Executives
Paul D. Meringolo - Chairman of the Board, President, Chief Executive Officer
Charles L. Kelly Jr. - Chief Financial Officer
Analysts
Matthew Dolan - Roth Capital Partners, LLC
Mitra Ramgopal - Sidoti & Co.
Stephen Freedman
Gerry Heffernan - Lord Abbett and Company
Medical Action Industries Inc. (MDCI) Q2 2010 Earnings Call November 6, 2009 10:00 AM ET
Operator
Good morning ladies and gentlemen my name is Stephanie and I will be your conference operator today. At this time I would like to welcome everyone to the Medical Action Industries Second Quarter 2010 Earnings Conference Call. (Operator Instructions). I will now turn today’s call over to Mt. Charles Kelly, Chief Financial Officer. Thank you. Sir, you may begin your conference.
Charles Kelly
Thank you, Stephanie. Good morning and thank you for holding. With me on this call are Paul Meringolo, CEO and President of Medical Action Industries. The primary purpose of this call is to discuss our results for the three and six months ended September 30, 2009, which were released this morning.
As you know we must first touch all of the legal bases by noting that 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 annual 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 results could differ materially from those projected or assumed in these forward-looking statements.
It is now my pleasure to introduce Paul Meringolo.
Paul Meringolo
Thanks Chuck, good morning and thank you for being here today. I assume that you have all had a chance to see our press release. We are pleased to report that net sales for the three months ended September 30, 2009 totaled $75,060,000, which is $1,236,000, or 1.7% above the same period last year when net sales were $73,824,000. Net income for the second quarter of fiscal 2010 was $3,987,000, or $0.25 per basic and diluted share, which is significantly higher than the $480,000, or $0.03 per basic and diluted share, reported for the second quarter last year.
Net sales for the six months ended September 30, 2009 amounted to $145,747,000, which is a decrease of $5,472,000 or 3.6% from the $151,219,000 in net sales reported during the comparable prior period. Net income for the six months ended September 30, 2009 amounted to $7,637,000 or $0.48 per basic and diluted share, which is $4,611,000 grater than the net income of $3,026,000 or $0.19 per basic and diluted share reported during the six months ended September 30, 2009.
Our strong second quarter results show that we are continuing to benefit from relative price stability of resin and our ability to make advanced purchases, stability in the cost of China stores products and stability of production activities in our Tennessee facility. We continue to work on improving the effectiveness of our sales and marketing teams to generate organic growth in an unsettled healthcare industry.
We have not seen any significant developments in the market during this past quarter. Conditions, as always, remain competitive acute care facilities are still under varying degrees of economic pressure. These conditions have existed for as long as we’ve been in business. We are cognizant of the impact these conditions may have on our operations; this is not uncharted territory for us. We will continue to monitor our markets and adjust our operations to meet the needs of our customers.
It is our intent to maintain our position as a high quality, low cost supplier in the market while adding value to our customers, which is an area where we will drive continued growth. Our ongoing focus on sales and marketing will be key in growing our market share organically.
With regard to our sales and marketing teams, as we discussed on earlier conference calls we have a new leadership team in both our sales and marketing departments. We are placing greater emphasis on growth and profitability and are placing higher levels of accountability on our sales and marketing teams.
We are evaluating our corporate account structure to ensure that we effectively leverage our deep relationships with CPOs and IVNs.
We believe that the Company is well positioned to offer our customers and healthcare partners added value by providing unique ways to manage their costs and obtain value from their supply chain in return for higher volume and longer term supply commitments.
We are looking at alternative ways to drive sales by expanding our sales coverage in a number of markets that we serve, as well as exploring the addition of the inside sales organization.
With regard to resin and China source products, we are pleased that the volatility in both these areas experienced during fiscal 2009 has settled down. We have seen the price of resin increase during the past six months and have begun to see some upward movement in the cost of products sourced from China. At present levels we can manage these price fluctuations and do not presently see them as a significant threat to our short-term results of operations.
As you are aware, we have a long-term supply agreement for a portion of our resin. This agreement expires in March 2010. We are presently in negotiations to extend this agreement, if we are able to agree to pricing that is advantageous to the Company. If successful, we would expect to be less vulnerable to further price volatility with respect to the resin market for the periods covered by such extension.
With regard to our Tennessee production facility, we have seen a stabilization of production activities during the six months ended September 30th. Back orders have been significantly reduced and we are bringing back into our facility the production of products which have been previously outsourced due to production difficulties. We have completed the installation of six new injections molding presses this year and have new molds coming online over the next several weeks.
