Medical Action Industries Inc. F3Q09 Earnings Call Transcript

Medical Action Industries Inc. (MDCI)

F3Q09 Earnings Call

February 4, 2009 10:00 am ET

Executives

Richard G. Satin - Vice President - Operations, General Counsel, Corporate Secretary, Director

Paul D. Meringolo - Chief Executive Officer and President

Charles L. Kelly Jr. - Chief Financial Officer

Analysts

Matthew Dolan - Roth Capital Partners, LLC

Mitra Ramgopal - Sidoti & Co.

Presentation

Operator

Good morning, my name is Demetrius and I will be your conference operator today. At this time I would like to welcome everyone to the Medical Action Industries Third Quarter Earnings Results Conference Call. (Operator Instructions) Mr. Satin you may begin your conference.

Richard Satin

Good morning and thank you all for holding. With me on this call are Paul Meringolo, President and CEO and Chuck Kelly, Chief Financial Officer of Medical Action Industries. The primary purpose of this call is to discuss our results for the three and nine months ended December 31, 2008, which were released this morning.

As you know we must first touch all of the legal bases for noting that both our commentary and responses to your questions may include forward-looking statements. These forward-looking statements are subject to a number of risks and uncertainties discussed in detail in our report on Form 10-K, annual report to stockholders and our quarterly reports on Form 10-Q, all of which have been filed with the Securities and Exchange Commission. The company’s actual future results may vary.

It is now my pleasure to introduce Paul Meringolo.

Paul Meringolo

Good morning and thank you all for being here today. I am sure and assume that all of you had a chance to see the news release. Q3 results confirm that this is a transition year for us as we have managed through our challenges. We are at the tail end of this transition and pleased to be there.

On a positive note, we have seen some good progress on three challenges. We have seen, due to oil decreases, the lowering of resin costs, a lowering and stabilizing of cost of goods from China, as well as some of the progress we’re making in our plant in Tennessee. While we continue to make progress on each, improvements had very little impact on the Q3 numbers, but should have a positive contribution to future results.

With raw materials cost stabilizing we are essentially done with price increases to the market, and so we are going to really turn our immediate focus on selling more existing product to our existing customers, as well as continuing to drive cost out of the manufacturing process, as well as our expense model which we have always been focused on.

Let’s look briefly at the third quarter numbers. Net sales are about $72 million down 75% from the prior year period.

Net income was $157,000 or $0.01 per diluted share versus $3.6 million or $0.22 per diluted share in the prior year period.

Again three challenges were resin, China and Tennessee which had a total impact on the quarter of a little over $6 million.

The nine-month numbers, net sales reached a record $223 million, $214,000, up 2% for the same period last year. Net income $3,183,000.00 or $0.20 per diluted share versus $10,428,000.00 or $0.64 per diluted share for the same period last year. The three challenges between resin, China and Tennessee had a total impact of $17,321,000.00 on those numbers.

Let’s first talk about the sales results for the quarter:

As I have said in the past supply chain in this marketplace, especially with some back order issues and volatility in cost and price increases create a real inefficient model. We believe the year-over-year third quarter decline was in due in part to higher than normal customer buying in the third quarter of ’08. Again, they wanted to avoid anticipated price increases and our shift in business had an affect on year-over-year revenue comparisons.

Another contributor is the full impact of some loss of business due to us raising prices and/or walking away from some private label business that we discussed on last quarter’s conference call. We have also seen an effect from back order issue earlier in the year that has since been resolved. New orders have not reappeared from some of those customers. We have reduced our back orders significantly over the last six to nine months and I believe that’s had a negative impact on re-orders as well.

As I mentioned in the last call, we have seen and heard stories about hospitals facing financial issues and the softening and volume of certain medical procedures. I have been in a number of hospitals myself over the past two months and have heard and seen some discomfort, especially in the OR, on the reduction in the amount of cases that they’re seeing. I don’t know, I can’t say whether this had an impact on our Q3 sales or if they could have an impact on future sales. It could have been isolated, but I continue to hear that more so than not; so that is an unknown for us as we speak.

