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Medical Action Industries Inc. (NASDAQ:MDCI)

Q4 2014 Results Earnings Conference Call

June 11, 2014 10:00 AM ET

Executives

Brian Baker - Chief Financial Officer

Paul Meringolo - Chief Executive Officer

Paul Chapman - President and COO

Analysts

Jack Wallace - Sidoti

Steve Friedman - Wells Fargo Advisors

Operator

Good morning. My name is Bridget, and I will be your conference operator today. At this time, I would like to welcome everyone to the Medical Action Industries’ Fourth Quarter and Fiscal Year 2014 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. And now, I would like to turn the call over to Mr. Brian Baker, Chief Financial Officer. Mr. Baker, you may begin your conference.

Brian Baker

Thanks you, Bridget. Good morning. And thank you for joining us to discuss our results for the fourth quarter and full year of fiscal 2014, which were released this morning. With me today are Paul Meringolo, Chief Executive Officer; and Paul Chapman, President and Chief Operating Officer.

In the course of today’s discussion, reference maybe made to projections, anticipated event or other information, which is not purely historical. Please be aware that statements made during this call which are not purely historical maybe considered forward-looking statements.

We caution you that all forward-looking statements involve risks, unanticipated events, uncertainties and other factors that could cause actual results to differ materially from those anticipated in such statements.

Many of these risks, events, uncertainties and other factors are discussed in our annual report on Form 10-K, our quarterly reports on Form 10-Q and other reports and filings with the Securities and Exchange Commission, which are available on our website.

To the extent any forward-looking statements are made during this call, such statements are made only as of today’s date and we do not assume any obligation to update any such statements.

It is now my pleasure to turn the call over to Paul Meringolo.

Paul Meringolo

Thanks Brian. Good morning and thank you all for joining us today. I’m excited to discuss our quarterly and year end results, which are testament to our efforts to think more strategically and to evolve Medical Action into a more focused, efficient and profitable company. These efforts are translating into improvements in net sales, gross profit and net income.

We continue to remain focused on building stockholder value by creating solutions for our customers and by providing the right products and services to help our healthcare partners improve outcomes and reduce costs across the entire supply chain.

Our approach to build this stockholder value also includes focusing on our core competencies and markets to ensure that we are providing innovative solutions to our customers in the most cost-effective manner. This has enabled us to make significant progress on multiple profit improvement and market positioning initiatives.

The progress that has been made by our management teams is remarkable, considering that the acute care market continues to experience flat utilization and given that for a significant portion of the year several members of the management team committed a significant amount of time to the Patient Care business unit divestiture.

As a result of the profitability improvements reported today and our significant restricted balance sheet the company is better positioned for success than it has been in years. I look forward to future earning calls to discuss the progress of our efforts.

I would like to turn it back over to Brian to discuss our results for the fourth quarter and full year of fiscal 2014.

Brian Baker

Thanks, Paul. As reported on June 2, 2014, the company completed the sale of its Patient Care business unit. The sale included our manufacturing, warehousing and distribution facilities in West Virginia and Tennessee, as well as the associated fixed assets and inventories.

The assets and liabilities associated with the divested business are presented as held for sale our balance sheet as of March 31, 2014. The operational results of the divested business are reflected in the income from discontinued operations net of taxes line on our statement of operations for all periods presented within our earnings release.

For purpose of today’s discussion references to net sales, gross profit and selling, general and administrative expenses excluded amounts associated with the divested business. References to net income include the earnings associated with the divested business.

In recent years we have discussed the impact to gross profit and operating results associated with fluctuations in resin costs and inefficiencies associated with our manufacturing facility in Tennessee.

Divestiture of the Patient Care business unit significantly reduces the impact to gross profit and operating results due to fluctuations in resin cost. While not necessarily indicative of future results, our remaining business units have historically been less prone to volatility and raw material costs and profitability.

The net sales for the fourth quarter of fiscal 2014 were $72.5 million, which represents an increase of $3.1 million or 4.5% compared to the comparable prior year period. Net sales for fiscal 2014 amounted to $287.8 million, which represents an increase of $3 million or 1.1% compared to fiscal 2013.

The changes in net sales are primarily attributed to greater domestic market share associated with our minor procedure kits and trays business, and an increase in the average selling prices in our custom procedure trays. These increases were partially offset by lower domestic market share associated with our operating room cost.

The gross profit for the fourth quarter of fiscal 2014 is $14.5 million or 20% of net sales, which represents an improvement of $1.7 million or 13.4% when compared to the comparable prior year period.

Gross profit for fiscal 2014 amounted to $55 million or 19.1% of net sales, which represents an improvement of $4.1 million or 8.1% when compared to fiscal 2013. The margin expansion is attributable to focused efforts on our organic revenue growth, improve pricing discipline and various cost containment initiatives.

