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MDCI > SEC Filings for MDCI > Form 10-Q on 5-Nov-2012All Recent SEC Filings

Show all filings for MEDICAL ACTION INDUSTRIES INC

Form 10-Q for MEDICAL ACTION INDUSTRIES INC


5-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statement

This report on Form 10-Q contains forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Forward-looking statements include plans and objectives of management for future operations, including plans and objectives relating to the future economic performance and financial results of the Company. The forward-looking statements relate to (i) the expansion of the Company's market share, (ii) the Company's growth into new markets, (iii) the development of new products and product lines to appeal to the needs of the Company's customers, (iv) the retention of the Company's earnings for use in the operation and expansion of the Company's business and
(v) the ability of the Company to avoid information technology system failures which could disrupt the Company's ability to function in the normal course of business by potentially causing delays or cancellation of customer orders, impeding the manufacture or shipment of products, or resulting in the unintentional disclosure of customer or Company information.

Important factors and risks that could cause actual results to differ materially from those referred to in the forward-looking statements include, but are not limited to, the effect of economic and market conditions, the impact of the consolidation throughout the healthcare supply chain, volatility of raw material costs, volatility in oil prices, foreign currency exchange rates, the impact of healthcare reform, opportunities for acquisitions and the Company's ability to effectively integrate acquired companies, the ability of the Company to maintain its gross profit margins, the ability to obtain additional financing to expand the Company's business, the failure of the Company to successfully compete with competitors that have greater financial resources, the loss of key management personnel or the inability of the Company to attract and retain qualified personnel, the impact of current or pending legislation and regulation, as well as the risks described from time to time in the Company's filings with the Securities and Exchange Commission, which include this report on Form 10-Q and our Annual Report on Form 10-K for the fiscal year ended March 31, 2012.

The forward-looking statements are based on current expectations and involve a number of known and unknown risks and uncertainties that could cause the actual results, performance and/or achievements of the Company to differ materially from any future results, performance or achievements, express or implied, by the forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, and that in light of the significant uncertainties inherent in forward-looking statements; the inclusion of such statements should not be regarded as a representation by the Company or any other person that the objectives or plans of the Company will be achieved.


Overview

We manufacture and market single-use medical products used principally by acute care facilities within the United States. Our product lines are divided into two markets, Clinical Care and Patient Care. Our Clinical Care market includes custom procedure trays, minor procedure kits and trays, operating room disposables and sterilization products. Our Patient Care market includes patient bedside products, containment systems for medical waste and laboratory products.

Our market approach encompasses ongoing strategic relationships with group purchasing organizations ("GPOs"), integrated delivery networks ("IDNs"), acute care facilities, surgery centers, clinical decision makers and procurement managers within acute care facilities, national and regional distributors and other end users of our products. Over the previous two years we have implemented an internal structure to support a market presence which encompasses; i) a marketing team comprised of product line managers for each of our key product categories, ii) an Executive Health Services team, that directly maintains our relationship with GPOs and IDNs, iii) regional managers who supervise both Clinical Care and Patient Care sales representatives and maintain relationships with larger acute care facilities and iv) sales representatives which maintain a direct presence with the end users of our products and manage compliance levels on GPO and IDN contracts. While we view the end users of our products as the critical decision point driving our market penetration approximately 67% of our products are sold through two national distributors.

We have supply agreements with substantially every major GPO and IDN in the country including Novation, Premier and MedAssets. A majority of the acute care facilities that we sell to are members of at least one GPO. The supply agreements we have been awarded through these GPOs designate the Company as a sole-source or multi-source provider for substantially all of our product offerings. We consider our relationships with the GPOs and IDNs that we conduct business with to be valuable intangible assets. The supply agreements with GPOs and IDNs typically have no minimum purchase requirements and terms of one to three years that can be terminated on ninety days advance notice. While the acute care facilities associated with the GPOs and IDNs are not obligated to purchase our product offerings, many of these supply agreements have resulted in unit sales growth for the Company. Acute care facility orders purchased through our supply agreements by the three largest GPOs in the healthcare industry, Novation, Premier and MedAssets, accounted for $101,692 or 45% of our total net sales for the six months ended September 30, 2012.