I should also add that we continue to see a lot of sales opportunities out there and are very focused on and committed to identifying them and closing them as well.

In this competitive environment we have sharpened focus on revenue growth. In the past month we have transformed the sales staff and are training all of them to sell all of our products to all of the appropriate customers in all geographic locations, so we restructured.

In the past we have had some sales staff selling medical action products. We have had some sales staff selling Medigen products and then we had a number of our sales people that had the ability to sell both. We now have one concerted sales force that sells the entire book of products which we believe will improve the sales productivity and efficiency out in the field, will help to strengthen our customer relationships out there and take away some of the confusion that was created by two sales people calling on the same hospital; having two different regional managers in the past, and will continue to support our current drive to sell more existing products into our existing channels. This is a very important component for us.

On Monday we start a list of many sales training initiatives. We are bringing half the entire sales force into the New York location. They start at 8:00 am on Monday morning and will end at 5:00 pm on Friday night. They will be getting back to the basics training on all of our products and strategies for how we approach the market. Then two weeks from that time the other half of the sales force will be coming into our Arden, North Carolina facility for the same training and we will continue to follow up with leadership training for our regional managers and another set of training in June at our national sales meeting. So, we are excited about getting back to basics and getting our people tooled up to be more effective in the field.

Let’s talk about the three challenges now:

Resin, we are relieved that oil has subsided to unbelievably low points which we could have never predicted. We all know and I stated in the release and in past quarters what impact resin has had on our business. We have currently locked in a significant amount of resin during the third quarter at favorable rates due to the sharp declines. So we are out buying again. In some instances we are able to lock in prices without actually having to purchase the material and store it in our locations, so it has been a double positive for us. It hasn’t taken away from cash flow. It hasn’t created storage issues in our rail car siding and it has provided us with the opportunity to lock in prices for a number of months into the future. This should have a positive impact on the future quarters.

At current prices, and what we believe we have bought through the fourth quarter, the average resin price for all of fiscal ’09 will probably match our projection at the beginning of the year. Our cost would be in line with recent past price increases which were minimal. Again, when oil ran away from itself and resin skyrocketed we were actually in the midst of planning our next price increase which we never, ever executed. So, we are happy we did not, because we would have had to roll back those price increases. That is the only positive note on being behind in our price increases with respect to what is going on in the marketplace; so we feel we are at a good place right now.

We are going to continue to monitor the volatility of oil prices and take advantage of low resin pricing where possible: however, we know the volatility of this market. If resin prices continue to fall for any length of time that could put downward pressure on pricing of finished goods throughout the industry. Again, we remain committed that if it continues to fall we will pass those decreases along to our customers.

China, again, we have very clearly articulated that previously higher costs for Chinese products have had a negative impact on the results. During this past quarter we have seen a lowering of the Chinese product costs as number one, their economy has slowed; number two, raw material has decreased, especially resin related products and we see a stabilization of a lot of the raw materials that are used in our products in China. We are fairly confident that in the foreseeable future the costs from China will be relatively stable and as raw material decreases, as a part of that cost, we might see some decreases as well going forward. So, for the foreseeable future we are fairly comfortable that that will create a stable cost basis for us going forward.

Tennessee, Tennessee we continue to focus all of our efforts on reducing the plant inefficiencies. We have clearly, again, articulated in the previous quarters what impact it has had on our results and we are starting to see incremental benefits from the new equipment installations we discussed on the last call which included new injection molding machines, robotic equipment, molds for the machines that are all now running in house. As previously discussed, those investments were designed to increase output and meet the demands of our customers on a timely basis, increase the capacity to manufacture a broader range of products, reduce the need for manual labor, including some outsourced labor, reduce waste, and help to alleviate some of the margin pressures.

By no means are we anywhere near where we want to be yet. We have got a long way to go in that facility, but we are pleased with the progress we are making and we are absolutely committed to accelerating the process and progress that we have seen to date. That process will continue throughout the balance of this year and for the foreseeable future. So, I am excited about the opportunities that exist there.

