Executives
Bill Barba – Treasurer
Bill Hemelt – President and CEO
Analysts
Scott Henry – Roth Capital
Matt Daniels [ph] – Madison Street Partners
Nick Genova – B. Riley & Co.
Kevin Kendra – Gabelli
Wayne Smith – Touchstone Investment
Matrixx Initiatives, Inc. (MTXX) F2Q10 (Qtr End 09/30/09) Earnings Call Transcript October 27, 2009 11:00 AM ET
Operator
Ladies and gentlemen, good morning. At this time I would like to welcome everyone to the Matrixx Initiatives fiscal 2010 second quarter conference call. During the presentation, all participants will be in a listen-only mode. A question-and-answer session will follow the company’s formal remarks. (Operator Instructions).
Today’s conference call is being recorded. On the call we have Bill Hemelt, President and Chief Executive Officer; and Bill Barba, Treasurer of Matrix Initiatives.
And now I would like to turn the call over to Mr. Bill Barba. Please go ahead, sir.
Bill Barba
Thank you, Brendan. Good morning everyone and thank you for joining the Matrixx Initiatives fiscal 2010 second quarter conference call. At the conclusion of today’s prepared remarks, we will open the call for a Q-and-A session.
Before we begin, I do need to advise you that this call may contain forward-looking statements, not limited to historical facts, but reflecting our current beliefs, expectations or intentions regarding future events.
A number of factors could cause actual results to differ materially from those in the forward-looking statements, because actual results may differ from expectations, we caution you not to place undue reliance on these statements. Additional information concerning risk factors that could affect our results are described in our filings with the SEC, including our 2009 10-K and first quarter 10-Q.
I would now like to turn the call over to Mr. Bill Hemelt. Bill?
Bill Hemelt
Thank you, Bill. Good morning and thank you for participating in our conference call today to discuss our financial results for the second quarter of our fiscal year 2010.
As noted in our press release issued yesterday, we recorded $25.6 million in revenues for the second quarter of this year versus $33.6 million for the comparable quarter last year. And we reported earnings per share of $0.55 versus $0.86 last year. The decline in both sales and earnings will be discussed in detail by Bill Barba, but relates principally to the loss of the sale of our nasal Cold Remedy products, which we withdrew from the market in June of this year.
A significant factor of that is to offset the loss of sales of the nasal Cold Remedy product has been the strong early start of flu illness associated with the rapid spread of the H1N1 or Swine Flu. The level of illness as measured by the weekly BAN [ph] report and the CDC Flu Tracker report is currently running at levels not normally seen until much later in the season, usually around January or February. This high level of illness has driven takeaway of our products and caused retailers to stock up in expectation of continued high level of illness.
For the Zicam brand in the quarter, we made up half of the loss sales of the withdrawn nasal products through a 53% increase in sales of our oral Cold Remedy products. Part of that increase is associated with sales of our two new Zicam Cold Remedy products, Zicam Zavors and Zicam Liqui-Loz, while the remainder is from the increased sales of our established Zicam Cold Remedy Oral products, RapidMelts, Oral Melts and Chewables.
According to IRI for the 12 weeks ended October 4th, if you exclude the nasal Cold Remedy products sales from last year, the sales of our remaining products for the products that we currently have in the marketplace are up 4% versus a 2% increase in the category for the same period. The higher level of sales began around Labor Day, and has continued to escalate since then.
I think the conclusion that can be drawn from those data is that Zicam branded products and in particular, our Zicam Oral products are receiving a solid share of the current strong market. But I would caution investors that we are still very early in the season and should not extrapolate this early data to the whole season. The H1N1 flu is the driver of current activity in the marketplace. We do not know how long it will continue, particularly given at the expense of vaccination program that the government is planning is just now getting underway.
Further, we do not have any indication how strong the regular cough-cold season will be nor how strong the regular seasonal flu season will be. However, we are very encouraged by our success in coming out of the blocks this season.
We have finalized our promotional and advertising plans for the season. Our promotional program that we have put in place with our retail customers is as extensive as our program was last year and features significant tie-in with flu shop programs at various retailers. Perhaps you have seen some of the end cap display or the palette program that we had at some club stores. These programs will continue in coming months.
More importantly, our new commercial will be on air next year. We think that the commercial presents the benefit of taking Zicam early to treat us the cold in a clever, humorous way. As part of the advertising program, we have changed the way we are buying media this year, to capitalize on the very low advertising rates available in local media outlets. Basically we hope to match these local buys with an increase in illness in local markets. These local buys however would be an addition to our strong national advertising program. Our hope is that this new program will allow us to directly market the consumers who are more likely to be in the market for our Cold Remedy products.
