table below summarizes the elements included in the calculation of basic and diluted net income (loss) per common share for the three and six months ended September 30, 2010 and 2009. Unvested restricted stock and options to purchase 301,751 and 318,759 shares of common stock for the three and six months ended September 30, 2010, respectively, were not included in the computation of diluted loss per share because their effect would be anti-dilutive. Unvested restricted stock and options to purchase 449,649 and 400,423 shares of common stock for the three and six months ended September 30, 2009, respectively, were not included in the computation of diluted loss per share because their effect would be anti-dilutive.
                                 
    Three Months Ended     Six Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
Net income (loss) applicable to common shareholders
  $ 5,290,935     $ 5,078,387     $ 2,857,927     $ (17,753,865 )
 
                       
Weighted average common shares outstanding — Basic
    9,301,924       9,228,970       9,294,791       9,199,561  
Dilutive Securities:
                               
Options
                       
Restricted Stock
                       
 
                       
Weighted average common shares outstanding — Diluted
    9,301,924       9,228,970       9,294,791       9,199,561  
 
                       
 
Net income (loss) per common share:
                               
Basic
  $ 0.57     $ 0.55     $ 0.31     $ (1.93 )
Diluted
  $ 0.57     $ 0.55     $ 0.31     $ (1.93 )

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MATRIXX INITIATIVES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)
5. Inventories
     Inventories are stated at the lower of cost or market. The Company uses first-in, first-out method to value inventory. Inventories consisted of the following at September 30, 2010 and March 31, 2010:
                 
    September 30,     March 31,  
    2010     2010  
Raw materials and packaging
  $ 397,610     $ 623,808  
Finished goods
    9,070,963       5,543,001  
 
           
Total
  $ 9,468,573     $ 6,166,809  
 
           
6. Product Recalls and Withdrawals
     Zicam Cold Remedy Nasal Gel and Cold Remedy Gel Swabs Recall
     Matrixx establishes a reserve for product recalls and withdrawals on a product-specific basis when circumstances giving rise to the recall or withdrawal become known. Facts and circumstances related to the recall or withdrawal, including where the product affected by the recall or withdrawal is located (in inventory or at retail customers) and cost estimates for shipping and handling for returns, are considered when establishing a product recall or withdrawal reserve. These factors are updated and reevaluated each period and the related reserves are adjusted when the factors indicate that the recall or withdrawal reserve is either not sufficient to cover or exceeds the estimated product recall or withdrawal expenses.
     The Company received a warning letter from the Food and Drug Administration (the “FDA”) in the first quarter of fiscal 2010, dated June 16, 2009, regarding Zicam Cold Remedy Nasal Gel and Zicam Cold Remedy Gel Swabs. The FDA referred to complaints it had received of smell loss, also known as anosmia, associated with these products and asserted that the Company was in violation of FDA regulations by failing to file a new drug application for the products. The FDA also asserted that the products were misbranded under FDA regulations for failing to adequately warn of the risk of smell loss. Although the Company disagreed with the FDA’s allegations (see Note 7 — “Legal Proceedings” of this Report for more information on the Company’s position with respect to the FDA’s warning letter), the Company cooperated with the FDA and recalled the Zicam Cold Remedy Nasal Gel and Cold Remedy Swabs from the market.
     In the quarter ended June 30, 2009, the Company recorded a $9.0 million reserve for estimated costs to recall these products. The reserve charge was recorded in selling, general and administrative expense in the accompanying statement of operations for the six months ended September 30, 2009. As of June 30, 2010, the recall reserve was exhausted. During the quarter ended September 30, 2010, we recorded $252,000 of additional recall charges.

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MATRIXX INITIATIVES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
7. Legal Proceedings
     The Company is involved in various product liability claims and other legal proceedings. The Company’s legal expense for these lawsuits continues to have a significant impact on the results of operations as the Company defends itself against the various claims.
     Among the principal matters pending to which the Company is a party are the following:
Product Liability Matters
     General. Since 2003, a number of lawsuits have been filed against us alleging that our Zicam Cold Remedy nasal gel products have caused the permanent loss or diminishment of the sense of smell or smell and taste. Prior to the Company’s receipt of the FDA’s June 16, 2009 warning letter (see Note 6 — “Product Recalls and Withdrawals”), the number of lawsuits filed against the Company was steadily declining; in fact, the numbers of pending lawsuits, plaintiffs, new lawsuits and potential claimants were at their lowest levels since early 2004.
     Since the Company’s receipt of the FDA warning letter, numerous product liability lawsuits have been filed against the Company, many of which cite the FDA warning letter as support for their claims. The lawsuits principally fall into two categories of product liability claims: (i) those alleging that our Zicam Cold Remedy nasal gel products caused the permanent loss or diminishment of the sense of smell or smell and taste (i.e., personal injury claims) and (ii) those seeking compensation for the purchase price of the Zicam Cold Remedy nasal gel products or various forms of equitable relief based on allegations that the Company misrepresented the safety and/or efficacy of such products to consumers (i.e., economic injury claims). On October 9, 2009, a judicial panel ordered the centralization and transfer of a number of economic injury and personal injury actions pending in federal court to a federal court in the District of Arizona pursuant to federal multidistrict litigation (“MDL”) procedures (see “Multi-District Litigation Matters” below for a discussion of the cases that have been consolidated and transferred). The Company is vigorously defending itself against each of these lawsuits. All of the economic injury lawsuits have been filed as class actions but none of the classes has been certified to date (uncertified class actions are referred to as “putative” class actions). See “Settlement with Certain Claimants” below for a discussion of the settlement status of the economic injury lawsuits.
     Our Position and Our Response. We believe the claims made in these lawsuits are scientifically unfounded and misleading and we disagree strongly with the FDA’s allegations that Zicam Cold Remedy nasal gel products may be unsafe and that they were unlawfully marketed. The Company’s position is supported by the cumulative science, a multi-disciplinary panel of scientists, and the decisions of 10 separate federal judges in 10 different cases in multiple jurisdictions. In October 2009, in response to the Company’s request, the FDA advised the Company that it was unwilling to reverse its position. On November 16, 2009, the Company filed its response to the FDA’s warning letter. In its response, the Company reiterated its position that there is no valid scientific evidence that Zicam nasal Cold Remedy products are unsafe and requested the FDA to withdraw the warning letter. By letter dated March 4, 2010, the FDA reaffirmed its original position and denied the Company’s request.
     Product Safety. There is no known causal link between the use of Zicam Cold Remedy nasal gel and impairment of smell or smell and taste. To date, no plaintiff has ever won a product liability case against the Company on those grounds. The Company believes that upper respiratory infections and nasal and sinus disease are the most likely causes of the smell dysfunctions reported by some consumers. One of the most common causes of smell disorders is the cold itself, the very condition our product was used to treat. Other causes are sinusitis and rhinitis, conditions which are sometimes present when our product is used.

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MATRIXX INITIATIVES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
     Federal law requires that the testimony of a scientific or medical expert witness be reliable and based on valid scientific data and analysis before it can be allowed into evidence. To date, the Company has submitted motions in ten different federal lawsuits against the Company challenging the reliability and admissibility of the testimony of expert witnesses who claim that Zicam Cold Remedy is capable of causing or has caused smell and taste loss. To date, the courts have ruled in the Company’s favor on all ten motions. Each court has ruled that the theory that Zicam Cold Remedy nasal gel causes smell loss, as promoted by the plaintiffs’ experts, has no reliable scientific support and was reached without application of proper scientific standards and procedures. Federal courts have made such rulings against the three most prominent causal experts that plaintiffs have hired to date as well as various other expert witnesses.
     In addition, on April 3, 2008, jurors in a California case unanimously found that Zicam was not the cause of plaintiff’s smell loss.
     Product Effectiveness. Our claims and advertising are subject to the requirements of the Federal Trade Commission Act (“FTC”). On March 21, 2006, the FTC’s East Central Region (Cleveland, Ohio office), initiated a detailed inquiry to determine whether the Company engaged in unfair or deceptive acts or practices in violation of the Federal Trade Commission Act in connection with the Company’s advertising and promotional activities for several of the Company’s nasal and oral cold remedy products, including Zicam Cold Remedy Nasal Gel and Zicam Cold Remedy Swabs — the products that are the subject of the FDA warning letter. As part of the inquiry, the FTC requested and received, among other things, the Company’s documentation regarding product safety, including side effects, adverse events and consumer complaints, and efficacy, including the scientific proof establishing the efficacy claims made by the Company. Following a nearly year-long process, during which the Company provided the FTC with over 65,000 pages of documentation and met with the FTC to discuss the information, on March 5, 2007, the FTC notified the Company that it was no longer pursuing the inquiry.
     Total Pending Product Liability Lawsuits. As of October 26, 2010, the Company is aware of 286 pending product liability lawsuits against the Company, involving 1,023 plaintiffs. Of those cases, 216 are pending in Federal court and 70 are pending in State court.
     Cases filed since June 30, 2010 (Pending in Federal Courts): The Company is aware of the following pending federal court cases, covering 76 named plaintiffs, which were filed against and/or served on the Company between July 1, 2010 and October 26, 2010.
     Personal Injury:
         
Date Filed   United States District Court   Named Plaintiff
7/1/2010
  Arizona   Warrington, J.
7/9/2010
  Arizona   MacDonald, C.
7/14/2010
  Arizona   Barton, J.
7/15/2010
  Arizona   Holloway, S.
7/15/2010
  Arizona   Wilhite, J.
7/15/2010
  Arizona   Ponthieux, S.
7/15/2010
  Arizona   Murter, J.
7/20/2010
  Arizona   Carter, C.
7/20/2010
  Arizona   Davis, L.
7/20/2010
  Arizona   Floyd, R.
7/20/2010
  Arizona   Foley, L.
7/20/2010
  Arizona   Hamilton, A.
7/20/2010
  Arizona   Jackson, A.
7/20/2010
  Arizona   Jackson, R.