I am going to ask Chuck to make some financial comments with respect to the company.

Charles Kelly Jr.

Thanks Paul. As of December 31, total debt was approximately $56.4 million. This balance is $8.5 million above the $47.9 million in borrowings that was outstanding as of March 31. During the nine months ended December 31, 2008 the company generated $5 million in cash from operations. We expended $10.4 million on the purchase of property, plant, and equipment during the period. During the comparable prior period the company generated $14.1 million in cash from operations expended $4.1 million on the purchase of property and equipment and reduced its term loan by $10.3 million.

As discussed during our second quarter conference call, we amended the terms of our credit agreement, which in part changed the scheduled amortization payments of our term loan. The amendment was done in part to provide sufficient head room under our credit facilities to support the working capital requirements of the company.

Our credit agreement includes a $20 million revolving credit facility. As of March 31 we had drawn down approximately $900,000.00 on the revolver. When we amended our credit agreement, on September 30, we had approximately $13.9 million outstanding on the revolver. The increase in the amount drawn on the revolver was principally used to pay for the purchase of property and equipment and to make scheduled payments under our term loans. We anticipated after amending the payment schedule that our under our term loan we would make further drawings on the revolver and be almost fully drawn under the terms of the revolver during the months of December 2008 and January 2009.

We are pleased that we have effectively managed cash flows during the quarter and through to today and as of December 31 we had $13.5 million drawn on the revolver and we currently have $12.5 million drawn on the revolver as of today.

You will note that our inventory position as of December 31 is approximately $41.3 million. We have reduced inventories by $2 million since September 30; however, inventories have increased $7.8 million over March 31 balances. Our inventory turn over as of December 31 is 6.7x. As of September 30 and March 31 our inventory turn over was $6.5 and $6.9 respectively. The composition of our inventory has changed over the periods to reflect lower resin balances and greater finished good balances.

The increase in finished goods reflects the timing our purchases made from overseas vendors in anticipation of the Chinese New Year when our vendors close their factories. We have used substantially all of the higher priced resin that we purchased during the first and second quarters of the year end production to date.

While as Paul had mentioned, while have not taken substantial inventory positions in resin as of December 31, we have made forward purchases at current prices which will meet our production needs during the fourth quarter into the first quarter of our next fiscal year. We believe that we are effectively managing our working capital and anticipate further improvement in cash flows during the fourth quarter. This is going to come through continued management of our balance sheet and in particular our accounts receivable and on inventory, which we expect to improve over the next three months, as well as improved profitability.

While we have not given guidance to our profitability in the past, if you were to read our 8-K that we filed in September of 2008 regarding the change in our credit agreements, certain provisions of the covenants and agreements require the company to improve profits incrementally as measured by EBITDA by $2.5 million over the fourth quarter over the third quarter.

As long as resin prices remain stable and China prices remain stable we believe that we will comfortably meet the requirements of our crediting facility.

With that I will turn it back over to you Paul.

Paul Meringolo

Great, so again, we will continue to monitor oil prices and the China situation as they affect the entire industry. We will continue to make progress in Tennessee and position that plant for additional growth. We will utilize a revitalized sales force to go after the plethora of opportunities out there, especially in minor procedure kit and trade, patient bedside products, containment business and our all out product segments.

We maintain the company’s strong foundation, solid loyal customer base, a combination of superior service, of fair pricing, and a strong competitive position. We are confident in our ability to deal effectively with challenges and return to long-term growth.

In closing, I would like to thank all of you for participating in the call today and we look forward to keeping you posted on the progress.

With that, I would like to open the floor up to any questions you might have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Matthew Dolan from Roth Capital Partners.

Matthew Dolan - Roth Capital Partners, LLC

Paul, just give us a little more on the concept of a transition year. It sounds like Q3 was a revenue trounce in your view. With oil coming back in, obviously price increases won’t be necessary, but how are hospitals treating this new environment relative to their spending? Do you think that inherently they may look for price decreases going forward? And maybe you can give us some commentary as we have entered calendar year ’09 here as to what you have seen. I am just basically trying to get some comfort around returning to actual growth in your near term sales outlook.