Selling, general and administrative expenses incurred during the fourth quarter of fiscal 2014 were $12.5 million or 17.3% of net sales, which represents an increase of $0.1 million when compared to the comparable prior year period.

Selling, general and administrative expenses for fiscal 2014 amounted to $48.7 million or 16.9% of net sales, which represents an increase of $0.6 million when compared to fiscal 2013.

The increases in selling, general and administrative expenses are primarily attributable to investments in infrastructure, legal expenses associated with the Patient Care divestiture and a full year of medical device excise taxes. These increases were partially offset by the elimination of certain consulting services required under our prior credit agreement and various expense management initiatives.

Net income for the fourth quarter of fiscal 2014 amounted to $0.9 million or $0.05 per diluted share, compared to $0.7 million or $0.04 per diluted share for the comparable prior year period.

Net income for fiscal 2014 amounted to $4.3 million or $0.25 per diluted share, compared to a net loss of $54.9 million or $3.35 per share for fiscal 2013. Net loss reported for fiscal 2013 is primarily attributable to goodwill impairment charge of $57 million, which is net of the applicable tax benefit.

Improvements in profitability have enabled us to repay $12.6 million on outstanding debt during fiscal 2014. As of March 31, 2014, $40.1 million in total debt was outstanding. Working capital was $49.1 million and we were in compliance with all financial covenants and ratios required under our credit agreement.

In addition, we have $21.9 million in available borrowing capacity under our credit agreement. Subsequent to year end, the company used the portion of the proceeds from the Patient Care business unit divestiture to repay $40.1 million in outstanding debt. The remainder of the proceeds will be utilized to pursue strategic business opportunities and for working capital to support the future growth in the company’s remaining business unit.

I will now turn the call back to Paul Meringolo for closing comments.

Paul Meringolo

Thanks Brian. What a difference the year makes. Once again I’m excited about the progress that has been made in our efforts to evolve Medical Action into more focused, efficient and profitable company. The acute care marketplace continues to navigate through a period of significant change.

This change is creating numerous opportunities for organizations like medical action to develop and execute an adaptable, strategic and operational initiatives that positively impact operational results. Our management teams are implementing and developing such initiatives and I’m confident that they will not only build stockholder value but will help our healthcare partners to improve outcomes.

Finally, as always I’d like to recognize the contributions of all of our teammates whose continued focus, energy, enthusiasm and dedication to Medical Action and our customers are greatly appreciated. With our culture of team work, accountability and collaboration, I expect our recent progress and improvement of our financial results to continue for our employees to remain focused and to continue to build on our fiscal 2014 achievements and beyond.

Thank you for participating on our call this morning. We look forward to discussing our progress with you on future calls.

At this time, Bridget, I’d like to invite security analyst to ask any clarifying questions.

Question-and-Answer Session

Operator

(Operator Instructions) And we do have a question from the line of Jack Wallace with Sidoti.

Jack Wallace - Sidoti

Good morning guys and thanks for taking my question this morning.

Paul Meringolo

Good morning.

Jack Wallace - Sidoti

So gross margin at 20%, I know that it’s been a goal on previous calls, it certainly been voiced. Congratulations on getting there this quarter after the adjustments that were made. Is there a pretty good place going forward? Could we see some more margin expansion with the existing business?

Paul Chapman

Jack, this marketplace is tough. I think that we expect to continue to make slow and steady progress. And the margin line is in area that we’re going to be focused on. Having said that, there also continues to be margin compression in the marketplace. So it's a balancing act that we've lived for many years and we continue to try and win more than we lose.

Jack Wallace - Sidoti

It must be nice thought not having to be at the mercy of the floating markets there with cost of resin. It seems at least that this line item will be more stable going forward. And we won’t have to deal with -- over the last several quarters, you’ve made a number of initiatives that have made parts of business more profitable but you again have been at the mercy of resin. Just going forward again, it's got to be nice knowing that you don’t have to worry about that to the extent that you did?

Paul Meringolo

That’s on for sure.

Jack Wallace - Sidoti

Off the 20% of gross margin number in the quarter, if that was not adjusted with the discontinued line item there, what would the gross margin have been?

Brian Baker

Jack, we had some significant cost increases on resin. If you look at it year-over-year and it was about $2.2 million in higher resin cost in fourth quarter of fiscal ‘14 when you compare it to the fourth quarter of the prior year and about $2.8 million for the full year compared to ‘14 versus ‘13. So from a gross profit percentage, when you look at it overall, including discontinued operation, the fourth quarter would have been about 17.4%. Again the main driver between those two were resin costs.