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Date Filed   United States District Court   Named Plaintiff
7/20/2010
  Arizona   Lipscomb, D.
7/20/2010
  Arizona   Moore, B.
7/20/2010
  Arizona   Pilkenton, L.
7/20/2010
  Arizona   Rentch, B.
7/20/2010
  Arizona   Saur, M.
7/20/2010
  Arizona   Short, J.
7/21/2010
  Arizona   Richmond, J.
7/26/2010
  Arizona   Swenson, J.
7/27/2010
  Arizona   Cochren, M.
7/28/2010
  Arizona   Hill, S.
8/2/2010
  Arizona   Flom, J.
8/11/2010
  Arizona   Saunders, L.
8/11/2010
  Arizona   Bethel, C.
8/11/2010
  Arizona   Nunley, Janee
8/11/2010
  Arizona   Nunley, Juliette
8/12/2010
  Arizona   Lundgren, K.
8/12/2010
  Arizona   Chase, T.
8/13/2010
  Arizona   Strickland, A.
8/16/2010
  Arizona   Richardson, D.
8/16/2010
  Arizona   Williams, L.
8/16/2010
  Arizona   Beamon, K.
8/16/2010
  Arizona   Bernholz, D.
8/17/2010
  Arizona   McAllister, B.
8/17/2010
  Arizona   Hernandez, B.
8/17/2010
  Arizona   Reynolds, C.
8/17/2010
  Arizona   Yeager, L.
8/17/2010
  Arizona   Annunziata, T.
8/24/2010
  Arizona   Meza, L.
8/25/2010
  Arizona   Haller, J.
8/27/2010
  Arizona   Schmidtman, D.
9/1/2010
  Arizona   Ryan, C.
9/2/2010
  Arizona   Chontos, J.
9/2/2010
  Arizona   Carlson, L.
9/9/2010
  Arizona   Helm, J.
9/13/2010
  Arizona   Forray, T.
9/13/2010
  Arizona   Harley, R.
9/16/2010
  Arizona   Archias, K.
9/20/2010
  Southern District, Florida   Stone, J.
9/21/2010
  Arizona   Bucher, R.
9/21/2010
  Arizona   Fugozzotto, S.
9/22/2010
  Arizona   Driscoll, J.
9/22/2010
  Arizona   Lock, P.
9/24/2010
  Arizona   Brown, D.
9/27/2010
  Middle District, Florida   Barber, J.
9/29/2010
  Arizona   Collins, R.
9/29/2010
  Arizona   Henry, C.
10/1/2010
  Illinois   Anderson, N.
10/1/2010
  Arizona   Thompkins, S.
10/8/2010
  Eastern District, New York   Burns, J.
10/25/2010
  Western District, Missouri   Artrip, M.
10/25/2010
  Western District, Missouri   Hall, J.
     Putative Class Actions for Economic Injury: None.
     Multi-District Litigation Matters. As previously disclosed, in August 2009, the Company filed a motion to consolidate and transfer all of the personal injury and economic injury matters, including any purported class actions, pending against the Company in federal court to the District of Arizona, pursuant to MDL procedures. On October 9, 2009, the Judicial Panel on Multidistrict Litigation (“Panel”)

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established MDL No. 2096, In Re: Zicam Cold Remedy Marketing and Sales Practices Litigation, and centralized the economic injury and personal injury actions that involve common questions of fact before a federal court in the District of Arizona. With one exception, the Panel transferred all of the economic injury cases at issue in the original MDL request. The Panel also began the MDL transfer process for the remaining economic injury and personal injury matters pending against the Company in federal courts across the country. The plaintiffs in these remaining cases will have the opportunity to object to the MDL transfer of their specific case. The Panel determined that the case of Hohman et. al. vs. Matrixx Initiatives, Inc. et. al. (filed June 18, 2009, Northern District of Illinois) did not involve sufficient common questions of fact to allow for consolidation and transfer to the MDL at that time. The Company expects any federal economic injury and personal injury matters filed in the future to be transferred and consolidated pursuant to the MDL transfer process, subject to the plaintiffs’ opportunity to object. See “Settlement with Certain Claimants” below for a discussion of the settlement status of the economic injury lawsuits.
     Cases filed since June 30, 2010 (Pending in State Courts). The Company is aware of the following state court cases, covering 243 named plaintiffs, which were filed against and/or served on the Company between July 1, 2010 and October 26, 2010:
     Personal Injury:
         
Date Filed   Court   Named Plaintiff
7/8/2010
  Maricopa County, AZ   Michaels, A.
7/9/2010
  St. Clair County, IL   MacDonald, C.
7/23/2010
  Jerome County, ID   Huettig, L.
7/26/2010
  Maricopa County, AZ   Allen, R.
8/2/2010
  Maricopa County, AZ   Kolomyetz, A.
8/2/2010
  Maricopa County, AZ   Martin, M.
8/2/2010
  Maricopa County, AZ   Michelson, P.
8/3/2010
  Maricopa County, AZ   Bey, C.
8/16/2010
  Maricopa County, AZ   Vosh, L.
8/18/2010
  Maricopa County, AZ   Bloodworth-Ferrero, C.
8/27/2010
  Maricopa County, AZ   Young, J.
9/2/2010
  Pinellas County, FL   Whiteside, J.
9/10/2010
  Palm Beach County, FL   Benfante, R.
9/14/2010
  Maricopa County, AZ   Allen, P.
9/15/2010
  Maricopa County, AZ   Altman, S.
9/24/2010
  Maricopa County, AZ   Tuma, J.
10/4/2010
  Maricopa County, AZ   Ellison, G.
10/15/2010
  Maricopa County, AZ   Allen, S.
10/18/2010
  Montgomery County, AL   Johnson, R.
10/22/2010
  Twin Falls County, ID   Hine, C.
     Putative Class Actions for Economic Injury: None.
     Cases Dismissed Subsequent to June 30, 2010 (Federal Courts). On August 6, 2010, the United States Court of Appeals for the Fifth Circuit, New Orleans, Louisiana, affirmed the order granted on October 26, 2009 by the Federal District Court for Middle District of Louisiana dismissing the case of Carter vs. Matrixx Initiatives, Inc. et al., filed on February 29, 2008. There were no other federal court cases pending against the Company dismissed subsequent to June 30, 2010.
     On August 6, 2010, the court affirmed the order granting dismissal of the case. There were no other federal court cases pending against the Company dismissed subsequent to June 30, 2010.
     Cases dismissed Subsequent to June 30, 2010 (State Courts). The following state court case against the Company, which was an economic injury class action lawsuit, was dismissed subsequent to June 30, 2010:

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Date Filed   Court   Named Plaintiff   Date Dismissed
6/30/09
  St. Louis County,   West   10/4/10
 