Over time we have increased revenues both organically and via acquisition. At this time we have focused our resources on increasing sales within existing product lines and continuing synergy initiatives associated with the AVID acquisition to drive organic sales growth.

We source our products from our four production facilities in the United States and from foreign suppliers, principally based in China. Our domestic production facilities and foreign suppliers have sufficient capacity to meet current product demand.

We conduct injection molding production and blown film production in our Gallaway, Tennessee and Clarksburg, West Virginia facilities, respectively. We conduct minor procedure kit and tray assembly operations and custom procedure tray assembly operations in our Arden, North Carolina and Toano, Virginia facilities, respectively. The principal raw materials used in the production of our product lines include resin and cotton. Our production facilities consume over 50 million pounds of resin, namely polypropylene and polyethylene, per annum. Cotton is purchased by our foreign suppliers and converted into finished products, principally operating room towels and laparotomy sponges. We purchase finished goods that contain over 10 million pounds of cotton per annum.


The challenging economic environment of the past three years has negatively impacted hospital utilization, placed adverse economic pressure on acute care facilities and fostered volatility in commodity prices. These factors have impacted our revenues, average selling prices and gross profit. We have addressed these conditions by expanding our product lines, investing in our sales and marketing teams, managing our operating costs and differentiating ourselves in the market by emphasizing our ability to add value to our customers by improving their patient outcomes. We remain committed to being a trusted strategic partner to our customers known for delivering innovative solutions to the healthcare community to improve the quality of care and enhancing patient experiences.

During the three months ended September 30, 2012 and 2011, we reported revenues of $112,100 and $109,655, respectively. Our net income and earnings per diluted share during the three months ended September 30, 2012 and 2011 amounted to $65 or $0.00 per diluted share, and $554 or $0.03 per diluted share, respectively. Net income during the three months ended September 30, 2011 included a $440 gain, net of applicable taxes, on an insurance settlement relating to inventories damaged as a result of weather-related water damage.

During the six months ended September 30, 2012 and 2011, we reported revenues of $224,337 and $216,128, respectively. Our net income (loss) and earnings per diluted share during the six months ended September 30, 2012 and 2011 amounted to $(71) or $(0.00) per diluted share, and $817 or $0.05 per diluted share, respectively. Net income during the six months ended September 30, 2011 benefitted from the aforementioned insurance settlement.

THREE MONTHS ENDED SEPTEMBER 30, 2012 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2011:

The following table sets forth net sales by market for the three months ended
September 30, 2012 and 2011:

                                                                              Increase
                                                            Increase         (decrease)
                                                           (decrease)          due to
                            September      September         due to           volume /
                             30, 2012       30, 2011       price / mix          mix
Clinical Care Market        $   72,273     $   66,652     $         (25 )   $      5,646
Patient Care Market             42,752         45,496              (229 )         (2,515 )
Sales Related Adjustments       (2,925 )       (2,493 )            (366 )            (66 )
Total net sales             $  112,100     $  109,655     $        (620 )   $      3,065

Net sales were $112,100 and $109,655 during the three months ended September 30, 2012 and 2011, respectively. The increase in net sales was comprised of an increase in unit sales in the amount of $3,065, partially offset by a change in mix of products purchased by our customers in the amount of $620. The increase in unit sales was predominantly attributable to higher domestic market penetration within our minor procedure kits and trays and custom procedure trays products.


Gross profit was $17,470 and $16,686 during the three months ended September 30, 2012 and 2011, respectively. Gross profits as a percentage of net sales were 15.6% during the three months ended September 30, 2012 and 15.2% during the three months ended September 30, 2011. The increase in gross profits was attributable to higher sales volume and a decline in costs of raw materials.

Resin-related product lines which include containment systems for medical waste, patient bedside disposable products and laboratory products, represent approximately 35% of the Company's revenues for the three months ended September 30, 2012. The primary raw material utilized in the manufacture of these products is plastic resin. We continue to experience volatility in resin costs consistent with the changes in global market prices of oil. Our gross profit during the three months ended September 30, 2012 as compared to the three months ended September 30, 2011 was favorably impacted by $684 due to lower resin prices.