Jack Wallace - Sidoti

That said, it’s a sizable increase there. It just goes to show how much more efficient the business looks to be going forward. I guess, moving further down, actually, let’s talk a little bit high level, just about demand in play. You’ve made some comments about the industry changing and still being a difficult marketplace. Could you maybe talk just about some of the figures we discussed on previous calls such as procedure volumes and maybe any other changes in industry dynamics that are affecting the business -- that affected business both in the fourth quarter and moving forward?

Paul Meringolo

I mean, I think we continue to see that effect from a procedure side is flat, so we see. And again, I think there is a lot of unknowns in the marketplace with no regulatory issues and just demands on our customers everyday. It’s just a lot of uncertainty out there. I still believe that those challenges to our customer present opportunities for us.

And I just -- I've had the opportunity to spend a fair amount of time in the hospital over the last few months. And it’s unbelievable how much really our customers need our help in providing quality care. So again, even though I think the procedures are relatively flat, I think the opportunity for us continues to be strong if we’re focused and we’re sharp and we’ve got good programs and our sales people are effective, I think there continues to be a lot of upside for us.

Jack Wallace - Sidoti

You just mentioned your sales team being effective. I believe it is in the prepared remarks but certainly within the other press release early this morning, you talked about some market share gains and key product categories. Can you just touch on maybe where those were and why you think you have been able to take market share?

Paul Meringolo

I think our minor procedure kits and trays business continues to lead the path from a topline standpoint. I just think there is a lot of opportunity. It’s a very fragmented market. And I think that although we do very, very well in a number of categories in minor procedure kits and trays, there are many other categories that we have not been as effective in and should be. However, the manufacturing capability and the footprint and I think the teams are much more focused than they have ever been before. The team on our minor procedure kits and trays business has been evolving over the past couple of years. And I think they are finally hitting their stride and will continue to do that. So, I mean, that’s probably why that’s moving a little bit quicker than our customer procedure tray business.

Jack Wallace - Sidoti

Got you. Thanks. That’s helpful. And with the existing business, there is a lit bit of the -- excuse me the clinical business that stayed back looks to be somewhere between $2 million or $3 million a quarter. Can you just talk a little bit about what that is and what other exposures that business has going forward, that the limited amount of resin impact you will have?

Paul Meringolo

It’s really -- I mean none of it has resin impact. I mean, so part of it is patient slippers which is not plastic and the other part is packaging and sterilization products. Those are legacy -- the packaging and sterilization products are legacy products to Medical Action for many, many years since late-80s, early-90s. And so they have -- even though there is some resin that’s utilizing that product, it’s not material compared to what that resin and the Patient Care business that we sold.

Jack Wallace - Sidoti

Okay. And I noticed the tax rate was roughly 60% in the quarter, can you just talk about when did that tax rate and maybe what a normalized tax rate could look like?

Brian Baker

Yes. So we had to report discontinued operations separately from continuing operations and that adjustment is effectively driving how that effective tax rate looks on the P&L. And if you would have looked at it on a consolidated basis, it’s much more consistent with the historical average of 40%. And the expectation should be moving forward that it would be in the 40% range.

Jack Wallace - Sidoti

Olay. And there was some legal expenses about $390,000 in the quarter. What other I guess post-transaction charges might we see in the first quarter of fiscal ’15?

Brian Baker

Well, we closed June 2, so we will have two months worth of this business from a reporting standpoint in the first quarter results and there was some more legal work that was done during first quarter of fiscal ’15. So there will be some additional legal expenses.

Jack Wallace - Sidoti

Okay. And just trying to back into maybe a steady state EPS and just to follow with me if you will, adjusting for a tax rate maybe closer to 40% and taking out the excess legal expense should be an adjusted EPS around $0.08 in a quarter, does that sound about right?

Brian Baker

We historically don’t provide guidance, so…

Jack Wallace - Sidoti

Just be backward looking, you speak for the fourth quarter?

Brian Baker

Well, the fourth quarter, if you look at our EPS on a diluted share basis, I think it rounds to $0.0548 per share. And when you take into consideration that there is almost $400,000 of legal expenses related to a transaction, that’s not expected to be recurring, I guess you could back in and take the approach that way of tax affecting that and adding it back to the net income that we reported for the fourth quarter.

Jack Wallace - Sidoti

Okay. And then lastly, was there any weather impact here in the fourth? And if so, could you maybe quantify that?

Paul Meringolo

I would say there was, but I don’t think we could quantify it.

Paul Chapman

I mean if you are talking about January, February, March, we all look anybody on the East Coast lived through those issues and it was a constant battle that our teams in North Carolina and our teams in Virginia battled on a regular basis and they rallied. So I am sure it costs us money and inefficiency and over time to kind of makeup that time, but there is nothing I think that we can quantify here on the call today. But I give those people credit for rallying their troops and doing what they needed to do to get product to our customers at a critical time from those weather related issues.

