Medical Action Industries Inc. F1Q09 (Qtr End 06/30/08) Earnings Call Transcript

Transcripts

Medical Action Industries Inc. (MDCI) F1Q09 (Qtr End 06/30/08) Earnings Call Transcript August 7, 2008 10:00 AM ET

Executives

Richard Satin – VP of Operations and General Counsel
Paul Meringolo – Chairman, CEO and President
Charles Kelly – CFO

Analysts

Matthew Dolan – Roth Capital
Mitra Ramgopal – Sidoti
Gerry Heffernan – Lord Abbett & Co.
Steve Friedman – Wachovia Securities

Operator

Good morning. My name is Cheryl and I will be your conference operator today. At this time, I would like to welcome everyone to the Medical Action Industries’ first quarter 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

Thank you, Cheryl. Good morning and thank you all 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 months ended June 30, 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 our 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.

I would like now to introduce Paul D. Meringolo.

Paul Meringolo

Good morning and thank you all for being here today. I assume that you have all had a chance to see the news release and so we are pleased with the quarter from a sales growth perspective with revenues growing more than 10% first quarter this year versus the first quarter last year. More than half of that growth has come from increased unit volume while a portion of it is from mix as well as price increases instituted over the past year. Let’s look briefly at the first quarter numbers.

Net sales for the first quarter reached a record $77,395,000; an increase of $7,149,000 or 10% over the $70,246,000 in net sales reported for 3 months ended June 30, 2007.

Net income for the first quarter was $2,546,000 or $0.16 per basic and diluted share, as compared with $3,512,000 or $0.22 per basic and diluted share reported for the prior year period.

We continue to feel the effects on gross margins from – as we spoke on last conference calls from increased cost of resin, increased cost of material sourced from China, and some of the efficiency issues that we are having in our Tennessee plant. In the first quarter the effects from those three totaled about $4.7 million. On the positive side, we continue to be pleased with the sales growth in that quarter, of course all of our major product categories. We have as we spoke last quarter we have hired a new – an additional VP of sales as well as our new CFO Chuck Kelly coming onboard. And we are pleased with the progress Perry [ph] is making with the sales team and structure as well as the progress Chuck is making in leading the financial functions of this business. So, it is two great (inaudible) for the business that we are very exited about.

From a sales side again we remain exited. There are a plethora of opportunities out there for us and we continue to work diligently on capturing those either in our current market or the existing markets outside of the hospital market, alternate care, international, veterinary that we try very hard to have deeper penetration in those markets.

From an expense side, we have continued to manage that rather effectively. Although we had a 10% top line growth our SG&A held pretty flat for the quarter, and even with the addition of senior sales executives. So, we are – we remain focused on making sure that we are prudent in how we spend our money both from a cost of goods sold and a capital side – capital equipment side but also from an expense side.

Let us just talk about some of the challenges we faced in the quarter and had been facing in previous quarters. And again I will break it up into a couple of different pieces and let’s just talk about cost of goods sold and if we take a look at resin I am sure I don’t have to educate everybody on what is going on in the plastics market. We continue to see higher cost of raw materials due to oil prices. First quarter cost impact on the P&L was about $1.7 million. Since our last call we have continued to see some increases in cost of resin. We have tried to manage them best as possible. As you can see from the balance sheet we have had some inventory tick up that has to do with some of the hedging that we tried to do by buying ahead of these increases. Right now we think we are in a fairly good position from an inventory perspective and hopefully resin will adjust down as well as oil has done over the last few weeks. That is what our hope is.

Again it is unclear whether that recent drop in oil is going to affect resin or not, but we remain hopeful that it will.

From a China perspective we continue to see pressure from cost of goods sold from China. First quarter costs totaled about $1.45 million. We have all indications that there we will continue to see some inflation from China, although we don’t believe it will be as volatile as resin. It is going to be something that we are going to have to learn to live with and manage that business accordingly. Both those issues, resin and China are not something that is remained to just Medical Action. These two issues are putting pressure on the entire medical device industry and a number of other businesses as well. And so we have got to make sure that we are focused on addressing those issues. So, with respect to cost of goods from those two items. Again, we have started to build a long-range plan to raise prices and these price increases as I have talked about on other conference calls are not something that impacts the P&L on day one. There are lengthy negotiations with current contracts that we have, there is notification timing that has to be done from a distribution side and from a group side and from a hospital side. There is some hesitancy from the market place because again this is – they have got to come in from all angles at them from the hospital side. So, I would take it is not an easy process to go through. We continue to be fair, honest, and prudent with our price increases to our customers. We continue to communicate what we see from a cost side and we continue to remain highly competitive and we want to be the low cost producers in the market that we compete in. We believe the customers are better educated than they have been in the last 6 months and that helps in the process and we will continue to be fair with them from a pricing model.