During the three months ended September 30, 2012, we imported approximately $15,622 of finished goods and certain raw materials from overseas vendors, principally China. Our main imports are operating room products, which include operating room towels and laparotomy sponges, minor procedure kits and trays and surgical instruments used in our minor procedure kits and trays and certain containment products and patient bedside disposable products that we do not produce domestically. The products we import from China include cotton and plastic resin as raw materials.

The costs within the global market for cotton, while still volatile, have declined from their peak in March 2011. While the Company does not directly purchase unfinished cotton and convert the material into finished goods, it is the primary raw material utilized in the production of our operating room towels and laparotomy sponges. Our gross profit during the three months ended September 30, 2012 as compared to the three months ended September 30, 2011 was favorably impacted by $56 due to lower costs of products sourced from overseas vendors.

Selling, general and administrative expenses amounted to $16,166 and $15,355 during the three months ended September 30, 2012 and 2011, respectively. The increase is primarily due to $480 in higher GPO administration fees resulting from higher sales volume and a new GPO supply agreement, $300 in professional services associated with the renegotiation of our credit agreement and $184 in higher stock-based compensation expense. These increases were partially offset by declines of $183 in depreciation expense and $50 in various recall-related expenses (associated with a supplier) incurred during the three months ended September 30, 2011.

Distribution expenses, which are included in selling, general and administrative expenses, amounted to $2,078 and $1,933 during the three months ended September 30, 2012 and 2011, respectively. The increase is primarily due to increased sales volumes and labor-related costs, principally overtime expenses.

Interest expense amounted to $1,197 and $1,130 during the three months ended September 30, 2012 and 2011, respectively. The increase in interest expense was attributable to an increase in interest rates, partially offset by a decrease in outstanding principal loan balances.

Income tax expense amounted to $41 and $347 during the three months ended September 30, 2012 and 2011, respectively. Income tax expense as a percent of income before income taxes was 38.5% during the three months ended September 30, 2012 and 2011.


SIX MONTHS ENDED SEPTEMBER 30, 2012 COMPARED TO SIX MONTHS ENDED SEPTEMBER 30,
2011:

The following table sets forth net sales by market for the six months ended
September 30, 2012 and 2011:

                                                                              Increase
                                                            Increase         (decrease)
                                                           (decrease)          due to
                            September      September         due to           volume /
                             30, 2012       30, 2011       price / mix          mix
Clinical Care Market        $  142,236     $  133,681     $         732     $      7,823
Patient Care Market             88,254         88,871              (812 )            195
Sales Related Adjustments       (6,153 )       (6,423 )            (534 )            804
   Total net sales          $  224,337     $  216,128     $        (614 )   $      8,822

Net sales were $224,337 and $216,128 during the six months ended September 30, 2012 and 2011, respectively. The increase in net sales was comprised of an increase in unit sales in the amount of $8,822, partially offset by a change in mix of products purchased by our customers in the amount of $614. The increase in unit sales was predominantly attributable to higher domestic market penetration within our custom procedure trays, minor procedure kits and trays and patient bedside disposable products.

Gross profit was $34,415 and $33,658 during the six months ended September 30, 2012 and 2011, respectively. Gross profits as a percentage of net sales were 15.3% during the six months ended September 30, 2012 and 15.6% during the six months ended September 30, 2011. The increase in gross profits was attributable to higher sales volume. The decline in gross profits as a percentage of net sales was due to a change in mix of products purchased by our customers.

Resin-related product lines which include containment systems for medical waste, patient bedside disposable products and laboratory products, represent approximately 35% of the Company's revenues for the six months ended September 30, 2012. The primary raw material utilized in the manufacture of these products is plastic resin. We continue to experience volatility in resin costs consistent with the changes in global market prices of oil. Our gross profit during the six months ended September 30, 2012 as compared to the six months ended September 30, 2011 was unfavorably impacted by $215 due to higher resin prices.

During the six months ended September 30, 2012, we imported approximately $33,807 of finished goods and certain raw materials from overseas vendors, principally China. Our main imports are operating room products, which include operating room towels and laparotomy sponges, minor procedure kits and trays and surgical instruments used in our minor procedure kits and trays and certain containment products and patient bedside disposable products that we do not produce domestically. The products we import from China include cotton and plastic resin as raw materials.