  Missouri        
     Settlement with Certain Claimants. In July 2010, the Company entered into settlement agreements with approximately 46 claimants who had previously threatened to file lawsuits against the Company. The individual settlement amounts were $5,000 or less per claimant and were charged to our litigation reserves (see “Product Liability Litigation Reserves” below). The settlement documents for all claimants acknowledge that Matrixx denies any liability to them. Those who are eligible and elect to participate in the settlement program dismiss their claims with prejudice and provide written releases of their claims against the Company in return for their participation. Each of the claimants alleged use of the Company’s single hole actuator Cold Remedy nasal gel product, which was last sold in 2005. To date, the Company has never settled product liability claims relating to nasal gel products other than the single hole actuator product.
     On August 19, 2010, the Company and plaintiffs’ attorneys representing all of the various nationwide and statewide economic injury plaintiffs signed a Memorandum of Understanding (“MOU”) setting forth their agreement in principle to settle those 18 lawsuits. On August 26, 2010, the MDL Judge issued an order objecting to the procedural mechanism the parties proposed for effectuating the settlement; the order did not consider the merits of the proposed settlement. On October 1, 2010, the Company and lead plaintiffs’ attorneys representing all of the economic injury plaintiffs executed a revised Memorandum of Understanding setting forth a different procedure for seeking approval of the settlement. The revised Memorandum of Understanding sets forth a procedure for approval of the settlement of injunctive relief claims relating to the safety of the Zicam Cold Remedy nasal gel spray and swabs before the MDL Court and approval of the settlement of claims relating to the efficacy of the Zicam Cold Remedy nasal gel spray and swabs as well as other current products in the Northern District of Illinois, the jurisdiction where Hohman v. Matrixx Initiatives, Inc. is pending. On October 19, 2010, the parties entered into a Settlement Agreement to resolve the injunctive relief claims relating to safety of the Zicam Cold Remedy nasal gel spray and swabs. On the same day, Plaintiffs filed a motion to certify an injunctive relief settlement class based on the terms of the Settlement Agreement before the MDL Court. On November 2, 2010, the MDL Court requested that the parties submit additional briefing explaining various aspects of the Settlement.
     As part of the settlement of the safety claims set forth in the Settlement Agreement, which remains subject to court approval, the Company agreed that, if its Zicam Cold Remedy nasal gel spray and/or swab products are re-introduced into the market, the packaging will include any language regarding adverse effects required by the FDA. Under the Settlement Agreement, the Company will be required to pay plaintiffs’ attorneys fees and has agreed to not object to an attorneys fee application not to exceed $150,000, which fee award is subject to court approval.
     As part of the settlement of the efficacy claims as set forth in the MOU, the Company has agreed to add certain clarifications to its packaging regarding the use and status of several current products. In addition, the Company will be required to pay the plaintiffs’ attorneys fees and costs for the litigation in an amount that will be decided by the court. The Company will also pay incentive awards to the named plaintiffs in an aggregate amount not to exceed a total of $35,000 and be responsible for the costs of providing notice of the settlement to class members.
     The Company cannot predict with certainty whether definitive agreements finally settling all of the economic injury claims will ultimately be approved by the courts. Nothing in the revised MOU or Settlement Agreement constitutes an admission of any wrongdoing, liability, or violation of law by the Company. Rather, the Company agreed to settle the economic injury claims to reduce its high litigation defense costs and to avoid the inherent risks associated with litigation. Additionally, the settlement allows the Company to focus greater resources on the hundreds of product liability claims for personal injuries that are still pending.

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     Potential Claimants. Approximately 1,142 potential claimants have advised the Company by means of a written notice that they are considering filing a lawsuit against, or are interested in pursuing settlement negotiations with, the Company. The Company is in the process of determining the nature or basis of their purported claims and when or if these potential claimants will ultimately file one or more lawsuits against the Company.
     Plaintiffs’ law firms may continue to solicit potential claimants and, as a result, additional lawsuits may be filed against us. We cannot predict the outcome of the litigation, but we will defend ourselves vigorously. If any liability were to result from one or more of these or future lawsuits, we believe our financial results could be materially impacted. Our financial results also could be materially impacted by the adverse publicity that may result from the lawsuits.
     Litigation Reserves. As of December 31, 2005, the Company established a reserve of $1.3 million for any future payment of settlement or losses related to the Cold Remedy litigation. This reserve was based on certain assumptions, some of which are described below, and was the amount, excluding defense costs, the Company believed it could reasonably estimate would be spent to resolve the remaining cases that had been filed or to resolve matters with the potential claimants. Some of the significant factors that were considered in the establishment of the reserve were as follows: the actual costs incurred by the Company up to that time in resolving several claims; the development of the Company’s legal defense strategy; settlements; and the number of cases that remained pending against the Company. There are events, such as the dismissal of any of the cases, the filing of new lawsuits, threatened claims, the outcome of a trial, rulings on pending evidentiary motions, or adverse publicity that may have an impact on the Company’s conclusions as to the adequacy of the reserve for the pending product liability lawsuits. The Company maintained a $522,500 reserve balance as of September 30, 2010, compared to the $740,000 reserve at March 31, 2010. The settlement with 46 potential claimants, mentioned above, was paid from the reserve in July 2010. Thus the decline in the reserve balance was due to settlements of certain claims. However, following the Company’s receipt of the FDA’s warning letter and the resulting increase in the number of product liability lawsuits being filed, the amounts that may be spent to resolve matters with actual and potential claimants could be higher than our reserve. The Company will continue to review the product liability claims situation and will adjust the litigation reserve in the future when we can reasonably estimate changes in the amounts and likelihood of resolving the claims. Litigation is inherently unpredictable and excessive verdicts do occur. Although we believe we have substantial defenses in these matters, we could, in the future, incur judgments or enter into settlements of claims that could have a material adverse effect on our results of operations in any particular period.
Securities Litigation Matters
     Two class action lawsuits were filed in April and May 2004 against the Company, our previous President and Chief Executive Officer, Carl J. Johnson, and William J. Hemelt, our President and Chief Executive Officer, alleging violations of federal securities laws. On January 18, 2005, the cases were consolidated and the court appointed James V. Siracusano as lead plaintiff. The amended complaint also includes our Vice President of Research and Development, Timothy L. Clarot, as a defendant and was filed March 4, 2005. The consolidated case is Siracusano, et al. vs. Matrixx Initiatives, Inc., et al., in the United States District Court, District of Arizona, Case No. CV04-0886 PHX DKD. Among other things, the lawsuit alleges that between October 2003 and February 2004, we made materially false and misleading statements regarding our Zicam Cold Remedy products, including failing to adequately disclose to the public the details of allegations that our products caused damage to the sense of smell and of certain product liability lawsuits pending at that time. We filed a motion to dismiss this lawsuit and, on March 8, 2006, the Company received an Order dated December 15, 2005 granting the motion to dismiss the case, without prejudice. On April 3, 2006, the plaintiff appealed the Order to the United States District Court of Appeals, Ninth Circuit and on October 28, 2009, the Ninth Circuit Court reversed the decision of the United States District Court, District of Arizona. On June 14, 2010, the United States Supreme Court granted certiorari review and will hear the case during the Court’s 2010-2011 term.
     A separate putative class action was filed on July 17, 2009 against the Company; William J. Hemelt, our President and Chief Executive Officer; Samuel C. Cowley, our Executive Vice President of Business Development, General Counsel and Secretary; Timothy L. Clarot, our Vice President of Research &

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Development; and Carl J. Johnson, our former President and Chief Executive Officer, alleging violations of federal securities laws. Shapiro et al. vs. Matrixx Initiatives, Inc. et al., in the United States District Court, District of Arizona, Case No. 2:09-cv-01479-ECV (the “Shapiro” action). The lawsuit alleges that the Company and the named officers failed to disclose to the FDA and to the public information about adverse events regarding the Zicam Cold Remedy nasal gel products and that the Company and such officers made false and misleading statements regarding the Company’s compliance with FDA regulations. Plaintiff filed a consolidated amended complaint on September 27, 2010, to which the Company must respond by November 26, 2010. The Company believes plaintiff’s allegations are without merit and intends to vigorously defend the lawsuit.
     In accordance with and subject to the provisions of the Company’s Certificate of Incorporation, Messrs. Hemelt, Cowley, Clarot and Johnson will be indemnified by the Company for their expenses incurred in defending each of these lawsuits and for any other losses which they may suffer as a result of these lawsuits. The Company has submitted each of these matters to its insurance carriers. If any liability were to result from these lawsuits that is not covered by insurance, we believe our financial results could be materially impacted.
Shareholder Derivative Lawsuits
     On September 11, 2009, a shareholder derivative lawsuit was filed by Timothy Hall, on behalf of the Company, against all of the Company’s current directors and the following current and former officers of the Company: William Hemelt, Samuel Cowley and Carl Johnson. The lawsuit alleges, among other things, that the officers and directors named in the complaint violated their fiduciary duties to the Company by (i) misrepresenting the safety of the Zicam Cold Remedy nasal gel products, (ii) failing to warn consumers that use of the Zicam Cold Remedy nasal products could result in anosmia and (iii) failing to disclose reports of anosmia to the FDA and otherwise misrepresenting the Company’s compliance with FDA regulations (Timothy Hall v. William J. Hemelt, et al., United States District Court, District of Arizona).
     On September 18, 2009, a shareholder derivative lawsuit was filed by Theodore C. Klatt, on behalf of the Company, against all of the Company’s current directors and the following current and former officers of the Company: William Hemelt, Samuel Cowley, Carl Johnson, Timothy Clarot and James Marini. The lawsuit alleges, among other things, that the officers and directors named in the complaint violated their fiduciary duties to the Company by (i) misrepresenting the safety of the Zicam Cold Remedy nasal gel products, (ii) failing to warn consumers and shareholders that use of the Zicam Cold Remedy nasal products could result in anosmia and (iii) failing to disclose reports of anosmia to the FDA and otherwise misrepresenting the Company’s compliance with FDA regulations (Theodore C. Klatt v. William J. Hemelt, et al., United States District Court, District of Arizona).
     On October 14, 2009, the parties filed a stipulation to transfer the Klatt action and consolidate it with the Hall action. On November 4, 2009, the stipulation was granted. On January 19, 2010, the Company moved for a stay of the consolidated derivative action pending the outcome of the Shapiro action (discussed under “Securities Litigation Matters” above), which the Court granted on March 1, 2010.
     On November 20, 2009, a shareholder derivative lawsuit was filed by Bette-Ann Liguori, on behalf of the Company, against all of the Company’s current directors and certain of their spouses, and the following current and former officers and directors of the Company and certain of their spouses: Carl Johnson, Timothy Clarot, Timothy Connors, Lynn Romero, Michael Voevodsky, James Marini, and Edward Faber (Liguori v. Egan, et al., Superior Court of the State of Arizona, County of Maricopa). The lawsuit alleges, among other things, that the officers and directors named in the complaint violated their fiduciary duties to the Company by (i) misrepresenting the safety of the Zicam Cold Remedy nasal gel products, (ii) failing to warn consumers and shareholders that use of the Zicam Cold Remedy nasal products could result in anosmia and (iii) failing to disclose reports of anosmia to the FDA and otherwise misrepresenting the Company’s compliance with FDA regulations. On January 19, 2010, the Company filed a motion to stay the action pending the outcome of the Shapiro action or, in the alternative, pending the outcome of the consolidated derivative action filed in Federal court. On May 18, 2010, the court granted defendants’ motion and ordered the parties to file a status report in six months.