As you can see from the first quarter numbers there has been some effect due to raised prices in the market place and again that is only scratching the surface. From the most recent price increases I believe, our quarter was only impacted in June. So, we expect a full quarter of some of those increases to hit in the second quarter. But as I have said we have seen some escalating resin prices hit us more recently and even though we have done a good job at hedging some of that through purchasing I think we are going to – we are still going to be impacted from that in the short-term.

We do have a plan. We do have numerous contracts that have been renegotiated successfully and so we will continue to make sure that we educate, communicate, and be fair with our customers along with making sure that we adjust our contracts to not give long-term price protection and making sure that there are plenty of triggers which comes to commodity prices like resin in our contracts to make sure that we can adjust as needed along the contract period.

From an efficiency standpoint we are making progress, although in Q1 we have had a negative impact to the P&L of about $1.5 million, we continue to remain very optimistic about what the potential is in that plant in Tennessee. As I said on previous conference calls we have closed out Colorado. Colorado facility is shut down. All phones, all people are no longer present in that facility and all are in-house in the Tennessee facility. There has been a lot of work going on to upgrade the facility both from a machinery and equipment and just from a – just from a general plant process. We have installed two new rather large presses. We have installed four new robots on equipment that is going to help drive efficiency and downtime and help streamline the labor portion of our business. We have new presses, additional presses on order. We have done a lot of work to again the fundamentals of that operation, air and material handling and roof and flooring. And so we are very confident that in the next couple of quarters we will start to reap the benefits of those processes and equipment that we put in place.

We also have focused on making sure that we have got the right people in the right spots. And I think from a mechanical side, from a technical side, and now from a plant supervision side we have made the necessary changes that we have got the right team in place to drive the culture that exists in all of our facilities here stateside and we are very confident that over the next couple of quarters that that team along with the capital investments that we are making in that business will bear fruit in the upcoming quarters.

We anticipate that we are going to – we will – it will be a continual process to invest in that plant and equipment and processes, but I think we have made a – we have taken a major chunk with the equipment that has been installed and the decisions that we have made on new equipment that will – due to be installed in the next 3 to 4 months.

From the future, we continue to anticipate strong sales. We view this period of time for Medical Action as a bump in the road and we are confident in our ability to address these issues. We continue to monitor oil prices and how the changes in China will affect our costs. We will continue to communicate with our customers and rise pricing accordingly. We will continue to invest in Tennessee and the rest of our plants and in our businesses and we are optimistic about our ability to move our margins up and to get earnings back to record results. And so with that unless Chuck or Richard have anything else they want to add to that commentary, I would love to open the floor up for questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Your first question is coming from Matthew Dolan of Roth Capital.

Matthew Dolan – Roth Capital

Hi, guys. Good morning.

Paul Meringolo

Hi, Matt.

Charles Kelly

Good morning Matt.

Matthew Dolan – Roth Capital

Question on the sales line, any highlights you can give us there Paul, were there any big orders or categories that shipped during the June period that provided the upside, at least relative to our numbers, and then maybe break it out Medegen versus Medical Action?

Paul Meringolo

Normal business. There were no real anomalies from an ordering standpoint. I think it was pretty much across all product categories. I think – again I think you will see it in the Q, but I think it was pretty healthy across the product categories.

Matthew Dolan – Roth Capital

Okay, very good and then as we look at these price increases a couple of questions, but it sounds like you are getting a couple of big increases in the September period. Can you maybe outline the rest of fiscal year in terms of when we should see improvements in pricing and how that really should affect gross margin. And the second question is relative to your competitors, how are they reacting in this environment, you know, as you balance your plant to raise prices to offset your cost but try to maintain obviously your customer base. What are you seeing the competition doing and is that impacting your ability to maintain your account base or take accounts from them?