The costs within the global market for cotton, while still volatile, have declined from their peak in March 2011. While the Company does not directly purchase unfinished cotton and convert the material into finished goods, it is the primary raw material utilized in the production of our operating room towels and laparotomy sponges. Our gross profit during the six months ended September 30, 2012 as compared to the six months ended September 30, 2011 was favorably impacted by $238 due to lower costs of products sourced from overseas vendors.


Selling, general and administrative expenses amounted to $32,109 and $30,783 during the six months ended September 30, 2012 and 2011, respectively. The increase is primarily due to $1,057 in higher GPO administration fees resulting from higher sales volume and a new GPO supply agreement, $682 in professional services associated with the renegotiation of our credit agreement and $184 in higher stock-based compensation expense. These increases were partially offset by declines of $440 in depreciation expense and $250 in various recall-related expenses (associated with a supplier) incurred during the six months ended September 30, 2011.

Distribution expenses, which are included in selling, general and administrative expenses, amounted to $4,219 and $3,809 during the six months ended September 30, 2012 and 2011, respectively. The increase is primarily due to increased sales volumes and labor-related costs, principally overtime expenses.

Interest expense amounted to $2,422 and $2,247 during the six months ended September 30, 2012 and 2011, respectively. The increase in interest expense was attributable to an increase in interest rates, partially offset by a decrease in outstanding principal loan balances.

Income tax expense (benefit) amounted to $(45) and $511 during the six months ended September 30, 2012 and 2011, respectively. Income tax expense (benefit) as a percent of income (loss) before income taxes was 38.5% during the six months ended September 30, 2012 and 2011.

Liquidity and Capital Resources

Cash Flows

Cash and cash equivalents changed as follows during the six months ended
September 30:

                                                    2012          2011
Cash provided by (used in) operating activities   $  12,397     $ (1,856 )
Cash used in investing activities                 $    (925 )   $   (341 )
Cash provided by (used in) financing activities   $ (16,312 )   $  1,307
Decrease in cash and cash equivalents             $  (4,840 )   $   (890 )

Historically, the Company's primary sources of liquidity and capital resources have included cash provided by operations and the use of available borrowing facilities while the primary uses of liquidity and capital resources have included acquisitions, capital expenditures and payments on debt.

Cash provided by operating activities during the six months ended September 30, 2012 was primarily comprised of depreciation of $2,591, amortization of $1,910 and increases in (i) accrued expenses of $6,594, (ii) accounts payable of $4,986 and a decrease in inventories of $2,226. This was partially offset by increases in accounts receivable of $5,211.

Cash used in investing activities during the six months ended September 30, 2012 consisted of $925 in purchases of property, plant and equipment. The majority of these capital expenditures related to machinery and equipment for our injection molding facility located in Gallaway, Tennessee. The Company's credit facilities contain certain covenants and restrictions, which include limitations on capital expenditures. During fiscal 2013, the Company is permitted under the terms of its Credit Agreement, to spend up to $4,000 on capital expenditures per annum.


Cash used in financing activities during the six months ended September 30, 2012 consisted primarily of $16,245 in net payments on our Credit Agreement. During the six months ended September 30, 2012, the Company reduced its term loan by $6,000 and its revolving credit loan by $10,245.

Financial Position

The following table sets forth certain liquidity and capital resources data for
the periods indicated:

                             September 30,      March 31,
                                 2012              2012
                              (Unaudited)

Cash and cash equivalents   $           544     $    5,384
Accounts receivable, net    $        36,050     $   30,845
Days sales outstanding                 28.9           26.0
Inventories, net            $        51,599     $   53,825
Inventory turnover                      6.4            6.3
Current assets              $        97,071     $   98,183
Working capital             $        49,908     $   60,621
Current ratio                           2.1            2.6
Total borrowings            $        73,145     $   89,457
Stockholder's equity        $       149,259     $  148,807
Debt to equity ratio                   0.49           0.60

The Company is committed to maintaining a strong financial position through maintaining sufficient levels of available liquidity, managing working capital and generating cash flows necessary to meet operating requirements. Total borrowings outstanding were $73,145 with a debt to equity ratio of 0.49 to 1.0 at September 30, 2012 as compared to $89,457 with a debt to equity ratio of 0.60 to 1.0 at March 31, 2012. Cash and cash equivalents at September 30, 2012 were $544 and the Company had $12,291 available for additional borrowings under its revolving credit facility.