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MATRIXX INITIATIVES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)
     In accordance with and subject to the provisions of the Company’s Certificate of Incorporation, each of the named directors and current and former officers and spouses will be indemnified by the Company for their expenses incurred in defending each of these lawsuits and for any other losses that they may suffer as a result of these lawsuits.
Related Legal Matters — Informal Inquiries
     As previously reported, the Company received an inquiry from several county district attorneys in one state regarding enforcement of certain consumer protection statutes involving our product packaging size. We have reached an agreement in principle to settle this matter by implementing certain changes in our packaging over a twelve-month period from the final date of settlement. In addition, the Company has agreed to pay the state approximately $400,000, which has been previously accrued. We do not believe this matter will have a material adverse impact on our operations, liquidity or cash flow.
Legal Expense
     The Company is incurring significant legal expense for the lawsuits referenced above. As previously disclosed, the Company had a limited amount of product liability insurance to cover litigation expense, losses and/or settlements associated with claims that our Cold Remedy products caused a loss of smell. The insurer has determined the ultimate defense costs and claims associated with the anosmia allegations will likely exceed the policy limit of $5 million. To avoid ongoing administrative costs, in July 2010, the Company and its product liability insurer reached agreement that the insurer would pay the full amount of the $5.0 million policy to the Company. The Company received the cash in August 2010. Net product liability and regulatory related legal expense was $1.0 million ($2.9 million prior to allocating $1.9 million of insurance reimbursement) in the quarter ended September 30, 2010, which compares to legal expense of $2.4 million in the quarter ended September 30, 2009. For the six months ended September 30, 2010, net product liability and regulatory related legal expense was approximately $700,000 ($4.8 million prior to allocating $4.1 million of insurance reimbursement), versus $3.0 million in the six months ended September 30, 2009. We expect the remaining $900,000 of insurance reimbursement to be applied against legal expense in our fiscal third quarter and we do not expect to receive additional reimbursements for legal expense. We expect to continue to incur legal expense of $1.3 million to $1.8 million per quarter before allocation of insurance proceeds.
8. Goodwill and Asset Impairment Charges
     Intangibles consist of goodwill (which is the excess of purchase price over the net assets of businesses acquired), intellectual property, and trademarks. Goodwill is not amortized but finite-lived intangibles are amortized using the straight-line method. The Company’s $15.0 million in goodwill was related to the Company’s acquisition of the 40% Zicam, LLC interest acquired from Zensano, Inc. in December 2001. The business of Zicam, LLC at that time was to develop and produce homeopathic nasal gel products based on a proprietary zincum gluconium delivery system.
     Goodwill and certain other assets must be tested upon a triggering event to identify potential impairments and the amount of any impairment loss. Following the June 16, 2009 FDA warning letter and subsequent recall of our Zicam Cold Remedy Nasal Gel and Zicam Cold Remedy Swabs, the Company concluded a triggering event had occurred and performed an impairment assessment as of June 30, 2009. The Company performed an assessment within the accounting fair value hierarchy, in which it evaluated, among other things, the impact of the foregoing events on the market’s perception of the value of the Company’s stock, the expected increase in legal activity, and the expected decline of Zicam product sales. The Company first determined the fair value using two valuation methodologies: (a) the income approach,

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MATRIXX INITIATIVES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)
which uses discounted cash flow projections, and (b) the market value approach, which uses quoted market prices or unobservable inputs that are corroborated by market data. The determination of fair value requires the use of significant judgment and estimates about assumptions that management believes were appropriate in the circumstances, although it is reasonably possible that actual performance will differ from these assumptions. The most significant assumptions include those relating to our ability to sell nasal gel Cold Remedy products in the future, our ability to introduce new nasal products, sales expectations of our other swab products, and market trading multiples for the Company.
     The assessment resulted in the Company recording charges of $23.9 million ($14.6 million after-tax) in the quarter ended June 30, 2009, to reduce the carrying amounts of goodwill and other tangible and intangible assets to fair value. These charges include: a non-cash impairment charge of $15.0 million related to the goodwill associated with the zincum gluconium nasal gel products; a non-cash impairment charge of $3.9 million to write-down the inventory value of nasal Cold Remedy products and other nasal application inventory; an impairment charge of $4.3 million ($3.4 million of which is non-cash) for a new swab manufacturing line that was built to produce our nasal swab product; and $616,000 for the unamortized amount of our Cold Remedy nasal gel patent. The charge was included in “Goodwill Impairment and Asset Impairments” in the accompanying statement of operations for the six months ended September 30, 2009.
     In addition to the impairment charges associated with our nasal Cold Remedy products discussed above, in the quarter ended June 30, 2009, we recorded a charge of $420,000 to write down the value of patents and certain other assets associated with the development of an oral care product developed to reduce tartar. We do not anticipate launching this product on our own and determined the assets associated with the product’s development were impaired. This charge was recorded in research and development expense in the accompanying Financial Statements for the six months ended September 30, 2009.
9. Financial Instruments Fair Value
     The Company follows the FASB guidance that defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements for all financial assets and liabilities.
     Cash, cash equivalents, accounts payable and accounts receivable: Carrying amounts approximate fair value because of the short maturity of those instruments.

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     Certificates of Deposit: The Company occasionally purchases certificates of deposit from FDIC-insured institutions at or below the FDIC-insured limits and all certificates of deposit have maturities of one year or less. The purchase price of each certificate of deposit is treated as its fair market value on the purchase date. We account for these certificates of deposit at amortized costs and they are held to maturity.
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
     The Company develops, markets and sells innovative, over-the-counter (OTC) healthcare products with an emphasis on those that utilize unique delivery systems. The Company currently markets its products within the U.S. $4.0-$5.0 billion overall cough and cold category at retail. Our Zicam products are sold in the cold remedy, allergy/sinus, cough and multi-symptom relief market groups of the overall cough and cold category. A mix of our products is currently available at all of the major food, drug, and mass merchant retailers.
     The products we market are seasonal in nature, and sales at retail generally increase as the incidence of colds and flu rises. We record sales when products are shipped from our warehouse facilities to customers. During the July through September quarter, the Company’s sales volume is primarily affected by retailers stocking our products and ordering displays to prepare for the upcoming cough and cold season. Additional sales (re-orders) to retailers are highly dependent upon the incidence of illness within the population. Retail sales of our products are highest during the cough and cold season, which usually runs from October through March. We increase our advertising campaigns to coincide with the cough and cold season and generally realize higher advertising expense in the October through March time periods. Because of the seasonality of our business, results for any single quarter are not necessarily indicative of the results that may be achieved for the full fiscal year.
     We received a warning letter from the FDA on June 16, 2009 regarding Zicam Cold Remedy Nasal Gel and Zicam Cold Remedy Swabs. The FDA referred to complaints it had received of smell loss, also known as anosmia, associated with these products and asserted that the Company was in violation of FDA regulations by failing to file a new drug application for the products. The FDA also asserted that the products were misbranded under FDA regulations for failing to adequately warn of the risk of smell loss. Although the Company disagreed with the FDA’s allegations, the Company cooperated with the FDA and recalled the Cold Remedy Nasal Gel and Cold Remedy Swabs from the market.
     The FDA warning letter, the recall of Zicam Cold Remedy Nasal Gel and Zicam Cold Remedy Swabs, and the subsequent litigation have had a material adverse impact on our business. The recalled products accounted for approximately 40%, or $42.5 million, of our net sales in the fiscal year ended March 31, 2009; and, prior to the recall, accounted for approximately $2.0 million of net sales in the quarter ended June 30, 2009. Our primary focus since the withdrawal of our nasal gel products has been the conversion of consumers that used our nasal Cold Remedy products to our oral Cold Remedy offerings. As a result, our promotional and marketing support primarily focuses on Zicam oral Cold Remedy products.
     Certain information is set forth below for our operations, expressed in thousands of dollars and as a percentage of net sales, for the periods indicated:
                                                                 
    3 Months Ended September 30,     6 Months Ended September 30,  
$000s   2010     % NS     2009     % NS     2010     % NS     2009     % NS  
Net Sales
  $ 21,311       100 %   $ 25,627       100 %   $ 24,518       100 %   $ 32,543       100 %
 
