Medical Action Industries Inc. F4Q08 (Qtr End 03/31/08) Earnings Call Transcript

May.30.08 | About: Medical Action (MDCI)

Medical Action Industries Inc. (NASDAQ:MDCI)

Q4 2008 Earnings Call

May 30, 2008 10:00 am ET

Executives

Richard D. Satin – VP Operations & General Counsel

Paul D. Meringolo – President & CEO

Charles L. Kelly - CFO

Analysts

Matthew Dolan – Roth Capital Partners

Mitra Ramgopal – Sidoti & Company

Operator

Good morning, at this time I would like to welcome everyone to the Medical Action Industries’ fourth quarter and year end financial results conference call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Richard Satin; sir you may begin your conference.

Richard Satin

Good morning and thank you for holding. With me on this call are Paul D. Meringolo, CEO and President and Charles L. Kelly, Chief Financial Officer of Medical Action Industries. The primary purpose of this call is to discuss our results for the three and 12 months ended March 31, 2008, which were released this morning. As you know we must first touch all of the legal bases by 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 Quarterly Report 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 being here today as we report our 31st year of being in business; a challenging one at best and nevertheless remain diligent on focusing on our business and our customers and our shareholders on a day-to-day basis. Having said that, I’ll go through the financials for the year as well as the quarter and then give you some of my input on what we see and then I’ll open the floor for questions.

Today Medical Action, a leading supplier, today reported record revenue and earnings for the fiscal year ending March 31, 2008. Net sales for the 12 months ended March 31, 2008 reached a record $290,528,000, an increase of $73,200,000 or 34% over the $217,328,000 in net sales reported for the 12 months ended March 31, 2007.

Net income for the period was a record $13,225,000 or $0.83 per basic share, $0.81 per diluted share, an increase of $256,000 or 2% as compared with $12,969,000 or $0.82 per basic share, $0.80 per diluted share reported for the comparable 12 months in fiscal 2007. All per share amounts reflect a 3-for-2 stock split in the form of a dividend that was distributed on February 9, 2007.

This marks the 13th consecutive year of record revenue and 11th consecutive year of record net income.

Net sales for the three months ended March 31, 2008 totaled $72,099,000, an increase of $2,694,000 or 4% over the $69,405,000 in net sales reported for the three months ended March 31, 2007. Net income for the three months ended March 31, 2008 was $2,797,000 or $0.18 per basic share, $0.17 per diluted share, a decrease of $430,000 or 13% compared with $3,227,000 or $0.20 per basic share, $0.19 per diluted share reported for the comparable three months in fiscal 2007. Again all per share amounts reflect the 3-for-2 stock in the form of a stock dividend that was distributed on February 9, 2007.

From a quarterly perspective, it hasn’t been too often in the past 11 years that we’ve had to report a decrease of quarter-over-quarter but I think as we all know from an industry perspective there has been significant challenges. For one, not the least, oil being at $126 a barrel. It remains our challenge to effectively execute on our plan of continuing to provide our customers with the cost-effective products.

There are some things that are within our control and there are some things that are out of our control. From a gross margin standpoint, I’m just going to focus on two areas; prices and cost and I’ll just focus on prices for a second. In the marketplace we are all faced with significant pressures from a cost side. Medical Action over the years has done very well at focusing on driving cost out of our products through efficiency and product innovation and design and packaging and size and many, many different criteria that we have used for the past 30 plus years in effectively competing in the marketplace.

In our plastics business and now in particular in our business that’s sources from China, we’ve had significant cost increases in the base cost of our raw materials. The efficiencies that we’re gaining or will gain from a manufacturing side cannot offset the huge increases that we’ve seen on the raw material side. So we are forced to go to the marketplace, to our customers, that we have done have a very good over the years of supplying as well as providing them with competitive prices. We have no other alternative and that’s what we’ve talked about in previous conference calls; to go out and raise prices.