Working capital at September 30, 2012 was $49,908 compared to $60,621 at March 31, 2012, and the current ratio at September 30, 2012 was 2.1 to 1.0 compared to 2.6 to 1.0 at March 31, 2012. The decrease in working capital is primarily the result of repayments of our long-term debt of $14,200 during the six months ended September 30, 2012.

On June 7, 2012, the Company entered into our Second Amended and Restated Credit Agreement. The Second Amended and Restated Credit Agreement requires us to comply with specified financial covenants relating to (i) maximum annual capital expenditures of $4,000, (ii) a minimum fixed charge coverage ratio of 1.00 to 1.00 on a rolling four fiscal quarter basis and (iii) minimum earnings before interest, taxes, depreciation and amortization for certain specified quarterly periods through the expiration of the loans, including $3,000 for the fiscal quarter ending on June 30, 2012, $7,500 for the two consecutive fiscal quarter period ending September 30, 2012, $13,750 for the three consecutive fiscal quarter period ending December 31, 2012, $18,000 for the four consecutive fiscal quarter period ending March 31, 2013 and $21,000 for the four consecutive fiscal quarter period ending June 30, 2013. In addition, the Company has committed to certain post-closing conditions, including providing monthly financial statements, quarterly updates of financial projections and filed mortgages on our North Carolina, West Virginia and Tennessee facilities. As of November 5, 2012, the Company is in compliance with all covenants and financial ratios under the Second Amended and Restated Credit Agreement.


Borrowings under the Second Amended and Restated Credit Agreement are collateralized by substantially all of the assets of the Company and its subsidiaries, and the agreement contains certain restrictive covenants, which, among other matters, impose limitations with respect to the incurrence of indebtedness, granting of liens, guarantees of obligations, mergers, acquisitions, capital expenditures, making loans or investments, specified sales of assets and prohibits the declaration and payment of dividends.

The Company believes that the anticipated future cash flow from operations, coupled with its cash on hand and available funds under its revolving credit facility will be sufficient to meet working capital requirements. Although we have borrowing capacity on our revolving credit agreement, have cash on hand and anticipate future cash flow from operations, we may be limited in our ability to allocate funds for purposes such as potential acquisitions, capital expenditures, marketing, development and other general corporate purposes. In addition, we may be limited in our flexibility in planning for or responding to changing conditions in our business and our industry, making us more vulnerable to general economic down turns and adverse developments in our business.

Borrowing Arrangements

On August 27, 2010, Medical Action entered into our Prior Credit Agreement, among the Company, as borrower, JPMorgan Chase Bank, N.A., as administrative agent and the lenders party thereto pursuant to which such lenders agreed to make certain extensions of credit to the Company. On June 7, 2012, the Company agreed to amend and restate the Prior Credit Agreement in its entirety and entered into a New Credit Agreement, among the Company, as borrower, JPMorgan Chase, N.A., as administrative agent, Citibank, N.A., as syndication agent and HSBC Bank USA, N.A., Sovereign Bank and Wells Fargo Bank, N.A. as co-documentation agents and the other lenders party thereto (the "Lenders").

The New Credit Agreement provides for a $51,000 secured term loan and a $25,000 secured revolving credit facility. The revolving credit facility is used to finance the working capital needs and general corporate purposes of the Company and its subsidiaries and for permitted acquisitions. As of September 30, 2012, $50,000 in term loans and $9,425 in revolving loans were outstanding under the New Credit Agreement.


Contractual Obligations

Certain contractual cash obligations and other commercial commitments will
impact our short and long-term liquidity. At September 30, 2012, such
obligations and commitments are as follows:

                                                          Less than 1       1 - 3        4 - 5      After 5
                                             Total           Year           Years        Years       Years
Principal payments of long-term debt       $  59,425     $       6,000     $ 53,425     $     -     $      -
Capital lease obligations                     29,042             1,503        3,097       3,222       21,220
Purchase obligations                          23,158            23,158            -           -            -
. . .
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