                                                               
Marketing
  $ 2,151       10 %   $ 2,518       10 %   $ 4,744       19 %   $ 5,830       18 %
Sales
  $ 892       4 %   $ 856       3 %   $ 1,436       6 %   $ 1,474       5 %
General & Administrative
  $ 2,664       13 %   $ 4,385       17 %   $ 5,178       21 %   $ 16,367       50 %
Legal -Product Liability & Regulatory
  $ 1,057       5 %   $ 2,391       9 %   $ 720       3 %   $ 2,968       9 %
Total Selling, General and Administrative
  $ 6,764       32 %   $ 10,150       40 %   $ 12,078       49 %   $ 26,639       82 %
Research & Development
  $ 354       2 %   $ 419       2 %   $ 884       4 %   $ 1,353       4 %
Goodwill & Asset Impairments
  $ 0       0 %   $ 0       0 %   $ 0       0 %   $ 23,867       73 %

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Net sales for the fiscal second quarter ended September 30, 2010 were $21.3 million, compared to $25.6 million for the quarter ended September 30, 2009. The lower level of sales versus the quarter ended September 30, 2009 is primarily attributable to high pre-season inventory purchases associated with the publicity of the H1N1 flu outbreak that occurred in the quarter ended September 30, 2009. We realized a 3% higher average unit sales price during the quarter ended September 30, 2010, compared to the quarter ended September 30, 2009. The increased average selling price was primarily due to decreased in-store promotions during the quarter ended September 30, 2010. Net income for the quarter ended September 30, 2010 was $5.3 million, or $0.57 per diluted share, compared to net income of $5.1 million, or $0.55 per diluted share, for the quarter ended September 30, 2009. Net income for the quarter ended September 30, 2009 reflects the higher legal expense and a charge related to the Company’s exit from the Canadian market in that period.
For the six months ended September 30, 2010, net sales decreased 25% to $24.5 million, versus $32.5 million in the six months ended September 30, 2009. The decrease in sales reflects the loss of nasal Cold Remedy products, which accounted for $2.0 million of sales in the six months ended September 30, 2009. In addition, the decline in cough and multi-symptom relief product sales accounted for $1.5 million of the decreased sales. The remaining decrease is associated with lower unit sales of oral Cold Remedy and Allergy/Congestion products. Net income for the six months ended September 30, 2010 was $2.9 million, or $0.31 per diluted share, compared to a net loss of $17.8 million, or $(1.93) per diluted share, for the six months ended September 30, 2009. Results for the six months ended September 30, 2009 included pretax charges of $9.0 million to reserve for recall-related costs and $23.9 million for goodwill and other asset impairments.
     We expect net income (loss) in future periods to be significantly affected by the level of sales; the timing and amount of our advertising; and the timing and amount of expenses incurred in defense of product liability litigation matters. Expenditures for advertising and research and development will vary by quarter throughout the year and could be significantly different in future periods than the amounts incurred in the same period in earlier years. We expect that advertising expenses will be highest during the cold season (third and fourth fiscal quarters). We anticipate quarterly earnings will continue to vary along with the seasonality of sales and the level of marketing and research and development expense.
     The Company’s management reviews several key indicators in evaluating overall performance:
  1)   We review sales and net income performance against our annual goals. In fiscal 2011, the Company will focus on growing sales in our core Cold Remedy and Allergy/Sinus franchise and offsetting declines in our symptom relief and other cough/cold products. For fiscal 2011, the Company anticipates revenue increasing 3% to 5% above the $67.3 million achieved in fiscal 2010. We anticipate expense for litigation will be between $1.3 million and $1.8 million per quarter (prior to insurance reimbursement) in fiscal 2011. We expect higher sales in the second half of fiscal 2011 as the incidence of illness increases during the cold season. In addition, we anticipate marketing expense and increased legal expense will somewhat offset higher gross profit associated with increased sales in the second half of fiscal 2011and we expect to report net income between $2.0 and $3.0 million for the full year.
 
  2)   We monitor sales of our products at retail because increased consumer purchases of our products are an indicator of growth. For the 12 weeks ended October 3, 2010, retail unit sales (as measured by three outlet syndicated scanner data, not including Wal-Mart) of our oral Cold Remedy products decreased approximately 4% while sales of our allergy and congestion products declined approximately 2% versus the comparable period in the previous year, while the entire cough and

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      cold category declined approximately 3%. We expect our retail unit sales to increase during the cold season.
 
  3)   We measure our ability to maintain strong gross margins on our products. During the quarter ended September 2010, we realized an average gross margin of 74%, compared to the 73% average gross margin achieved in the prior year. Gross margins on our existing products generally vary between 65% and 80%. Due to the decline in sales of our lower-priced symptom relief products and a lower level of in-store promotional activity, our average selling price per unit increased 5% in the six months ended September 30, 2010, compared to the prior year.
 
  4)   We evaluate our operating performance by reviewing, over time, our ability to decrease operating expenses as a percentage of net sales. We evaluate our ability to control operating expenses on an annual basis due to the seasonal fluctuations in quarterly net sales. We anticipate fiscal 2011 operating expenses will decline as a percentage of sales compared to the prior fiscal year.
 
  5)   We review the distribution and mix of our products by key national retailers. Our ten largest retail customers account for a substantial majority of our annual sales, and we encourage our largest customers to carry a mix of our highest-selling products. Retailers generally reset their cough and cold sections during the third calendar quarter of each year, at which time they add or discontinue products. We expect our ten largest retailers to have a net increase in Zicam oral Cold Remedy products on shelf during this year’s cold season. Although retailers are increasing the number of our products they sell, they are also increasing the number of store brand products that directly compete with our Zicam offerings. Store brand products are generally sold at a substantial discount to branded products. Store brand versions of our products may adversely affect our mix of products sold at retail as well as our sales levels.
Critical Accounting Policies and Estimates
     Our consolidated financial statements and accompanying notes have been prepared in accordance with GAAP applied on a consistent basis. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent 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, information from third party professionals, and various other assumptions that are believed to be reasonable under the facts and circumstances. Actual results could differ from those estimates made by management.
     We believe that our critical accounting policies and estimates include the accounting for intangible assets and goodwill, accounting for income taxes, revenue recognition, accounting for sales adjustments (returns and allowances), accounts receivable and allowance for doubtful accounts, accounting for legal contingencies, and accounting for product recalls.
     Legal Contingencies. We are subject to lawsuits, investigations and claims arising out of the normal conduct of our business (see Note 7 — “Legal Proceedings” for additional information regarding our pending and threatened litigation and our reserves for product liability litigation). While we are vigorously defending the Company in these proceedings, the outcome of these and any other proceedings that may arise cannot be predicted with certainty. The Company is required to accrue a contingent loss when the loss is deemed probable and reasonably estimable. The Company maintained a $522,500 reserve balance as of September 30, 2010, compared to $740,000 at March 31, 2010. Following the Company’s receipt of the FDA’s warning letter and the resulting increase in the number of product liability lawsuits being filed, the amounts that may be spent to resolve matters with actual and potential claimants could be higher than our reserve. In July 2010, the Company entered into settlement agreements with approximately 46 claimants who had previously threatened to file lawsuits against the Company. The individual settlement amounts were $5,000 or less per claimant and were charged to our litigation reserves in July 2010. The Company will continue to review and adjust the litigation reserve in the future when we can reasonably estimate changes in the amounts and likelihood of resolving the claims.

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     Intangible Assets and Goodwill. We recorded approximately $15.0 million in goodwill in connection with the acquisition of the 40% Zicam, LLC interest acquired from Zensano, Inc. in December 2001. Goodwill must be tested when a triggering event occurs or at least annually to identify a potential impairment and the amount of any impairment loss. Our fiscal 2009 annual valuation of goodwill (as of September 1, 2008) was completed in January 2009 and no impairment was identified. In connection with the Company’s receipt of the FDA warning letter and the resulting recall of our Cold Remedy Nasal Gel and Cold Remedy Swabs, as well as the associated negative publicity, impact on the market’s perception of the value of the Company’s stock, higher legal activity, and the expected decline of Zicam product sales, the Company performed an impairment assessment as of June 30, 2009, which resulted in the Company recording charges to reduce the book value of goodwill and other intangible assets.
     The determination of fair value requires the use of significant judgment and estimates about assumptions that management believes were appropriate in the circumstances, although it is reasonably possible that actual performance will differ from these assumptions. The most significant assumptions included those relating to our ability to sell nasal gel Cold Remedy products in the future, our ability to introduce new nasal products, sales expectations of our other swab products, and market trading multiples for the Company. These charges included: a non-cash impairment charge of $15.0 million related to the goodwill associated with the acquisition of zincum gluconium nasal gel products and $616,000 for the unamortized amount of our Cold Remedy nasal gel patent. These charges were recorded in the quarter ended June 30, 2009 and are reflected in Goodwill and Asset Impairments in our Financial Statements for the six months ended September 30, 2009. In addition, due to our inability to commercialize our oral care product developed to reduce tartar, we recorded a charge of $420,000 to write down the value of patents and certain other assets associated with the development of that product in the quarter ended June 30, 2009. We decided not to launch this product and determined the assets associated with the product’s development were impaired. This charge was recorded in research and development expense.
     Income Taxes. The provision for, or benefit from, income taxes is calculated using the asset and liability method, under which deferred tax assets and liabilities are recorded based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The Company has recorded deferred tax assets associated with tax loss carrybacks and carryforwards. These deferred tax asset amounts increased due to the Company’s fiscal 2010 operating loss. Deferred tax assets are evaluated on a quarterly basis to determine whether a valuation allowance is required. The Company assesses whether a valuation allowance should be established based on its determination of whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets depends primarily on the generation of future taxable income during the periods in which those temporary differences become deductible. Judgment is required in determining the future tax consequences of events that have been recognized in the Company’s consolidated financial statements and/or tax returns. Differences between anticipated and actual outcomes of these future tax consequences could have a material impact on the Company’s consolidated financial position or results of operations.
     Revenue Recognition. The Company recognizes revenue from product sales when the risks and rewards of ownership have transferred to the customer, which is considered to have occurred upon shipment of the finished product to retailers.
     Sales Adjustments. The Company routinely enters into arrangements with its retail customers to support sales programs that increase sales of our products to consumers. The programs include sales incentives, promotional allowances, coupons, rebates, and slotting fees. The programs involve fixed amounts or percentages of sales to customers. Reserves for such programs are calculated based on an assessment of purchases and performance under the programs and any other specified factors. While the majority of sales adjustment amounts are readily determinable at period end and do not require estimates, certain of the sales adjustments require management to make estimates. In making these estimates, management considers all available information, including the overall business environment, historical trends and information from customers.
     The estimate for product returns is based on our historical experience of sales to retailers and is reviewed regularly to reflect estimated product returns. We review the return provision at least quarterly and adjust the reserve amounts if actual product returns differ materially from our reserve percentage.

