Zicam manufacturer Matrixx Initiatives' sales dropped more than 50 percent in its most recent quarter as its legal costs continue to grow.

Matrixx currently contends with damages claims on two fronts: allegations that Zicam nasal gel products cause anosmia and that the company misrepresented the safety and efficacy of its products.

In October 2009, a judicial panel ordered that all the economic and personal injury cases pending in federal court against Matrixx be centralized and transferred to federal court in the District of Arizona, the company said in its 10-Q quarterly SEC filing, submitted Aug. 5. All of the cases were filed as class actions, but none of the classes has been certified.

As of Aug. 1, the company knew of 231 pending product liability suits involving 794 plaintiffs. Of those cases, 174 are pending in federal court and 57 in state court, the company said in its filing.

Additionally, approximately 500 more potential claimants advised the company they are considering litigation or are interested in a settlement.

"If any liability were to result from one or more of these or future lawsuits, we believe our financial results could be materially impacted," the company said in the SEC filing. "Our financial results also could be materially impacted by the adverse publicity that may result from the lawsuits."

Matrixx said it is in mediations with plaintiffs in those cases, but the firm will proceed with litigation if settlements are not reached "in the company's best interest."

The mediation process is moving quickly, President and CEO Bill Hemelt said during an Aug. 4 earnings call. "While we will not speculate on the outcome of either of those efforts, it is important to realize we are moving relatively quickly," Hemelt said.

In separate litigation, shareholders allege the Scottsdale, Ariz., firm withheld information on adverse event reports that, when disclosed, caused the stock's value to drop sharply.

The Supreme Court in June agreed to hear the company's appeal of a court ruling that overturned the standard that AERs must be statistically significant to be considered material. Hemelt said the company expects the Supreme Court to hear the case in December (¹ Also see "Matrixx Prompts Supreme Court To Consider What Firms Must Disclose" - Pink Sheet, 21 June, 2010.).

Additional shareholder litigation alleges certain company officials violated their fiduciary duty by failing to disclose reports of anosmia to consumers and FDA. That litigation is pending in federal district court in Arizona, the company said in the SEC statement.

The firm added in July it entered an agreement with 46 potential claimants who threatened damages claims. The company paid $5,000 or less per claimant in those cases.

Also during the current quarter, Matrixx's liability insurer agreed to award the firm the full $5 million value of its insurance policy to trim administrative expenses for the account.

Matrixx "had a limited amount of liability insurance," Finance and Accounting VP Bill Barba said.

The firm used $1.9 million of the insurance sum for first-quarter legal expenses, kept $300,000 available for liability credit and applied the remaining $2.8 million to future expenses.

Matrixx said it expects to incur legal costs - not counting settlement fees - of $1.3 million to $1.8 million per quarter before the remaining insurance payout is allocated.

The company anticipates net income of $2 million to $3 million for its fiscal 2011, but it did not include the cost of potential lawsuit settlements in the guidance.

In a May 12 note, Roth Capital analyst Scott Henry estimated the odds of Matrixx settling with damage claim plaintiffs at 60 percent, at a likely cost of $30 million. He put the chances of Matrixx losing and filing for bankruptcy at 35 percent, with the remaining 5 percent going to the likelihood of Matrixx prevailing over plaintiffs.

In an interview, Henry said he stands by his assessment following Matrixx's first-quarter earnings call.

Settling, rather than pursuing litigation that potentially could drive Matrixx to bankruptcy, is in plaintiffs' interests said Henry, who called the litigation process "a game of chicken." If the company does enter bankruptcy, he said, other creditors would be paid before plaintiffs. Secured creditors, like banks, are entitled to payment before others with whom a bankrupt company has debt.

"I wouldn't underestimate the bargaining power of the person with the cash in their hand," he said.

Matrixx declined to comment on the litigation beyond the SEC filing and quarterly earnings remarks.

The firm reports a 53.6 percent plummet in net sales to $3.2 million for the April-June period and a loss of $2.4 million, or 26 cents per share.

Matrixx's sales are seasonal, with its products selling primarily during the cold and flu season, and the company historically posts a first-quarter loss, Hemelt said.

"This quarter does not provide a good measure of the underlying strength of the Zicam brand nor does it provide or help in guiding to a full-year outlook for our business," he said.

Matrixx actually trimmed its loss from $22.8 million in the year-ago quarter, when FDA warned consumers of potential anosmia linked to the zinc gluconate-containing Zicam nasal swabs and advised Matrixx to pull the products - its top sellers - off the market (² Also see "FDA Uses "Unusual" Action To Get Matrixx's Zicam Off The Market" - Pink Sheet, 29 June, 2009.).

The firm struggles to compete by transitioning users of the recalled products to other Zicam stock-keeping units.

Products for nasal allergy and congestion relief "have not achieved high consumer acceptance," said Barba, adding Matrixx also faces private label competition.

But Hemelt pointed out retailers are receptive to the firm's promotional plans for the approaching cold and flu season. The 10 largest retail customers will have a net increase of Matrixx products on their shelves.

Retailers in 2009 stocked up on cough/cold products during the summer months due to expectations that the H1N1 influenza virus would drive up sales. However, after cough/cold sales did not climb, Matrixx shipped fewer products during the winter months as retailers sold down inventories.

Retailers so far in 2010 have not built inventories. They expect cold and flu season to hit later than in 2009 and may order products later in the year, Hemelt said.

- Carolyn B. Phenicie ( ³ c.phenicie@elsevier.com )

Zicam Maker Matrixx' Sales Plummet While Legal Costs Climb

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