Paul Meringolo

Again Matt, I think there are a couple of things. This is no different than the days of DRGs. I mean hospitals are under pressure and some of the first areas they go to are product acquisition costs. It is the environment that we have lived in for along period of time. I don’t think today is any different than the days in the 80’s when DRGs came in to affect.

We have got to continue to remain king. We have got to continue to remain a low cost producer. If we were a 60%, 80% margin company selling the products that we had I would think we would have some real issues in having to go out and lower our overall costs, but we remain a highly competitive, low cost producer of high quality products. I believe that even if there is a slight decline in demand out there on a consumable side there are still enough opportunities for us out there to grow our business effectively.

I think a lot of this stuff that you are seeing here in some of the numbers is again some loss of business in businesses that were not conducive to the profits that we would want to see. Whether it is crutches, whether it is non-sterile products that we sell, there are a whole host of competitors out there that are willing to sell at 3% or 5% margins. These are pieces of business that we have raised prices and effectively the customer is pushed back and we have walked away from some of that low margin business. I don’t think that is going to be the case on the bulk of our product line and the bulk of the volume that we sell today.

I also believe that we will be aggressive at growing the business and we will be a little bit more ahead of the curve when it comes to pricing philosophies as resin continues to decline. I still believe there is a whole host of upside opportunities for us that we should be getting at, with a more focused, better-trained, sales organization that is out there.

Matthew Dolan - Roth Capital Partners, LLC

Okay so to summarize, if an account came asking for a significant price decrease it would be, what, a case-by-case scenario or something that you probably wouldn’t entertain?

Paul Meringolo

It depends on the product. It depends on the margin. Again, we believe we are the low cost producer. So, if we are at a margin point that we believe that our competitors are either above us or at our margin point, they are not going to be able to drive significant savings out of those areas that are already low priced.

Matthew Dolan - Roth Capital Partners, LLC

Okay and then on the sales force restructuring can you tell us what the number of reps before and after, what the account stands at today and how that plays in to the top line here?

Paul Meringolo

Previous count was in the low 50-person range. Today we, I believe, with the hire today we at 44 territories out in the field.

Matthew Dolan - Roth Capital Partners, LLC

Okay so do you expect any of those territories to see near term disruption as you back fill them or?

Paul Meringolo

We absolutely do not.

Matthew Dolan - Roth Capital Partners, LLC

Okay.

Paul Meringolo

That is the optimal number that we went with. We went from I think it was 52 territories to 44 territories; that as by design. We felt that some of the Medigen reps that were out that there that just had Medigen products didn’t have enough products to sell or selling time. Again, this was not something that was driven from an expense side. It was driven purely from effective coverage of our existing customers. It is at 44 today and we will continue to monitor it. If it means that we have got to expand some territories we will add people as we see fit, but it will be a strategy that every sales person will have, the entire portfolio of products to sell.

Matthew Dolan - Roth Capital Partners, LLC

On the cost side of things, in the past we have had a number relative to resin which sounds like will be the first component of cost to recover most quickly here. How much do you think we could get back? I think the number was around $2 to $2.5 million in the September quarter in terms of the incremental cost. How much of that could we get back in the March quarter?

Charles Kelly Jr.

What we paid per pound for resin is a number that we don’t release. It is a competitive advantage to us based on the volume that we buy. You can say that we are buying 55 million pounds of resin and if you look at the spot market, prices have moved from the high 80s into the mid 40s. You can do the math off of that, but it is several million dollars. We have bought into it, so we have locked it in.

Paul Meringolo

I have also said that when we are done buying through the fourth quarter we will be back to our effective levels of what we believe we are going to be for the fiscal year. Having said that, if there was a negative impact of $2 million in the quarter we expect that that $2 million negative impact would go away as a result of getting back to normal levels. That would probably be a safe assumption to take.