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Additionally, we adjust the returns provision when a determination is made that a product will be discontinued, either in whole or by certain retailers. Should the actual level of product returns vary significantly from our estimates, our operating and financial results would be materially affected.
     We record reserves for sales programs and returns as sales adjustments that offset revenue in the period the related revenue is recognized. Sales adjustments totaled $2.5 million and $4.0 million for the three months ended September 30, 2010 and 2009, respectively. For the six months ended September 30, 2010 and 2009, sales adjustments totaled $4.6 million and $7.7 million, respectively. Management believes that the reserves recorded for customer programs at September 30, 2010 are adequate and proper.
     Accounts Receivable and Allowance for Doubtful Accounts. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. In recent years, the retail channel has experienced shifts in market share among competitors, causing some retailers to experience liquidity problems. There is a risk that customers will not pay, or that payment may be delayed, because of bankruptcy or other factors beyond the Company’s control. We increased the allowance for doubtful accounts from 0.02% of gross sales to 0.05% of gross sales for fiscal 2011. We review the allowance for doubtful accounts at least monthly and adjust the allowance amounts if actual or probable losses differ materially from our reserve percentage.
     Product Recalls. The Company establishes a reserve for product recalls and withdrawals on a product-specific basis when circumstances giving rise to the recall or withdrawal become known. Facts and circumstances related to the recall or withdrawal, including where the product affected by the recall or withdrawal is located (in inventory or at retail customers), and cost estimates for shipping and handling for returns are considered when establishing a product recall or withdrawal reserve. These factors are updated and reevaluated each period and the related reserves are adjusted when the factors indicate that the recall or withdrawal reserve is either not sufficient to cover or exceeds the estimated product recall or withdrawal expenses.
     For the six months ended September 30, 2009, the Company recorded a $9.0 million reserve for estimated costs to recall the Cold Remedy Nasal Gel and Cold Remedy Swabs. The reserve charges were recorded in selling, general and administrative expense in the accompanying Financial Statements for the six months ended September 30, 2009. The recall reserve has been exhausted. We expect any additional recall charges related to the June 2009 recall would be immaterial.
Results of Operations for the Three Months Ended September 30, 2010 Compared to the Three Months Ended September 30, 2009
     Certain information is set forth below for our operations expressed in $000’s and as a percentage of net sales for the periods indicated:
                                 
    Three Months Ended September 30,  
    2010     2009  
Net sales
  $ 21,311       100 %   $ 25,627       100 %
Cost of sales
    5,590       26       6,830       27  
 
                       
Gross profit
    15,721       74       18,797       73  
Selling, general and administrative
    6,764       32       10,150       40  
Research & development
    354       2       419       2  
Goodwill Impairment
                       
Asset Impairments
                       
 
                       
Income from Operations
    8,602       40       8,228       32  
Interest and other income
    6             38        
Interest expense
                       
 
                       
Income before income taxes
    8,609       40       8,266       32  
Income taxes
    3,318       16       3,188       12  
 
                       
 
                               
Net Income
  $ 5,291       25 %   $ 5,078       20 %
 
                       

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Net Sales
     Net sales for the three months ended September 30, 2010 were $21.3 million, versus net sales of $25.6 million for the quarter ended September 30, 2009. The decrease in net sales, for the quarter ended September 30, 2010 versus 2009, is primarily attributable to high pre-season inventory purchases by retailers due to publicity of the H1N1flu in the quarter ended September 30, 2009.
     Our average selling price per unit increased 3% in the quarter ended September 30, 2010, compared to the quarter ended September 30, 2009. The increase in average selling price was primarily due to a decrease in the level of in-store promotional activity, relative to level of unit sales that occurred in the quarter ended September 30, 2010, compared to the quarter ended September 30, 2009.
Cost of Sales
     For the quarter ended September 30, 2010, our cost of sales decreased to $5.6 million, compared to $6.8 million for the quarter ended September 30, 2009. The decrease was primarily due to the lower number of units sold.
Gross Profit
     Gross profit for the three months ended September 30, 2010 was approximately $15.7 million, compared to gross profit of approximately $18.8 million for the quarter ended September 30, 2009. The decreased gross profit is primarily attributable to the lower net sales recorded during the quarter, compared to the prior year. Gross margin for the quarter ended September 30, 2010 was 74%, compared to 73% in the comparable quarter ended September 30, 2009. Gross margin is affected by the relative mix of products sold, promotional activity, and changes in product sales prices and costs.
Selling, General & Administrative (SG&A)
     SG&A expense for the quarter ended September 30, 2010 was approximately $6.8 million, compared to approximately $10.2 million in the quarter ended September 30, 2009. The decreased SG&A expense is attributable to $1.6 million that was recorded in the quarter ended September 30, 2009 to account for costs and charges related to the withdrawal of Zicam products from Canada. In addition, marketing and labor expense declined $367,000 and $638,000, respectively, in the quarter ended September 30, 2010, compared to the prior year. The decrease in labor expense is primarily attributable to the higher labor expense in the prior year due to employee retention plans that were granted after the June 2009 recall of nasal Cold Remedy products.
     Legal expense associated with litigation and regulatory activities was affected by the recording of $1.9 million of insurance reimbursement, which resulted in net expense of $1.0 million for the quarter ended September 30, 2010, versus legal expense of $2.4 million in the quarter ended September 30, 2009 (see Note 7 — “Legal Proceedings — Legal Expense,” for more information regarding insurance reimbursement).
Research and Development
     Research and development expense was approximately $354,000 in the quarter ended September 30, 2010, versus $419,000 in the quarter ended September 30, 2009. The timing and amount of research and development spending will vary depending on new product development activities, which may include clinical research, and is not generally associated with our seasonal sales patterns.
Interest & Other Income
     Interest and other income was approximately $6,000 in the quarter ended September 30, 2010 versus approximately $38,000 in the quarter ended September 30, 2009. The decline in interest income reflects lower interest rates. There was no interest expense in the quarters ended September 30, 2010 or 2009.
Income Before Income Taxes
     Income before income tax for the three months ended September 30, 2010 was approximately $8.6 million, compared to approximately $8.3 million for the quarter ended September 30, 2009. The increase in income before taxes for the quarter ended September 30, 2010, versus the prior year, is due to the lower level of selling, general and administrative expense (discussed above). We expect that income (loss) in future periods will be significantly impacted by the sales levels of our products, product introductions, and

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changes in our advertising, research and development, and legal expenses. We anticipate quarterly operating results will continue to vary along with the seasonality of sales and expenses.
Income Taxes
     We recorded an income tax expense at our combined estimated annual effective tax rate of approximately 38.5%. Due to the income from operations in the quarter ended September 30, 2010, we recognized an income tax expense of approximately $3.3 million, compared to $3.2 million in the quarter ended September 30, 2009.
Net Income
     Net income was approximately $5.3 million in the quarter ended September 30, 2010, compared to net income of approximately $5.1 million in the quarter ended September 30, 2009.
Results of Operations for the Six Months Ended September 30, 2010 Compared to the Six Months Ended September 30, 2009
     Certain information is set forth below for our operations expressed in $000’s and as a percentage of net sales for the periods indicated:
                                 
    Six Months Ended September 30,  
    2010                     2009  
Net sales
  $ 24,518       100 %   $ 32,543       100 %
Cost of sales
    6,923       28       9,623       30  
 
                       
Gross profit
    17,596       72       22,920       70  
Selling, general and administrative
    12,078       49       26,639       82  
Research & development
    884       4       1,353       4  
Goodwill Impairment
                15,040       46  
Asset Impairments
                8,827       27  
 