Our new General Manager has made substantial improvements in operations during the past six months in changing our culture, business processes, while improving quality and production through put. In the short-term we will be looking to improve labor efficiencies and further increase production levels in this facility. We will continue to make capital improvements in the facility to ensure that we have a solid manufacturing foundation for future sales growth in our patient bedside disposable and laboratory product lines.
With regard to our balance sheet and cash flow, for the six months ended September 30, 2009 the Company generated $25.4 million in cash from operations. We used this cash to reduce debt by $21 million to $39 million, from $60 million as of March 31, 2009; we also expended $2.8 million in capital equipment.
Inventories have declined from $43.2 million as of March 31st to $35.3 million as of September 30th principally due to our use of the resin purchased during March.
It is our intent to continue to use cash provided by operations to pay down debt and purchase capital equipment. Subsequent to September 30th we have further reduced our debt by $3 million.
In closing, I would like to say that we are well positioned and have the resources necessary to meet the challenges of a changing market. We remain confident in our vision of Medical Action strengthening and extending our leadership position as a high quality, low cost and value added supplier of disposable medical products to our customers and healthcare partners.
Thank you for participating in our call today and we look forward to calls to report on our progress during the balance of the year.
With that, Stephanie, I will be pleased to answer any questions at this time. You can open the floor up to questions.
Question-and-Answer Session
Operator
(Operator Instructions) At this time you have no audio questions.
Paul Meringolo
That being the case, which I was hoping it wasn’t, again I would like to extend my gratitude to the team in Tennessee. I think Ralph Pena and that team down there has done an extraordinary job. We actually held our board meeting there the past two days and the board is excited and we’re excited about the progress that’s been made on all fronts in that facility and I think for the first time that facility will be a strong asset and contributor to the future growth of the business.
On another note, I would like to extend a sincere apology to our customers for which we had caused them some heartache over the past 12 and 18 months with service interruptions due to our issues in our Tennessee facility. I believe those are well behind us and I appreciate their support in staying with us. I know we have some damage control to do, but we are ever stronger as a plastics and patient bedside business and we intend to make sure that we prove that to our customers’ day in and day out.
Operator
Excuse me, sir; you do have questions in queue. Our next question comes from Matthew Dolan.
Matthew Dolan - Roth Capital Partners, LLC
What is happening with revenue in terms of unit growth versus any price erosion you’ve seen and just generally do you see your customers starting to loosen up and order more after a few tighter previous quarters?
Paul Meringolo
I don’t think I could that granular. I just think that we are continuing to make progress in the field and in a number of initiatives that we’ve been working on. I think there is a piece of that growth that is coming from unit increases and pieces of that growth that is from price. In the upcoming quarters I think we will see less from price and more from unit.
Matthew Dolan - Roth Capital Partners, LLC
Okay. The gross margin, it looks like you are seeing a relative stabilization in terms of China and resin; how much of an improvement quantitatively speaking are you anticipating getting out of Tennessee over time?
Paul Meringolo
Matt, you know how we operate and we tend to be fairly conservative. I am excited about the potential that exits in that facility. Do I want to quantify that at this point in time? I would rather not, but I think that it will help mitigate some potential increases that we could receive from a resin side. Again, I want to give them the continued time to make the progress and continue to have the progress that they’ve made, but I think it could be a good number.
Matthew Dolan - Roth Capital Partners, LLC
Okay fair enough and then Paul, this is I think maybe the second best EPS result in the past several years and you are on pace for what appears to be a record here. Can you just talk about the outlook in terms of the sustainability of these results and what might be generated in the coming quarters?
Paul Meringolo
I think what excites us is the opportunities that we have just internally and increasing our organic growth and the opportunities that exist in the markets that we play in today. So, I think from a top line standpoint we remain excited about the opportunities that are out there and I think we’ve got to execute on more effective ways to go out and capitalize on those opportunities. I think from a sales and marketing side we are very focused on optimizing those opportunities that are out there. We are not where we want to be yet from an organizational standpoint or from a pure coverage standpoint, but we are diligently working towards that end every day.
I think from the operations side of the business I have never felt better. Having said that, I think there is a significant opportunity to get better on the operating side. I think we know where it is. I think we know what we have to do to get it and I just think we need time to get it.
Matthew Dolan - Roth Capital Partners, LLC
Okay, so just to simplify, it sound like you think that these results could be improved over time, but they are at least sustainable in the near term.
Paul Meringolo
Yes.