We want to do that for two reasons, number one, we want to remain strong and healthy so we can provide them with high quality products and number two we want to provide a fair return to our shareholders. And a fair return is what we’re looking for. And so we are in multiple stages of price increase notification to our customers. Some are done and already reflected in the P&L to a small extent. Some have been negotiated and have been implemented but have not hit the P&L yet. And there are some that are still out there that are rather large, that are in the midst of negotiations as we speak and will be implemented over the upcoming quarters.

We remain firm in our focus in providing our customers with the visibility of things that we can control and things that we can’t and ask for their assistance in helping us weather the storm from a raw material side and acknowledging our minimal price increases in our existing contracts. That’s all we can do from a price side. And continue to educate the market on what it means to us and to them.

From a cost, we look at it in three different pieces and it’s very clear from the press release how we look at it. Number one is inefficiencies, and the inefficiencies come from challenging the way we do business from a Medegen side and from the integration. We never really created the expectation out there that closing down Colorado and moving it into Tennessee was going to be a simple task. People wanted to make it that way, but we knew early on that that was not going to be a simple task and sure enough, it turned out to be not a simple task.

As we speak today, Colorado is effectively shut down. I believe today the phones have been shut off in that location and its no longer operating as a facility in Colorado and that equipment is moved and in-house into our Galloway, Tennessee facility. Some of the things that we found in this consolidation was that some of the equipment that was in-house has some issues and mainly in age and shape of the equipment.

We’ve talked about this in the previous conference call and I will continue to talk about it; we remain confident in our ability to execute in our plastics business. It’s going to take come capital. It’s going to take our focus. We are well underway in our get-well process in Tennessee. We have equipment being installed as we speak. Equipment on the way as we speak. And we’ve got the next traunch of purchases of equipment already slated and ready to be executed on.

So I would think this year will be a pivotal year for the Tennessee facility as we really change the culture in that facility, change management, change facilities, upgrade equipment, which we believe will enhance the efficiency and our cost basis in that plant over what it is today. And as you can see, we breakout the efficiency pieces being about $3.7 million and again that is from just pure inefficiencies, that’s outside sourcing, that’s scrap, those are issues related to equipment not running at full bore.

Really what our ultimate concern right now is to make sure that we keep our customers supplied with a steady flow of product at whatever cost and I think slowly but surely, we’re getting out of that and we’re making tremendous headway there. From an efficiency standpoint, I think we have a lot of things going there and I believe this year will be a tremendous year for us to get that plant in shape and well on its way to being the efficient plant we believe it can be.

The other two areas that we are focused on are the resin cost as well as China. And as you can see in the quarterly and yearly numbers, resin cost has escalated dramatically over the entire year’s numbers in the fourth quarter. Increased resin cost amounted to approximately $2.3 million in the quarter and $3.7 million for the year. So you have a double negative there in Medical Action where we haven’t yielded the price increases yet in the marketplace but yet our costs have gone up.

And those are the things that we talk about with our customers when we come to them with price increases. We have already incurred these. They have been accommodating to us in helping us raise prices in the marketplace. They understand resin. We try to do as good a job as possible in relating that information to them and we have to continue to remain focused on communicating with our customers as resin goes up and in the event that resin should go down, we’re going to communicate the same way that we have on the way up, we’re going to communicate with our customers on the way down.

I think that process will continue to be a challenge but will continue to work well. The new wrinkle to the equation in these past few quarters is the challenges that we face in costs from China. Widely publicized, China’s currency floating now and value-added tax incentives taken away from manufacturers and some of the labor costs issues and just the general issues with China evolving, has put cost pressures on that country and facilities across the board.

We are starting to get impacted by cost increase in China. They are fairly significant as you can see here. For the quarter it was $750,000, for the year its $3 million and we have done very little in the marketplace to go out and capture that increase. There is more coming and that’s a fact. We know that we have another increase that’s hitting us right now as we speak and we are out communicating with our customers to raise prices for the first time on those China-related products, again which historically we have not, historically we were able to effectively produce that product and lower their overall costs in some cases.