Before I turn this over to Bill, let me emphasize that we are committed to providing the necessary advertising and promotional support to ensure that the Zicam brand is fully supportive during this season in order to not only keep our Zicam Oral users in the franchise, but also to transition our loyal nasal Cold Remedy consumers to our oral products. I am pleased by what we are seeing so far in the promo and advertising program and the plans that we have outlined for this year.
Now, I am going to turn it over to Bill, to provide more detail on the numbers.
Bill Barba
Thanks Bill. As Bill mentioned, net sales for our fiscal second quarter were $25.6 million, which compares to $33.6 million in the prior year second quarter. The lower sales comparison is primarily due to the loss of our nasal Cold Remedy products. Unit sales of our other Zicam products did increase 11%, led by a 53% increase in Cold Remedy oral product sales. Due to the mix of products sold and a price increase that became effective during the quarter ended September 30th of the prior year, we’ve realized a higher average selling price during the quarter compared to the prior-year second quarter.
Net income for the second quarter was $5.1 million or $0.55 per diluted share compared to net income of $8.2 million or $0.86 per diluted share for the second quarter of the prior year. For the six months ended September 30th, 2009 net sales decreased 23% to $32.5 million versus $42.1 million in the prior year six months ended September 30th. The company incurred a net loss for the six months ended of approximately $17.8 million or a loss of $1.95 per diluted share compared to net income of $6 million or $0.62 per diluted share in the prior year.
I would like to remind you that the $23.8 million income decline does include pretax charges associated with the FDA warning letter and recall of our nasal Cold Remedy products in the prior quarter. The charges were included in the first quarter results, it included $9 million to reserve for recall related costs and $23.9 million for goodwill and other asset impairments. Net income in the prior year did include $1.9 million reserve for charges associated with the previous reported recall of certain lots of oral Cold Remedy products.
For our fiscal second quarter, we achieved an average gross margin of 73% compared to 69% in the quarter ended September 30th of ’08. The higher average gross margins was due to higher average selling price as well as a lower average cost per units sold. Gross margins do vary by quarter generally due to mix of products sold and the levels of wins to our promotion. Gross margins on our existing products vary between 55% and 80%.
During the quarter, SG&A expense was approximately $10.2 million versus $8.8 million the prior year. We previously reported that we decided to withdraw our products from the Canadian marketplace in order to focus the company’s marketing efforts fully on US sales. The withdraw was initiated during the quarter and we did report approximately $1.6 million to reserve for withdraw charges in fees, as well as $423,000 to write down the inventory of products specific to the Canadian marketplace.
During the quarter, we also realized increased litigation expense of approximately $1.6 million above $759,000 recorded in the second quarter of the prior year. The increase is related to the product liability litigation as well as responding to the FDA’s warning letter and the SEC’s informal inquiry, as well as litigating clients of one of our formal manufacturer. We do anticipate that we will realize increased legal expense going forward.
Beyond those items, increasing SG&A, we realized the $1.2 million decrease in marketing expense. This decline was due to decreased spending for Allergy/Sinus products and we had incurred approximately $425,000 for trial marketing our Xcid antacid products during the prior year’s second quarter.
I would now turn the call back over to Bill Hemelt for additional comments. Bill.
Bill Hemelt
Thanks Bill. I want to conclude our formal comments to direct your attention to a note in our press release that says that our planning for the year reflects a revenue level for the current fiscal year in the $65 million to $70 million range.
It is very early in the game and there are a number of unknowns that I mentioned earlier. But we believe we have put in place a strong program to establish the Zicam franchise for profitable growth as we exit this year.
And with that, we will now invite questions.
Question-and-Answer Session
Operator
Thank you. (Operator Instructions). And we will take our first question from Scott Henry with Roth Capital.
Scott Henry – Roth Capital
Hello Bill. I guess just starting from the big picture, it seems that this quarter would at least preliminarily indicate that consumers are not afraid to take the oral dosages of Zicam which I guess would have been the worst-case scenario, I mean certainly evidence of gaining share would support that. I just wanted to get your thoughts on that kind of big-picture outlook for the brand?
Bill Hemelt
Yes, I would agree with that comment. The data that we are looking at particularly over the last six or seven weeks shows a willingness on consumers to buy the oral products just based on – I quoted IRI data earlier. But our point-of-sale data at some of our largest retailers shows increases in sales of some of our products in the 50% to a 100% range currently. Now, a large part of that obviously is driven by the fact that people are sick from the H1N1 or they think they are coming down with a cold. But clearly it demonstrates the willingness of consumers to buy Zicam branded oral products.