                       
Income (Loss) From Operations
    4,633       19       (28,939 )     (89 )
Interest and other income
    23             85        
Interest expense
                       
 
                       
Income (Loss) before income taxes
    4,656       19       (28,854 )     (89 )
Income taxes (Benefit)
    1,798       7       (11,100 )     (34 )
 
                       
 
                               
Net Income (Loss)
  $ 2,858       12 %   $ (17,754 )     (55 )%
 
                       
Net Sales
     Net sales for the six months ended September 30, 2010 were $24.5 million, versus net sales of $32.5 million for the quarter ended September 30, 2009. The decrease in net sales for the six months ended September 30, 2010 versus 2009, reflects the June 2009 withdrawal of nasal Cold Remedy products, which accounted for $2.0 million of net sales in the six months ended September 30, 2009. The decline in symptom relief product sales accounted for $1.5 million of the decreased sales. In addition, the lower level of sales reflects the high pre-season inventory purchases by retailers due to publicity of the H1N1 flu outbreak that occurred in the second quarter of fiscal 2009.
     Our average selling price per unit increased 5% in the six months ended September 30, 2010, compared to the six months ended September 30, 2009. The increase in average sales price was primarily due to a decrease in the level of in-store promotional activity, relative to the level of unit sales that occurred in the quarter compared to the prior year.
Cost of Sales

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     For the six months ended September 30, 2010, our cost of sales decreased to $6.9 million, compared to $9.6 million for the six months ended September 30, 2009. The decrease was due to the lower number of units sold.
Gross Profit
     Gross profit for the six months ended September 30, 2010 was approximately $17.6 million, compared to gross profit of approximately $22.9 million for the six months ended September 30, 2009. The decreased gross profit is primarily attributable to the lower net sales recorded during the quarter, compared to the prior year. Gross margin for the six months ended September 30, 2010 was 72%, compared to 70% in the comparable six months ended September 30, 2009. The increased gross profit is attributable to the higher average selling price realized in the six months ended September 30, 2010, compared to the prior year. Gross margin is affected by the relative mix of products sold, promotional activity, and changes in product sales prices and costs.
Selling, General & Administrative (SG&A)
     SG&A expense for the six months ended September 30, 2010 was approximately $12.1 million, compared to approximately $26.6 million in the six months ended September 30, 2009. The higher SG&A expense in the prior year is attributable to the $9.0 million charge recorded to account for estimated costs and charges related to the recall of nasal Cold Remedy products. In addition, a $1.6 million charge was recorded in the quarter ended September 30, 2009 to account for costs and charges related to the withdrawal of Zicam products from Canada. In addition, marketing expense declined approximately $1.1 million in the six months ended September 30, 2010, compared to the prior year. The higher level of marketing in the prior year reflects the high level of public relations activities surrounding the FDA warning letter and subsequent recall of nasal Cold Remedy products.
     Legal expense associated with litigation and regulatory activities was affected by the recording of $4.1 million of insurance reimbursement, which resulted in net expense of $700,000 for the six months ended September 30, 2010, versus legal expense of $3.0 million in the six months ended September 30, 2009 (see Note 7 — “Legal Proceedings — Legal Expense,” for more information regarding insurance reimbursement).
Research and Development
     Research and development expense was approximately $884,000 in the six months ended September 30, 2010, versus $1.4 million in the six months ended September 30, 2009. The timing and amount of research and development spending will vary depending on new product development activities, which may include clinical research, and is not generally associated with our seasonal sales patterns.
Goodwill and Asset Impairments
     In connection with the Company’s receipt of the FDA warning letter and the resulting recall of our Cold Remedy Nasal Gel and Cold Remedy Swabs, the Company performed an impairment assessment as of June 30, 2009, in which it evaluated, among other things, the impact of the foregoing events on the market’s perception of the value of the Company’s stock, the expected increase in legal activity, and the expected decline of total product sales. The assessment resulted in the Company recording a charge of $23.9 million to reduce the carrying amounts of goodwill and other tangible and intangible assets to fair value. This charge includes a non-cash impairment charge of $15.0 million related to the goodwill associated with the acquisition of the zincum gluconium nasal gel products; a non-cash impairment charge of $3.9 million to write-down the inventory value of nasal Cold Remedy products and other nasal application inventory; an impairment charge of $4.3 million ($3.4 million of which is non-cash) for a new swab manufacturing line that was built to produce our nasal swab product; and $616,000 for the unamortized amount of our Cold Remedy nasal gel patent. Those charges are reflected in the Consolidated Statements of Operations for the six months ended September 30, 2009. No impairment charges recorded in the six months ended September 30, 2010.
Interest & Other Income
     Interest and other income was approximately $23,000 in the six months ended September 30, 2010 versus approximately $85,000 in the six months ended September 30, 2009. The decline in interest income

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reflects lower interest rates. There was no interest expense in the six months ended September 30, 2010, or 2009.
Income (Loss) Before Income Taxes
     Income before income tax for the six months ended September 30, 2010 was approximately $4.7 million, compared to a loss of approximately $28.9 million for the six months ended September 30, 2009. The loss in the six months ended September 30, 2009, reflects the $32.9 million of recall charges and goodwill and asset impairments discussed above. We expect that income (loss) in future periods will be significantly impacted by the sales levels of our products, product introductions, and changes in our advertising, research and development, and legal expenses. We anticipate quarterly operating results will continue to vary along with the seasonality of sales and expenses.
     Income Taxes (Benefits)
     We record income tax expense and benefits at our combined estimated annual effective tax rate of approximately 38.5%. Due to the income from operations incurred in the six months ended September 30, 2010, we recognized an income tax expense of approximately $1.8 million, compared to a benefit of $11.1 million in the six months ended September 30, 2009 associated with the loss from operations incurred last year.
Net Income (Loss)
     Net income was approximately $2.9 million in the six months ended September 30, 2010, compared to a net loss of approximately $17.8 million in the six months ended September 30, 2009.
Liquidity and Capital Resources
     As of September 30, 2010, our cash, cash equivalents, and certificates of deposit balance was $24.0 million, compared to $30.2 million at March 31, 2010. The Company generally invests the majority of excess cash directly in a fund of U.S. Treasury Securities, U.S. government securities and repurchase agreements, and bank certificates of deposit insured by the U.S. government.
     Our working capital was $48.4 million as of September 30, 2010, compared to $44.4 million at March 31, 2010. During the six months ended September 30, 2010, trade receivables increased to $13.7 million from $5.4 million at March 31, 2010. The increase in accounts receivable reflects the timing of orders and an increase in sales as retailers prepare for the cold season. The Company’s principal source of liquidity is cash generated from sales of our products to retailers and distributors. The majority of sales are given 30 day credit terms; however, payment terms are occasionally extended, as retailers begin to increase inventory of our products prior to the onset of the cough and cold season. The Company records an estimated allowance for potentially uncollectible accounts, which is reviewed on a monthly basis. We believe our allowance as of September 30, 2010 is adequate. As a result of the Company’s fiscal 2010 operating loss, the Company recorded income tax receivables and deferred tax assets associated with tax loss carrybacks and tax credit carryforwards. We anticipate receiving tax refunds of approximately $5.3 million during fiscal 2011. Differences between anticipated and actual outcomes of these tax assets could have a material impact on the Company’s cash position in future periods.
     The changes in accounts receivable, inventory, accounts payable and accrued expenses largely reflect the seasonal nature of the Company’s business. Our working capital requirements fluctuate with the seasonality of our sales and are generally highest in the July through September quarter. The Company records the bulk of its sales, which is reflected in higher accounts receivable, in the second, third, and fourth fiscal quarters; generally builds inventory during the first through third fiscal quarter periods; and advertises its products, which is generally the largest component of accrued expenses, primarily in the third and fourth fiscal quarters. Although affected by the build-up of inventory, accounts payable and accrued expenses are generally more significantly affected by advertising spending. However, this year, we increased our up-front advertising commitment and expect to pay for advertising in advance. We do have working capital requirements arising from the increase of inventory and accounts receivable in excess of the increase in accounts payable, but these vary throughout the year reflecting the seasonal nature of our business. Generally, to the extent our operations are profitable; our business is cash flow positive.