Its unprecedented times for us from a cost perspective. I know in the things that we can control like the plants and efficiency, we are working and investing every day in making sure that we are the most efficient plastics producer in that product line. On the resin side we are going to continue to manage through and future-buy as much as we can if we think the price is at a low and try to manage through when it’s high from a buy and an inventory standpoint and a hedging standpoint. We will continue to communicate with our customers and try to be as reasonable as possible with our price increases.

With China again we’re going to continue to manage our inventory but also look for alternate sources as we speak. There are some processes that may be able to be brought back in-house that will render us a little bit more cost effective or equal to China but control it in-house. We are also looking at alternate sources outside China, but right now from what we can see, and some of the products that we’re in, China poses the best choice for us from a product, from a cost and from a quality standpoint.

Again, we will continue to work diligently on the efficiency issue. We will continue to communicate with our customers. We continue to remain very optimistic about the potential for future acquisitions and our capital structure. This is absolutely a small bump in the road for us and again we’re continuing to build infrastructure not only in equipment and processes, but in people. This is the first call that Charles Kelly, our new CFO, is on and you can expect him to be on future conference calls as well.

We look forward to his experience, not only from a financial management standpoint, but Charles has a wealth of experience on the operational side of the business as well and particularly in the injection molding end of the business. We are excited to have him. We have a new Senior Sales Executive that started this week as well in [Perry Borch]. We’re excited about the infrastructure that we will continue to build to help take this company to the next level.

With that I’d like to open the floor up to any question.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Matthew Dolan – Roth Capital Partners

Matthew Dolan – Roth Capital Partners

First looking at your gross margin, and Paul following up on your comments on pricing, a lot of detail there, but are you seeing or sensing any upcoming decrease in your ability to pass on these price expansions to your customer base with the overall economy and hospital spending the way it is, or do you anticipate that these will be able to offset the pressures going forward and I guess, the real question here is what would that imply for your gross margin in fiscal 2009 relative to what we saw in Q4 which was a few basis points below what we’ve seen in prior quarters?

Paul Meringolo

I think that as you can see from the margin side, we’re not this gigantic margin company. So I think the pricing that we ask for in the marketplace is absolutely fair and reasonable. We run a very tight ship here. So from a pricing standpoint I think—I don’t think we have any other choice but to stand firm when we go to our customers with increased price. I think from all perspectives we are the low cost producer and I think that if there is a competitor out there that’s willing to take the business below what we’re out there at—number one they would have had that business already. Number two it will be short-lived because I would believe anybody that’s importing from China is seeing the same pressure from a cost perspective, or they’re not good business people and eventually they’ll be in financial trouble and our customers will be back to us.

So we have to remain firm in our approach with our price increases but the one thing that will happen is, the increases that we’re looking for is purely just to cover our cost. If we’re able to do that, from a gross margin percentage standpoint, the margin will continue to be hit from a percentage standpoint, but I believe some of the things that we have in the works now from an increase standpoint, could take our margin back up to the 23% range.

Some of the things that we have to do from an efficiency side, as you can see, could add a point plus to margin as well. Just in Medegen alone. So I don’t want people to get this sinking feeling that we’re going to be a 19% margin company. I think we’ve got a lot of things in the works that are going to try in the next couple of quarters to offset that. This is not a switch that we’re going to flip and tomorrow it’s going to be 25% margin. Again this is a timing issue. We’re trying to be as reasonable as possible with our customers on some of these increases and trying to work with them from a timing and from an amount standpoint.

I think we have proven for many, many years with our customers that we are a good supplier. Have we had some hiccups in the past nine months? Absolutely but they are just what they are; hiccups. I’ve spent time in the field with our national buying groups and communicating our story to them. We will continue to be there as much as they want us to be there. We will continue to provide them with information necessary they need, to help them make a decision. The beauty of being a public company is its fairly transparent what some of these increases are doing to us. And so our customers should be able to see that very clearly.

Matthew Dolan – Roth Capital Partners

On the SG&A side, you’re down $1 million, or over a million from where you were running, are there any cost savings programs you’ve implemented there or how should we look at that going forward here?