Scott Henry – Roth Capital
Okay, thanks. I think that’s pretty good news relative to worst case. But then looking a little bit more at the specific quarter and as we try to figure out what the organic growth rate is or I guess decline in this case, and even in stripping pricing out of it, I am a little more curious at the rate when you look at year-over-year. I mean you reported minus 24% year-over-year. I guess you are starting out at minus 4% when you strip out the nasal. I mean, how do you think of that 24% decline going forward? I know that’s hit – an one-time event that hit your quarterly numbers, but I am just trying to get a read on how should we think of the year-over-year track?
Bill Hemelt
Yes, it’s a very good question, and I must tell you that the data at this point is hard to come by. I mentioned in my comments that not only have we seen increased takeaway stores, but we have also seen a significant increase in inventory build by the retailers in response – obviously they are expecting higher sales and that’s why they are willing to bulk up. And as you know in prior years, they were going in just the opposite direction.
The H1N1 effect is causing them to buy ahead, and we have never seen this kind of advanced purchasing before. So it’s really is skewing the data, but what we are looking at in particular obviously is the IRI data and our point-of-sale data which gives us some sense of how well it’s doing.
All that being said, I am not sure – at this point we’re still at the early part of the season. I mean normally at this time last year, we’d be talking about the oncoming season not really a season that really started at almost a peak levels in September. So we are dealing with kind of an unknown factor here.
Scott Henry – Roth Capital
Okay. It sounds like from your guidance, you are baking in sort of a 35% year-over-year decline which I guess could be considered conservative when you factor in. You only lost 40% of the business, the rest of the business seems to be gaining share in your pricing, but I guess it’s clearly still very early, so I guess that makes sense. On the other front, how does store brand competition, what percent of your business seems at risk?
Bill Hemelt
We have seen increases in knock-offs not only of our RapidMelts but also now our Oral Melts. And that’s pretty much it. But all – at least two of our RapidMelt orange with vitamin C and our RapidMelt with cherry is pretty much everywhere. It is clearly that is a strategy that our retail customers are going to employ and it’s not just against us, but against everybody and every product within their store. They want to build the – their profit margin. It’s again as the impact this year remains to be seen, obviously our sales are up. My guess is their sales are up as well.
Scott Henry – Roth Capital
Okay. From – I guess we can care to put a number on the percent of your business exposed, I think it was around 20% last year.
Bill Hemelt
Well, since we’ve lost 40%. I mean just by the nature of losing that that would double, so you are probably at risk against 50% of our product offerings.
Scott Henry – Roth Capital
Okay. And when you think of self space year-over-year for the brands that stuck around, I mean excludes the 40% that went away, how does shelf space look year-over-year for I guess you called them your legacy brands?
Bill Hemelt
Yes, I would like them to call legacy brand. We were very successful in maintaining shelf space, our retail customers were very quick to respond to the loss of the nasal products by either taking on products that they didn’t have before or picking up an additional one of our two new offerings. And in some cases, they are giving us double phasing of some of our products. So I think it’s a strong vote of confidence in the brand by retailers that we have not had any loss of shelf space. So I would say yes, we are probably where we were last year.
Scott Henry – Roth Capital
Okay. I guess final question, any comments on the new brands. Anything jump out or it’s still pretty early?
Bill Hemelt
The Zavors clearly has been the preferred choice of retailers, and that has gained acceptance I think almost everywhere. The Liqui-Loz didn’t get as much distribution. It obviously is an opportunity for next year. But we think that in terms of the sales, it’s again early to say, but it looks reasonably strong. And we think both of these are unique, which is part of our strategy to try to fight off some of the retailers’ generic brand.
Scott Henry – Roth Capital
Okay. Thank you for taking my questions, Bill.
Bill Hemelt
Okay, thanks.
Operator
We will take our next question from Matt Daniels [ph] with Madison Street Partners.
Matt Daniels – Madison Street Partners
Hi Bill, thanks for taking the question. I appreciate it. Two questions for you, Bill. I was hope you could update us with regards to the number of lawsuits – am I have to wait for the quarter or sorry the Q for that information? And then the second question would be, from a gross margin standpoint, can you help us understand sort of the moving parts within gross margin and why it was a bit higher in this quarter compared to previous quarters? Thanks.
Bill Hemelt
Yes, the growth factors that go into gross margin is any deduction from gross revenues down to net sales which includes promotions expense, slotting fees, and those vary by quarter. And even though we had some promotional activity going on in the September quarter, it will ramp up in the next quarter such that that would drive down margin in the next two quarters, so that’s the principal factor that vary quarter-to-quarter.
