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MDCI > SEC Filings for MDCI > Form 10-K on 14-Jun-2013All Recent SEC Filings

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Form 10-K for MEDICAL ACTION INDUSTRIES INC


14-Jun-2013

Annual Report


ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

We manufacture and market single-use medical products used principally by acute care facilities within the U.S. We divide our product lines 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, and dressings and surgical sponges. Our Patient Care market includes patient bedside products, containment systems for medical waste and laboratory products.

Our growth strategy has included both acquisitions and expansion of existing product lines. In August 2010, we acquired AVID which markets and assembles custom procedure trays. AVID's net sales were $149,201 for fiscal 2013 and $138,466 for fiscal 2012. While we had previously made both custom and standard minor procedure kits and trays, the acquisition of AVID significantly expanded our product line offerings within the Clinical Care market, increased our sales team and provided opportunities to cross sell our existing product lines. 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 belong to at least one GPO. The supply agreements awarded to us through these GPOs designate us as a sole-source or multi-source provider for substantially all of our product offerings. 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 90 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. Acute care facility orders purchased through our supply agreements with the three largest GPOs in the healthcare industry, Novation, Premier and MedAssets, accounted for $226,182 or 51% of our total net sales for the fiscal year ended March 31, 2013.

Although over time we have increased revenues both organically and via acquisition, at this time we are focusing 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 U.S. and from foreign suppliers, principally based in China. The principal raw materials used in the production of our product lines include resin and cotton. Our production facilities consume approximately 53 million pounds of resin, namely polypropylene and polyethylene, per year. 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 approximately 11 million pounds of cotton per year.

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 profits. 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 fiscal 2013, 2012 and 2011 we reported net sales of $441,593, $437,321 and $362,494, respectively. Our net income (loss) and earnings (loss) per diluted share during fiscal 2013, 2012 and 2011 were ($54,856) and ($3.35) per share, $181 and $0.01 per share and $4,354 and $0.27 per share, respectively. Our profitability during fiscal 2013 was adversely affected by a $77,780 goodwill impairment charge and certain expenses associated with the renegotiation of our Prior Credit Agreement.

The following table sets forth certain operational data (in dollars and as a percentage of net sales) for fiscal years 2013, 2012 and 2011:

                                                            Percent of                         Percent of                         Percent of
                                          Fiscal 2013       Net Sales        Fiscal 2012       Net Sales        Fiscal 2011       Net Sales
Net sales                                $     441,593            100.0 %   $     437,321            100.0 %   $     362,494            100.0 %
Cost of sales                                  369,224             83.6 %         372,380             85.2 %         298,615             82.4 %
   Gross profit                                 72,369             16.4 %          64,941             14.8 %          63,879             17.6 %
Selling, general and administrative
expenses                                        64,277             14.6 %          59,372             13.6 %          51,978             14.3 %
Goodwill impairment charge                      77,780             17.6 %               -              0.0 %               -              0.0 %
   Operating income (loss)                     (69,688 )          -15.8 %           5,569              1.3 %          11,901              3.3 %
Interest expense, net                            4,767              1.1 %           4,571              1.0 %           2,888              0.8 %
   Income (loss) before income taxes
and extraordinary items                        (74,455 )          -16.9 %             998              0.2 %           9,013              2.5 %
Income tax expense (benefit)                   (19,599 )           -4.4 %           1,272              0.3 %           3,821              1.1 %
   Income (loss) before extraordinary
items                                          (54,856 )          -12.4 %            (274 )           -0.1 %           5,192              1.4 %
Extraordinary gain (loss), net of
income taxes                                         -              0.0 %             455              0.1 %            (838 )           -0.2 %
   Net income (loss)                     $     (54,856 )          -12.4 %   $         181              0.0 %   $       4,354              1.2 %

FISCAL 2013 COMPARED TO FISCAL 2012

The following table sets forth net sales by market for fiscal years 2013 and
2012:

                                                                         Increase (decrease)       Increase (decrease)
                                     Fiscal 2013       Fiscal 2012       due to price / mix        due to volume / mix
Clinical Care Market Sales          $     284,190     $     273,126     $               3,077     $               7,987
Patient Care Market Sales                 169,816           178,697                    (1,563 )                  (7,318 )
Sales Related Adjustments                 (12,413 )         (14,502 )                   2,100                       (11 )
   Total Net Sales                  $     441,593     $     437,321     $               3,614     $                 658

Net sales were $441,593 during fiscal 2013 and $437,321 during fiscal 2012, representing an increase of $4,272 or 1.0%. The increase in net sales was comprised of $3,614 in higher average selling prices and $658 in higher volumes. The increase in average selling prices resulted principally from net price increases of $4,838 on custom procedure trays and operating room products as well as a decrease of $2,100 in sales related adjustments. The selling price increases were partially offset by $3,759 in lower pricing on patient bedside disposable products and minor procedure kits and trays. The increase in volumes was predominantly attributable to higher domestic market penetration of our minor procedure kits and trays and custom procedure trays, partially offset by domestic market losses in operating room products, protective apparel and containment systems for medical waste.