Jack Wallace - Sidoti

Okay. And then also you get $40 million in cash now after the sale, what kinds of use for the cash could we see going forward, typically you had next to nothing in terms of cash because all that excess cash have been used to pay down the debt. Looking at maybe some potential acquisitions there.

Paul Meringolo

I mean, we are going to continue to be just focused on building shareholder value and so we are not going to do anything crazy. If you really think about it, I mean we’ve got almost $2.50 a share in cash on the balance sheet, pretty remarkable change in the last year or two. We are going to continue to explore any opportunity that we have to enhance shareholder value. If that’s an acquisition, then we are going to pursue that. We are trying to speak to products that are more clinical in nature and again are either alongside or in front of other categories that we operate in today.

Jack Wallace - Sidoti

Got it. Thank you. That will be all for me.

Paul Meringolo

Thank you.

Operator

And your next question comes from the line of Steve Friedman with Wells Fargo Advisors.

Steve Friedman - Wells Fargo Advisors

Good morning, everyone. Congratulations on a successful year, improving margins, and the disposal of your Patient Care business which obviously lowers your exposure to resin cost. Could I ask -- a few of my questions have already been answered, but could I ask once again on the acquisition front now that you’re almost a clean balance sheet with debt free, except for your long-term leases and so forth. But do you have a pulse and Brian, do you still have the indication or at least the direction that you'd like to take on any acquisition that would be immediately accretive? Are there any thing in your bull's eye or target zone right now?

Paul Meringolo

Well, Steve I’ve known you for how many years. You asked that question on a regular basis. Steve, there’s nothing again how we operate, we’re very conservative when it comes to meeting and we like to -- again we don’t like to embellish. I think it would be premature to even comment at this time. I think what we’re going do is we continue to look again for opportunities and we believe we’ll create shareholder value.

I’m not going to get into something that’s outside our core competency. And I think we’re going to stay away from commodity-based products and we’re going to try and look at things that are more clinical in focus. And from what I see on the landscape, I think there are a number of interesting opportunities out there like usual. Whether we could culminate a transaction or not that’s accretive, it remains to be seen and I think the minute we do and we find one and we get to a point that we’re able to talk about it. I promise you, we’ll look.

Steve Friedman - Wells Fargo Advisors

All right. Thank you. I know you had this question asked by Jack, but also I’d like to repeat the question and that is going back to the gross margins. Back to 20% plus has always for the last couple of years through the resin volatility still been your goal. You’re at 20% at least for the fourth quarter and that traditionally has been an area that should like to be into the mid-20s. Again, is that a target or at least a goal going forward to get gross margins back over the year 20% level?

Paul Meringolo

Sure. Steve, I mean, that’s where we come to work every day to try to improve those margins either through more throughput through an existing cost structure and be more efficient. We’re daily focusing on increasing topline, increasing margin and reducing expenses. So I think our chances of continuing to expand the margin section of our financials becomes a little bit but easier, now that such a large chunk of our dependency on our raw material had such huge fluctuations in cost.

I think now that that’s eliminated. I think our chances are better to continue to have a stable margin line and potentially enhance it. So I hate to indicate that we expect to be a 24% by next quarter. There is a lot of things that we’ve been working on post closing of the [blue] (ph) -- of the Patient Care divestiture that we got to be working on to make sure that our cost structure is perfect.

Steve Friedman - Wells Fargo Advisors

Okay. Thanks. That answers that exactly, Paul. Once again, I have a question regarding sponsorship and the stock following. They have such a good story going forward right now with the capability of striking if anything in your target zone comes available. Do you plan to attempt to increase possibly some of the sponsorship or I should say the stock following by their analysts and other entities that would put out obviously the story that going forward you have?

Paul Meringolo

Yeah. Steve, I think probably we’re getting close to the time where we will be focused on going out talking about business, at least I will. I think this transaction sucked tremendous amount of time and after that, we have a lot of people here including me. And I think now that that’s behind us and the businesses are running fairly smoothly. I think that it’s probably about time for me to go out, start to focus on that a little bit. So I would anticipate to all things remain the same might be after talking to potential shareholders.

Steve Friedman - Wells Fargo Advisors

All right. That’s all I have. Thank you very much.

Paul Meringolo

Thank you, Steve.

Operator

And there are no further questions at this time.

Paul Meringolo

We could call it a day. Thank you all again for being on the call and being that this is year end, the first quarter will be relatively soon. We look forward to talk to you next month or so. Thanks and have a good rest of the day. Thanks Bridget.

Operator

And thank you. This does conclude today’s conference call. You may now disconnect your line.

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