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     The Company is involved in various product liability claims and other legal proceedings. The Company’s legal expense for these lawsuits continues to have a material impact on the results of operations and requires a significant use of cash as the Company defends itself against the various claims. Litigation is inherently unpredictable and excessive verdicts do occur. Although we believe we have defenses in these matters, we could, in the future, incur judgments or enter into settlements of claims that could have a material adverse effect on our cash position in any particular period. To avoid ongoing administrative costs, the Company and its insurer reached an agreement in July 2010 that the insurer would pay to the Company, the full amount of the $5.0 million policy, which the Company received in August 2010. Based on this agreement, the Company recorded $4.1 million, in the six months ended September 30, 2010, as reimbursement of legal expenses incurred to date for defending claims made against that policy. We expect the remaining $900,000 will be applied to legal expenses in our fiscal third quarter and do not expect to receive additional insurance reimbursements for legal expense.
     Historically, the Company has had low capital expenditures because we rely on third-party manufacturers to produce our products. Typical capital expenditures include investments in technology, office furniture, leasehold improvements, and small tooling requirements. The Company leased new corporate office and R&D space in March 2008 and invested approximately $650,000 in capital and tenant improvements, which we amortize over the term of the lease (approximately five years). The Company occasionally provides deposits and prepayments to our manufacturers to improve and increase manufacturing capabilities for our products. In 2006, the Company invested $4.2 million for an automated manufacturing line that produces our swab products. Based on the sales growth of our swab products, and our previous assumptions as to continued growth, we commissioned the building of a second manufacturing line to produce swab products at the end of fiscal 2009. However, due to the recall of our Cold Remedy swab product, we determined the new swab manufacturing line was impaired and, during the quarter ended June 30, 2009, we recorded a charge of $4.3 million to reduce the carrying amount of the new manufacturing line to fair value.
     We believe that our existing capital resources will be sufficient to fund our operations and capital requirements for at least the next 12 months.
     As discussed in more detail in Part II, Item 2. “Issuer Purchases of Equity Securities” of this Report, the Board of Directors of the Company approved a stock repurchase program, effective January 26, 2009, which permits the Company to purchase up to 1 million shares of the Company’s common stock. Concurrent with its approval of this repurchase program, the Board of Directors terminated the repurchase program previously authorized in April 2004. The Company does not anticipate repurchasing shares of its common stock on the open market for the foreseeable future. However, during the six months ended September 30, 2010, the Company repurchased 31,204 shares of common stock, with an aggregate value of $153,820, from employees in satisfaction of their applicable tax withholding obligations on the vesting of restricted stock awards. Shares so surrendered are repurchased pursuant to the applicable award agreements and not pursuant to publicly-announced share repurchase programs.
Off-Balance Sheet Arrangements
     As of September 30, 2010, we did not have any off-balance sheet arrangements.
Contractual Obligations
     We have entered into certain long-term contractual obligations that will require various payments over future periods as follows:

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            Contractual Cash Obligations          
            (In thousands of dollars)          
    Payments due by Period as of September 30, 2010  
            Less than                     After  
    Total     1 year     1-3 years     3-5 years     5 years  
Long-Term Debt Obligations
  $ 0     $ 0     $ 0     $ 0     $ 0  
Capital Lease Obligations
    0       0       0       0       0  
Operating Lease Obligations
    1,238       439       799       0       0  
Purchase Obligations
    11,058       11,058       0       0       0  
Other Long-Term Liabilities Reflected on the Company’s Balance Sheet under GAAP
    0       0       0       0       0  
 
                             
Total
  $ 12,296     $ 11,497     $ 799     $ 0     $ 0  
 
                             
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Forward Looking Statements
     This Report on Form 10-Q, including documents incorporated herein by reference, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words “believe,” “expect,” “estimate,” “anticipate,” “intend,” “may,” “might,” “will,” “would,” “could,” “project” and “predict,” or similar words and phrases generally identify forward-looking statements. Forward looking statements contained herein and in documents incorporated by reference herein include, but are not limited to statements regarding:
    our belief that any additional recall charges will be immaterial;
    our belief that reserves for customer programs are adequate and proper;
    our expectation regarding continued expansion of the Zicam line of products;
    our expectation of achieving fiscal 2011 revenue in the $69.3 million to $70.7 million range;
    our expectation of achieving fiscal 2011 net income in the $2.0 million to $3.0 million range;
    our belief that our allowance for uncollectible accounts is adequate;
    our expectation that ongoing legal expense will be between $1.3 million and $1.8 million per quarter;
    our expectation that any federal consumer fraud and personal injury matter filed in the future will be transferred and consolidated pursuant to the MDL transfer process, subject to the plaintiff’s opportunity to object;
    our intention to continue vigorously defending the Zicam Cold Remedy product liability and securities litigation claims, our expectation that additional product liability lawsuits may be filed against us, and our belief that any liability resulting from these or other lawsuits, including any adverse publicity, could materially impact our financial results;
    our expectations regarding litigation reserves;
    our expectation of utilizing deferred tax assets;

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    our expectation that sales in future periods will be affected by the recall of our nasal Cold Remedy products;
    our expectations regarding the effect of accounting standard updates;
    our expectation that retailers will add new and/or different Zicam products;
    our expectations regarding store brand competition;
    our intention to review our product return reserve provision regularly and adjust the reserve amounts if actual product returns differ materially from our reserve estimates;
    our expectation of making income tax payments at our statutory rates in future years;
    our expectation that operating expenses in fiscal 2011 will decline as a percentage of sales compared to fiscal 2010;
    our expectation that the average unit cost of goods sold and gross margin will continue to be affected by the relative mix of products sold;
    our expectation that our net income and operating expenses in future periods will vary largely with the seasonality of our sales, the severity of the cold season, the revenues and expenses associated with new products, and the timing and amount of advertising, research and development, and legal expenses;
    our expectations regarding derivative instruments;
    our belief that we will not repurchase shares of common stock in the open market;
    our expectations regarding the amount of advertising expense and that advertising expense will be highest in our third and fourth fiscal quarters;
    our intention of focusing promotional and marketing support on Zicam oral Cold Remedy products during the 2010/2011 cold season;
    our belief that focusing on consumer consumption of our oral Cold Remedy products will allow us to grow the Zicam brand;
    our belief that our existing capital resources are sufficient to fund our operations and capital requirements for the next 12 months;
    our expectations regarding our manufacturers’ ability to timely produce inventory adequate for sales of products through the 2010/2011 cough and cold season;
    our belief that moderate interest rate increases and current uncertainties regarding the availability of credit will not have a material adverse impact on our results of operations or financial position in the foreseeable future and that we are not subject in any material way to other forms of market risk.
          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.

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          Statements in this Report on Form 10-Q, including those set forth in the sections entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Risk Factors,” describe factors that could contribute to or cause actual results to differ materially from our expectations. Other such factors include (i) the possibility that future sales of our products will not be as strong as expected; (ii) a weak cough and cold season; (iii) lack of market acceptance for or uncertainties concerning the efficacy or safety of our products; (iv) regulatory or enforcement actions, including product recalls, that could restrict our ability to market our products; (v) changing or modified regulatory or enforcement standards that could impact our ability to market our products; (vi) difficulties in manufacturers or suppliers meeting production requirements or maintaining sufficient inventories to meet unexpectedly high demand in the short term; (vii) financial difficulties encountered by one or more of our principal customers; (viii) increased competition from store brand versions of our products; (ix) material litigation involving, product liability claims, consumer issues, securities violation claims, or patent and contractual claims; (x) the possibility of delays or other difficulties in implementing product improvements and introducing to the marketplace new products; (xi) adverse publicity regarding our products or advertising restrictions; and (xii) adverse economic changes that affect consumer demand.
     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.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
     We believe that our existing capital resources will be sufficient to fund our operations and capital requirements for at least the next 12 months. We believe that interest rate increases and the current uncertainties regarding available credit will not have a material adverse impact on our results of operations or financial position in the foreseeable future.
     As of September 30, 2010 and March 31, 2010, we did not participate in any financial-market risk-sensitive commodity instruments for which fair value disclosure would be required. 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 or commodity price risk.
Item 4. Controls and Procedures
     We carried out an evaluation, under the supervision and with the participation of our President and Chief Executive 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 President and Chief Executive Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the required time periods and is accumulated and communicated to our management, including our President and Chief Executive Officer, as appropriate to allow timely decisions regarding required disclosure. There have been no changes in our internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the fiscal quarter ended September 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II
OTHER INFORMATION
Item 1. Legal Proceedings
     See Note 7 — “Legal Proceedings” for a discussion of the principal legal proceedings to which the Company is a party.
Item 1A. Risk Factors
     In addition to the other information set forth in this report, you should carefully consider the risk factors disclosed in Part I, “Item 1A. Risk Factors” of our Annual Report on Form 10-K for the period ended March 31, 2010, each of which could materially affect the business, financial condition or future results of the Company. The risks described in such Form 10-K, and this Form 10-Q are not the only risks facing the Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial in the future, also may materially adversely affect the business, financial condition and/or operating results of the Company.
Item 6. Exhibits
     
Exhibit No.   Title
3.01
  Articles of Incorporation and Amendments thereto of the registrant (1)
 
   
3.02
  Bylaws of the registrant (2)
 
   
4.01
  Rights Agreement dated as of July 22, 2002 by and between the registrant and Corporate Stock Transfer, Inc. (3)
 
   
31.1*
  Certification of CEO and CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
   
32.1*
  Certification of CEO and CFO pursuant to 18 U.S.C. Section 1350
 
*   Filed with this Report on Form 10-Q.
 
**   Indicates management compensatory contract, plan or arrangement.
 
(1)   Incorporated by reference to the Registrant’s Amendment No. 1 to Form 8-A, filed June 18, 2002, file number 000-27646.
 
(2)   Incorporated by reference to the Registrant’s Report on Form 8-K, filed July 25, 2006, file number 001-31404.
 
(3)   Incorporated by reference to the Registrant’s Registration Statement on Form 8-A, filed July 23, 2002, file number 001-31404.

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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/ William J. Hemelt    
  William Hemelt   
  Chief Executive Officer and
Principal Financial Officer
November 5, 2010  
 

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