Paul Meringolo

I think that we’re not going to start cutting heads here because I think we need to make sure that we have good strong people in the right spots. So I wouldn’t think that that’s going to be a continuing trend. Again I think we’ve already added two significant players to our team post year-end. And so this is not one of let’s start getting rid of people. This is one that we’re going to continue to invent in the business because we believe what we’re doing is ultimately going to come out in a very positive release in the future rather then a negative release reporting comparisons that are below last year’s.

Matthew Dolan – Roth Capital Partners

In the past you’ve given us not guidance, but maybe some broad stroke, forward-looking comments. Are you anticipating a record fiscal 2009 this year?

Paul Meringolo

Oh you’re good, I think that that is very, very doable but that’s not—with this volatility and the timing of our price increases to our customers, we’re concerned enough about it that we don’t want to be so bullish to say that publically. I think you know us fairly well, we like to under-promise and over-deliver and we like to be conservative in our approach and that’s how we’re going to try to act for the foreseeable future.

Operator

Your next question comes from the line of Mitra Ramgopal – Sidoti & Company

Mitra Ramgopal – Sidoti & Company

I know you addressed the margin issue, clearly a lot of things you need to deal with but, I don’t k now if you can give us a sense on the revenue side, a little lighter then I was looking for, was there any particular weakness in any product lines or I don’t know if you can just give us some more color.

Paul Meringolo

I think that there were some issues with open orders that were not available—inventory wasn’t available to ship in Medegen. Typically a little bit higher then I’ve seen in previous quarters, so that hurt us a little bit. Other then what we’ve seen in some declines from a lap and a towel standpoint in previous—and we’ve talked about that in previous quarters, I don’t see anything that’s glaring that’s jumping off the page at us that we’re out there losing business. I think we’ve got to be concerned about service levels on Medegen and that we get the efficiencies and the production right from our customer perspective. Otherwise that could have some impact on revenue going forward. And again, we remain confident from a top line side that we’re going to continue to execute.

Mitra Ramgopal – Sidoti & Company

With a couple of months into this quarter relative to what we saw the last quarter, are you making any headway with regards to the inefficiencies and the productivity issues you alluded to?

Paul Meringolo

Every day we make headway. Whether it’s big enough to have a significant swing in margin in this quarter, we don’t believe so. Right now again as we speak, we have two brand new pieces of equipment on its way. We have the area prepped. The concrete footings in. Old equipment out. Molds in, robotics on its way. So I think that it’s going to take a little time for that equipment to get up and running and that is only the first step in helping cure some of these issues. There’s a lot of capital that we’re going to be spending this year and next year in upgrading the equipment and the processes in that plant in Tennessee.

The answer to your question is I don’t think you’re going to see anything significant immediately but I think you’ll see it build over time.

Mitra Ramgopal – Sidoti & Company

Coming back to acquisitions, I know you touched on it earlier, given you still have a lot on your plate to deal with just in managing and dealing with the price increases and margin pressures, is it fair to assume at least in the foreseeable future that we shouldn’t be looking for any activity?

Paul Meringolo

I think that we have been fairly active in a couple of areas with respect to acquisition and so we haven’t shut down that process. There could be some transactions that are natural line extensions that would be easy fold-ins so we’re not abandoning our efforts on the acquisition side and don’t plan on abandoning it. If we come across an acquisition that we believe is going to halt or alter our ability to continue to bring—continue to consolidate that Medegen acquisition and do what we need to do, then obviously we won’t do it. If there’s an acquisition that can enhance that, we might accelerate it.

Mitra Ramgopal – Sidoti & Company

What was long-term debt at the end of the year?

Paul Meringolo

It was $47 million.

Operator

At this time I would like to turn the floor back over to management for any closing remarks.

Paul Meringolo

Again we remain very focused on executing our plan and we appreciate all the work from our fellow teammates here at Medical Action. We appreciate the understanding of our customers during this tough time and our shareholders and we look forward to reporting enhanced financial results in the foreseeable future. So again thank you for your time and we look forward to seeing you at the Annual Shareholders’ Meeting and enjoy the rest of the day and have a good weekend. Take care.

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