Matthew Dolan - Roth Capital Partners, LLC

Okay, so looking at the sequential ticks here in fiscal ’09 would you say both on a revenue and an earnings basis this is the trounce of the recovery?

Paul Meringolo

Yes.

Operator

Your next question comes from Mitra Ramgopal from Sidoti & Co.

Mitra Ramgopal - Sidoti & Co.

I was just wondering if it was possible to break out the $6.1 million between China resin and Tennessee.

Charles Kelly Jr.

It is almost equal. I mean plus or minus it is almost equal between the three and it is in the Q.

Mitra Ramgopal - Sidoti & Co.

Okay I will look out for it. When is that being filed?

Charles Kelly Jr.

It will probably be filed tomorrow.

Mitra Ramgopal - Sidoti & Co.

Okay and again, as you look across the different product lines were you seeing any weakness in any particular one or strength that we can sort of…?

Paul Meringolo

Again, I think the shortfalls predominantly are in three areas: Number one, patient aids which is crutches, which we talk about which is that same thing that we talked about last quarter. Another big portion of it is in lapsed OR products, which is a result of the loss of the Premier contract, which we retained a good portion of that business; as well as some other non-sterile marginally profitable business that we walked away from which really should have very little impact on the margins side or the P&L side. It is a top line hit. The third area is patient bedside products which we believe that the majority of that shortfall in patient bedside products is due to the inefficiencies in the supply chain.

There was higher third quarter ordering last year, because we raised prices. We did not raise prices this year in the third quarter, at the December ending quarter, so there was no forward-buy from their side. We filled the pipe with, I think, at the high point we were over $3 million in back orders and I believe by the end of December and into January we were at the $600,000.00 range. So, we shipped $2.7 million of back orders out there. I think those kinds of things contributed to the short fall in bedside products. I think during our back order we may have missed a couple of cycles of orderings from some of our customers.

I think to a lesser extent, due to some of our service issues, we have lost some customers that we will go back out and regain.

Mitra Ramgopal - Sidoti & Co.

Okay and with regards to the sales force restructuring, is it largely completed? I know right there you talked about training sales people etc… but in terms of getting to the numbers where you want to be and looking for improvements?

Paul Meringolo

We announced and we transitioned in the month of January, February 1 we are effective with the new sales structure and training goes into effect Monday. So the new structure is in place. The people that are leaving the company have been notified. The people that are staying have been notified. From an information flow standpoint we have got that set up and we are ready to start training and very excited about it. For the first time we have got a strong, robust training program that we are about to launch and get us back to basics.

Mitra Ramgopal - Sidoti & Co.

Okay and if you could just give us an update on Tennessee with regards to the equipment upgrades, if that is pretty much finished now?

Paul Meringolo

Well that is never going to be finished. The upgrades of that equipment, that will be an ongoing process and as the new ones get old we are going to replace that. The five major pieces of equipment have been installed and are running well. We have got three new molds running. We continue to do upgrades to existing equipment. The robotics are on, seven or eight robots that we have acquired are on and running and helping in that process. We have a lot of work to do still to get better. There is a lot of cost there to drive out of that operation over the long haul, but I think for now we have stabilized that business. We are shipping products to our customers and getting better at it and we are going to be very, very focused on reducing the overall cost of that operation on an ongoing basis.

Operator

You have no further questions at this time. Do you have any closing remarks?

Paul Meringolo

If there are no further questions, be safe and we look forward to talking to you.

Just a quick note, this will probably be the last conference call we do from this location. Beginning of March we will be moving our cramped facilities here into our new facilities I believe, in the first week of March. It will be a seamless move. The cubicles are in place over there, phone systems are in place, network systems are in place already, so we don’t believe there will be any interruption in business in the move and we will be there the first week of March. When we report year-end numbers we will be doing it from our new facilities. Wish us good luck in that transition and we will talk to you all soon. Thanks again for participating.

Operator

This concludes today’s conference call.

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