With respect to the number of suits, I really don’t have that information in front of me. It is suffice it to say that we have had a number of individual lawsuits filed, places claiming that they have lost their sense of smell. Probably the bigger activity has been the class action lawsuits and I think they were maybe 13 or 14 of those filed in various states covering in some cases multiple states, and in one case I think covering the entire United States. Those consisted principally of a consumer fraud allegation.
The biggest development on that front is that we were successful in getting the multi-district litigation approved. That was approved about three or four weeks ago. And all of those cases that are filed at the federal level have now been consolidated before one judge in Arizona. And the process will – it will take about six months just for them to sort through and get all the documents into that one court, and then they will go through a process of identifying common issues.
The benefit of this process is that it reduces our cases across the country, and which will allow us to control and manage our litigation expenses. It also avoids the difficulty if you have decisions – differing decisions in various courts on the same point. And so this way we will have one consistent decision.
There are a still a number of cases that are in state court, those will continue to proceed in state court. But the MDL process will allow us to control or manage litigation expenses and hopefully in the long-term will allow us to manage us process. Again, we believe very strong in our position of these products don’t cause us problem. But – and we will continue to defend our products.
Matt Daniels – Madison Street Partners
Thank you.
Operator
And we will take our next question from Nick Genova with B. Riley & Co.
Nick Genova – B. Riley & Co.
On the legal expense, can you guys – I think you just formally talked about $4 million to $5 million annually in legal expense, but this kind of came in higher. Were any of this things sort of front-loaded in this quarter’s numbers or where do you guys think you are going to be at on an annual level?
Bill Hemelt
I think the $4 million to $5 million was in reference directly to the product liability and consumer fraud litigation. What we had in this quarter was a number of other legal matters, specifically the cost of responding to the FDA of warning letter, the cost of responding to the FDC [ph] inquiry request, as well as the case that we had against one of our previous manufacturers. Those were the three factors heavily and there are legal expense for this quarter. Obviously, they may continue at some level or they may hopefully disappear at sometime.
Nick Genova – B. Riley & Co.
But at least on the FDA response level, that’s pretty much done.
Bill Hemelt
No, I wouldn’t say it’s done. We filed an 8-K the other day which said that we are evaluating our options with respect to that. They have basically come back and reaffirmed their decision through the discussions that we have had with them. And so obviously there is going to be some continuing legal work associated with our whatever response we undertake.
Nick Genova – B. Riley & Co.
From a marketing standpoint, you guys were talking about doing a promotional campaign that’s as extensive as last year. From an overall dollar level, I mean are you – it still sounds like you guys are going to be more price conscious, so can you give us a sense for where you think you will come in at a dollar level compared to last year?
Bill Hemelt
Yes, and that’s a question. Maybe when we talk about it at the same level as last year and we probably need to be more clear that it’s not necessarily the same dollar level, but I think it’s going to be in terms of effectiveness at the same level. We are anticipating some improvements in our ability to buy media.
We believe that our reach and frequency will be at comparable to last year principally because of the softness in the advertising market. So I think as a percent it will – it maybe a little higher. I think in years past, we have always mentioned the 30% level; it may be in the 30% to 35% for the full year this year, but it – dollars it would still be down from last year.
Nick Genova – B. Riley & Co.
Okay, thanks.
Operator
(Operator Instructions). And we will take our next question from Kevin Kendra with Gabelli.
Kevin Kendra – Gabelli
Hi guys, I was wondering if you can give a bit more detail on what’s supporting that $65 million to $70 million figure that you guys put out there?
Bill Hemelt
What’s supporting it? I think at a simplistic level, you can take last year’s number and take off 40% and there is obviously more to within that. We’ve tried to take into a town to an expectation of a normal season. I would tell you right now we are not experiencing a normal season, but there is still a number of unknowns. As you know in prior years, we have had a couple of very soft illness periods that have caused us to go on lower than our guidance.
Beyond that, obviously we have had some products withdrawals of our non – Cold Remedy non-allergy products; those are sales that we don’t have this year. So all of that is factored into our estimate for this year, and obviously we are making some assumptions as to how many people are going to convert from our nasal products to our oral products and that’s quite honestly is our – the biggest unknown we’ve faced.
Kevin Kendra – Gabelli
Okay. And I believe on the last call, the first quarter, you guys mentioned a sort of cash threshold that you thought you could end the year end; I believe it was $27 million or so. Does that still hold?
Bill Hemelt
Yes, I don’t remember the exact number, but I think in the mid-20s, I think it was for sure we should be able to achieve that.