Paul Meringolo

The national players more and more are doing exactly what we expected them to do, is raise prices. They are – and some of them are little slower than we had anticipated, but when they came they came hard in certain price categories. So that allows me to be a little bit bullish with respect to the plastic side of our business. China side is a little bit different because you got some irrational players in there that are vying for some position in the market place. So, they may act irrational from a price standpoint but I don’t believe that they are going to be able to withstand that long-term. I think quality will suffer, service will suffer, and on a lot of those items they are invasively used and we are just not going to comprise there. So, we are going to study the course from that perspective and again be fair with our customers. From a volatility standpoint we believe the China side is not as dramatic as the – once it stabilizes as resin. So, when you take a look at our price increases, you have got, they are really all over the place. You know, you have got some that you know will hit in June, you have got some that are going to be effective November 1st. You have got some that are going to effective December 1st. You have got some that are going to be effective January 1st. You have got some that are going to be effective October 1st. So, I think you know it is going to be a – there is a lot of contracts, there are lot of different situations, and they range anywhere from 5% to 12% in some cases. So, it is a – it depends on product category, it depends on commitment, it depends on a lot of things, but again we are fairly confident that we are going to win more than we lose in that process.

Matthew Dolan – Roth Capital

Okay, and then finally on the gross margin maybe for Chuck or Richard too but is there a time when you expect or can you give us maybe a timeline of when you get above 20 or closer to that 23% to 25% target, any timeline brackets we could put around that?

Charles Kelly

I don’t think we are at the point where we are going to start forecasting the margins are going pick up over 20%. That is certainly going to hinge on the improvements in the efficiency in the factory, the manufacturing variances which we expect to improve over the balance of the year and gain traction with the price increases that were in place last year, most of all we did during the fourth quarter. So, we haven’t done any modeling as far as when the percentage is going to move forward, just qualitatively we know that are going to start picking up for us.

Matthew Dolan – Roth Capital

Okay, great thanks guys.

Charles Kelly

Thanks Matt.

Paul Meringolo

Thanks Matt.

Operator

(Operator instructions) Your next question is coming from Mitra Ramgopal of Sidoti.

Mitra Ramgopal – Sidoti

Yes. Hi, good morning guys.

Paul Meringolo

Hi Mitra.

Charles Kelly

Good morning.

Mitra Ramgopal – Sidoti

A couple of questions, again just coming back to the nice top line we saw in the quarter, how much of that was volume as opposed to price?

Paul Meringolo

A little bit more than half was volume and the other percentage was some from mix, most from price.

Mitra Ramgopal – Sidoti

Okay, and again you mentioned your hedging for resin. I don’t know if you gave us a sense as to how much of your resin needs for fiscal ’09 you are hedged?

Charles Kelly

In some facilities we are out 6 months and in another facility we could be at 4 months.

Mitra Ramgopal – Sidoti

Okay, and I know, you mentioned you are boosting some of your investments, if you can tell us what you are planning for CapEx this year?

Charles Kelly

Well, Mitra, look I just don’t want to confuse the buildings, the building project. When you talk about equipment in that plant, you are probably talking north of $5 million of CapEx.

Mitra Ramgopal – Sidoti

Okay, and again just sort of if you can give us an update on the SAP system that was implemented, if it is fully operational, have you started to see any benefits from it as yet?

Charles Kelly

It is not fully operational. From a sales standpoint, you know, revenue and invoicing we are fully operational. We are now going through an integration of merging back-end manufacturing accounting systems from an SAP standpoint and we expect that to be completed in this fiscal year is what we are targeting.

Paul Meringolo

And is principally clean up and administrative work. The power of the system is supports the business from a sales and market intelligence and where we are touching the customers it is all in place in operating. This is more back office, accounting, warehouse managing and the like which is going to add value to us and efficiencies in the plant but is not going to be the big driver behind the systems investment (inaudible).

Mitra Ramgopal – Sidoti

Okay, finally again it seems like really nice top line here and obviously it is tough to predict where prices going forward for commodities will be but is it fair to assume that you know, going forward in light of the price increases efficiencies et cetera that you expect to realize that we should start seeing some improvement off of the first quarter?

Paul Meringolo

From a top line standpoint?

Mitra Ramgopal – Sidoti

No overall profitability.

Paul Meringolo

And again it all remains on what happens with resin cost and what goes on with the progress we make from Gallaway, Tennessee facility. Okay.

Mitra Ramgopal – Sidoti

Thanks again guys.

Operator

Thank you. The next question is coming from Gerry Heffernan of Lord Abbett & Co.