Matthew Dolan - Roth Capital Partners, LLC
Okay and then finally on the M&A side, you put some text into your press release on that topic. What debt level do you become comfortable making a sizable transaction? Secondly, maybe just give us some parameters in terms of what you’re looking for, strategic fit, size of the revenue base, and maybe margin, those types of things. What do you generally look at through our filter?
Paul Meringolo
Matt, I am going to be a little careful on this one. I am going to let Chuck talk a little bit about what his tolerances are from a debt level standpoint, which he has been very focused on. But, I think from the acquisition side we are just starting as a leadership team to talk about the potentials that exist out there, whether it be a technology, or whether it be a company. We remain very focused on the fruit that is on the trees today internally here.
There is a tremendous opportunity both on the operating side of the business and from an organic growth side that we don’t really want anything to get in the way in the short term of us building that platform to make sure that we’re running on as many cylinders as possible. So, we are starting to refocus our efforts on acquisitions and we’re looking at a number of different technologies and a number of companies that are out there. But again, the parameters will be similar from a financial side, they will be accretive to earnings immediately, but I think they could look a little bit different from a product perspective and that is from my perspective.
Matthew Dolan - Roth Capital Partners, LLC
Okay and do you care to put some time parameters around that?
Paul Meringolo
I would think that we’re probably not going to do something in the next six to nine months.
Charles Kelly
From a debt level, we are keenly trying to pay down our debt. All free cash flow that we have is going to the amortization of the other term loan, which is all that we have outstanding now. If you take the quarter that we just reported and annualize it, we could probably carry just shy of about $100 million in debt given the capital markets today. We have no intent to go anywhere near that. Looking forward, what we would do is that any deal we would get into would be a traditional debt finance deal. We look like we could probably gear it to 3 ½ x EBITDA, but any deal that we would bring on would first of all have to be accretive to earnings and EPS as well as have top positive cash flow. So, we haven’t looked at any firm numbers as far as what we would be looking to carry in debt, but we have started conversations with the banks about renegotiating the agreement, or actually putting a new agreement in place, which we had discussed last quarter. It is our intent to put some type of accordion facility in that will let us go up perhaps back as high as the debt level that we brought on when we did Medegen.
Matthew Dolan - Roth Capital Partners, LLC
Okay thanks that’s helpful. Chuck can you talk a little bit about CapEx? What does it look like this year and maybe help us normalize your CapEx going forward. I know there have been some big investments made, so what should we think about in terms of an annual run rate?
Charles Kelly
Well our debt agreement lets us borrow formal with CapEx in at $4 million a year. We are going to amend that right now to put $5 million in this year, which we’ll probably spend. We are embracing a philosophy that to really drive the patient bedside utensil business we have to acknowledge the capital intensity of the business and the fact that we have to drive efficiencies both in through put through the factory as far as labor utilization. At the present debt level we don’t believe that we should have any limitation on CapEx and we will make any CapEx expenditure that’s going to have pay back in less than two years. So, I wouldn’t look at it as to say that we’re going to be at $2 million, $4 million, or $5 million, we’d invest what we need to invest in to make that the most efficient injection molding facility that we have in this business.
Matthew Dolan - Roth Capital Partners, LLC
Great, thanks a lot guys.
Operator
Your next question comes from Mitra Ramgopal.
Mitra Ramgopal - Sidoti & Co.
I was wondering if you could give me a little more color on the revenue improvement we saw in the second quarter, as it relates to, I think it is mostly volume driven, but if any product lines in particular stood out and how much of it you would really attribute to the sales and marketing push that you’ve been doing.
Paul Meringolo
We are continuing to make strides on the sales and marketing side, but I don’t think they are evident in the numbers yet. I think part of the increase is just ordering patterns of our customers. I think part of it is a shipping of some of our back orders that were in the plastics business and again it is not material numbers. I just think it’s some new business kicking in. I think it is many things.
Mitra Ramgopal - Sidoti & Co.
Did you benefit at all, if you could identify it, from say H1N1?
Paul Meringolo
I think to a very, very small extent. I think we have gotten some increased orders of isolation gowns and things like that, but I don’t think the majority of that shipped in that quarter.
Mitra Ramgopal - Sidoti & Co.
Just going back on your product offering again, facemasks are not something you currently offer do you?
Paul Meringolo
Not to any large extent, correct.
Mitra Ramgopal - Sidoti & Co.
Okay and again on the SG&A side, is it fair to assume that you’ve pretty much done most of the hiring you want to and now it is just a question of being able to leverage that?