Kevin Kendra – Gabelli
Okay. And looking at the cash number for this quarter, how much of that has absorbed that $9 million or so in recall expenses versus how much still has to flow through?
Bill Hemelt
We have seen approximately two-thirds of it come through so far.
Kevin Kendra – Gabelli
Okay. And –
Bill Hemelt
One of things you should note also is September is generally our lowest cash position of the year prior to or in the months preceding the September, you build up inventory and you increase the accounts receivable, and then it kind of goes sideways through the end of the year, and then it the cash flows in the last quarter of the year as we draw down inventory and the accounts receivable are converted to cash.
Kevin Kendra – Gabelli
Okay. And if I look at your sales based on the numbers you guys put in the press release, it looks like 56% -- if you strip out the products that were recalled, remaining products plus the new products up 56% year-over-year, is that an accurate way to do the math?
Bill Hemelt
I thought it was 53%, but –
Bill Barba
Stripping out the nasal units were 11%. I thought orals were up 53%.
Kevin Kendra – Gabelli
Okay, it’s up 11%. Okay. All right thank you.
Bill Hemelt
Thank you.
Operator
And we will take the next question from Wayne Smith with Touchstone Investment.
Wayne Smith – Touchstone Investment
Hi, I was just wondering if you could give us some color as far as a particular channels that you guys are seeing strength or weakness in them. And I have noticed particularly in – I think you talked about this in the last conference call with the club stores seems to have been ramped up activity a lot. I was just wondering if you could touch on those guys specifically, and maybe the grocery channel if you are seeing an improved traction there as far as getting your products on the shelves?
Bill Hemelt
With respect in the club stores and principally the Costco chain, we had a palette program there last year, and we were very pleased that to repeat that palette program with our oral products this year. In fact, I think this maybe the last week of it. From all indications, the product sold extremely well through Costco.
Wayne Smith – Touchstone Investment
And when you say a palette program, what exactly do you mean? Is it like an end cap kiosk or something?
Bill Hemelt
It is a palette, it’s a full-size palette. But with about three layers of product on it and a correct round in the bottom is our graphics highlighting those (inaudible) brand.
Wayne Smith – Touchstone Investment
Okay.
Bill Hemelt
And it’s at the same size as it was last year, which was great. We had a plan to the increase of this year, but then with the loss of the nasal, we backed off and just kept it at the same size. It’s the products have sold very well over the last four or five weeks, we really managed to time that right. And as I said, it’s pretty much run its course, so they will be in the essence tearing down those palettes and putting the products on the shelf. But that has been very successful.
We have a very expensive program at Walgreens this year, it’s tied in with their flu shop program. If you go in and get a flu shop, it should be right on the table, a little display with the information about the difference between colds and flu, and basically saying okay, now that you’ve protected yourself for the flu, why don’t you protect yourself or be ready for your cold by Zicam, and I think there is a coupon in the brochure.
We are also on the end caps at Walgreens in very prominent place. We also have some additional promotional programs planned at Walgreens later in the season. Those are the things that come to mind. But I would say when I compare this year versus last year, the size of the programs across the board are about at the same level, which is quite obviously a true testament to our sales force who was very aggressive out there in responding to the loss of our nasal products, and I am really pleased with what the work they did to recover from that.
Wayne Smith – Touchstone Investment
And then the grocery, Krogers and Albertsons of the world, have you guys been making inroads there, it’s just it seems to me that I see your products lot more at the grocery.
Bill Hemelt
You will see it more this year. I will be doing some – that’s right, excuse me, we have a new broker who is focusing principally on our food outlets and there has been an improvement in shelf placement there. And it’s – I don’t know I have any specific numbers, but I do think that they have been very successful in getting us a better shelf placement and getting more skews on the shelf. I will tell you that food stores generally only account for maybe 15% of over-the-counter drug sales.
Wayne Smith – Touchstone Investment
Okay. And then any place that you guys have any particular weakness or customers that decide carry less this year versus – because of the issues?
Bill Hemelt
No, as I’ve said before, I think we’ve maintained pretty much our shelf exposure.
Wayne Smith – Touchstone Investment
Okay, thanks.
Bill Hemelt
Okay.
Operator
And we have no further questions at this time. I would like to turn the call back over to Mr. Hemelt for any additional or closing remarks.
Bill Hemelt
Okay. I want to thank you again. As I said, I think we have gone out of the blocks here really in good fashion and we are very pleased by it. I think there is a lot of activity. I certainly look forward to talking with you again in late January when we will update you on the third quarter of our fiscal year. And again I thank you for your interest in the company.
Operator
That does conclude today’s call. Thank you for your participation.
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