Paul Meringolo
Like I discussed in my commentary, we are looking at a number of ways to expand our coverage and so I think the way the organization is structured today we’ve got to look at more effective means to get to more of our customers. I think that we’re going to call on 5,500 hospitals using 45 sales professionals. It is probably not optimum, they are not getting to every hospital as much as we would like them to. So, we are going to look at augmenting and continuing to look at better ways to get to more of our customers on a regular basis to drive more sales growth. If that means that we are going to have to make some investments in people or outside help we are looking at a number of organizations that could help us with some inside sales with an inside sales structure.
We have been toying with building that inside sales structure ourselves here, but we don’t have any experience in building an inside sales organization. There are companies out there that are very well versed in medical devices and in inside sales. We have interviewed a number of them and we are looking at that opportunity as well. We believe that there is a significant upside in that effort and we’re going to look at how we could maximize our sales potential that’s out there in a number of different ways. That may create some upside from an expense side, but I believe it will be paid for greatly from the growth in sales that we will get as a result of that.
Mitra Ramgopal - Sidoti & Co.
Okay and then it seems like you are obviously set for a very nice year here with resin and China on the controllers. If we look at Tennessee for example, would you say most of the savings you expected out of that have pretty much been realized or is there still a lot to go there?
Paul Meringolo
We haven’t even started yet. We just got the facility stabilized and producing consistently and reducing scrap. We haven’t even seen anything yet from a financial side from that facility.
Mitra Ramgopal - Sidoti & Co.
Is that more of a fiscal 2011 story do you think?
Paul Meringolo
I would think we are going to start seeing it shortly and we will continue to see a ratcheting up of realized cost savings as we start to tackle each and every initiative that we have out there from a cost side. I think there will be some in the rest of 2010. I think there will be a good portion in 2011 and I think there will be some more in 2012. The real cheese is to continue to drive volume through that existing core structure as well.
Mitra Ramgopal - Sidoti & Co.
Right and again, it seems like given everything you are doing there is no reason why we shouldn’t start to see more of an up tick in volume.
Paul Meringolo
Some of the things I talked about after my commentary were that we have done some damage with our customers as a result of poor performance on the service side. We acknowledge that. We are out there actively talking to our customers and reassuring them that we’ve got this business back on track, never to go back to that situation again. We are going to have to continue to prove that and be aggressive and continue to position ourselves accordingly. So, I think there was some residual damage, but I think some of the things that we’re doing now will mitigate that in a very short period of time.
Mitra Ramgopal - Sidoti & Co.
Okay thanks again.
Operator
Your next question comes from Stephen Freedman
Stephen Freedman
I just have one clarification question. Paul, did you indicate that even since the quarter ended that you had paid down, besides the $21 million on debt, an additional $3 million, so making the debt about $36 million if I see that correct?
Paul Meringolo
We paid an additional $3 million down after the [inaudible].
Stephen Freedman
That’s all I had. Thanks again and great quarter.
Operator
Your last question comes from Gerry Heffernan.
Gerry Heffernan - Lord Abbett and Company
I wanted to say thank you as a long-term shareholder for what you guys have put together this quarter and I’m looking forward to more. I wanted to ask you about the import business from China. Certainly that was a sticking point over the more recent period here. This is getting out of my area of expertise here quickly, but we have a constant discussion in the media of the weakening of the dollar, how for importing into the states that is a problem, but you seem to be overcoming that. What is the effect of currency on your business right now and if we should see the dollar begin to strengthen again does that improve the business that is currently being sourced out of China?
Paul Meringolo
Up until now everything that we traded to China has been in US dollars. So, most of the savings that we discussed in the Q, and it gets released later today, is actually being driven by lower freight costs either in ocean liner or transshipment across the country. The price of the actual product in China has been relatively stable, probably going on nine months or so. We’ve seen a little bit of an up tick lately, but the unique thing that we’ve seen is that within the China economy where everybody only wanted to trade in US dollars, now some of them are looking to trade in local currency. So, with regards to, say our office in Shanghai they want to rent in yuan rather than US dollars. So, we’re starting to see a fundamental shift in how that is happening. It is not widespread, but we are certainly paying attention to it. But, if the dollar were to strengthen right now it probably wouldn’t have any significant impact on the operations.
Gerry Heffernan - Lord Abbett and Company
Okay great, that’s all I had. Thanks again guys.
Paul Meringolo
Great Demetrie and I have enough time to go celebrate our Yankee victory. I know you are a Boston fan but 11:00 I’m sure you’ll be there. Thank you all for being here today and I look forward to speaking to you after the third quarter. Thanks again. Take care.
Operator
Ladies and gentlemen that does conclude the conference call for today. We thank you for your participation. (Operator Instructions).
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