Gross profit was $72,369 during fiscal 2013 and $64,941 during fiscal 2012, representing an increase of $7,428 or 11.4%. Gross profit as a percentage of net sales was 16.4% during fiscal 2013 and 14.8% during fiscal 2012. Our products


generated $7,428 more in gross profit compared to the prior fiscal year due to the increase in average selling prices, the mix of products sold and a decrease 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 our fiscal 2013 revenues. The primary raw material utilized in the manufacture of these products is plastic resin. In recent years, we have consistently increased the amount of resin used in production due to higher market penetration, a reduction in outsourcing and a change in the mix of products produced. During fiscal 2013, we used over 53 million pounds of resin in production. The average purchase price of the resins used in production has increased significantly since fiscal 2010; however, resin prices decreased in fiscal 2013 as compared to fiscal 2012. Our gross profit during fiscal 2013 as compared to fiscal 2012 increased by $2,999 due to lower resin prices.

During fiscal 2013, we imported approximately $64,689 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 procure from China-based vendors include plastic resin and cotton as raw materials.

The costs within the global market for cotton, while still volatile, have declined from their peak in March 2011. We do not directly purchase unfinished cotton and convert the material into finished goods; however, cotton is the primary raw material utilized by our vendors in the production of our operating room towels and laparotomy sponges. The volume of cotton included in our products is estimated to be approximately 11 million pounds per annum. Our gross profit during fiscal 2013 increased by $780 due to lower costs of products sourced from overseas vendors.

During the three months ended March 31, 2013, we identified an overstatement of inventories at our West Virginia location that arose during the five year period ended March 31, 2012. After consideration of both quantitative and qualitative factors, we determined the amounts were not material to any of those prior period financial statements or the fiscal 2013 consolidated results of operations and thus corrected the inventory balance in the year and three months ended March 31, 2013. The adjustment resulted in a reduction of inventory of $829, with a corresponding increase in cost of sales in the consolidated statement of operations for the year and three months ended March 31, 2013.

Selling, general and administrative expenses amounted to $64,277 and $59,372 in fiscal 2013 and 2012, respectively. The increase was primarily due to $3,108 in higher compensation-related expenses, $1,717 in consulting services associated with the renegotiation of our Prior Credit Agreement and $1,864 in higher GPO administration fees resulting from a change in the mix of sales and a new GPO agreement. The increases were partially offset by declines of $670 in depreciation expense and $1,114 in all other selling, general and administrative expenses.

Distribution expenses, which are essentially warehousing, storing, packing and certain shipping costs, are included in selling, general and administrative expenses and amounted to $8,321 and $7,474 in fiscal 2013 and 2012, respectively. The increase was primarily due to higher labor costs, principally medical and overtime expenses. We do not classify any expenses as distribution related in our Toano, Virginia facility added in the AVID acquisition as we utilize a third-party logistics provider for that facility's supply chain management functions. Such expenses are deemed to be freight-out and are


included in cost of sales.

The goodwill impairment charge of $77,780 recorded during fiscal 2013 represents our impairment analysis that was performed in connection with our annual assessment of goodwill. The initial goodwill impairment charge of $78,609, reported during the three and nine months ended December 31, 2012, was reduced by $829 during the fourth quarter of fiscal 2013 to properly reflect the book value of certain inventories.

Interest expense amounted to $4,767 and $4,571 in fiscal 2013 and 2012, respectively. The increase in interest expense was attributable to an increase in interest rates under our Prior Credit Agreement.

During fiscal 2012, we negotiated a $700 settlement with our insurance broker for reimbursement of inventories damaged as a result of weather-related water damage. This reimbursement was categorized as an extraordinary gain in our consolidated statement of operations.

Income tax expense (benefit) amounted to ($19,599) and $1,517 (inclusive of the applicable taxes resulting from extraordinary items) for fiscal 2013 and 2012, respectively. Income tax expense (benefit) as a percentage of income before income taxes was (26.3%) and 127.5% for fiscal 2013 and 2012, respectively. The tax benefit for fiscal 2013 was less than the federal statutory rate of 35.0% primarily due to a portion of the goodwill impairment that was not deductible for income tax purposes.

FISCAL 2012 COMPARED TO FISCAL 2011

The following table sets forth net sales by market for fiscal years 2012 and
2011:
                                                                         Increase (decrease)       Increase (decrease)
                                     Fiscal 2012       Fiscal 2011       due to price / mix        due to volume / mix
Clinical Care Market Sales          $     273,126     $     204,940     $              (5,011 )   $              73,197
Patient Care Market Sales                 178,697           168,811                      (718 )                  10,604
Sales Related Adjustments                 (14,502 )         (11,257 )                  (2,377 )                    (868 )
   Total Net Sales                  $     437,321     $     362,494     $              (8,106 )   $              82,933

Net sales were $437,321 during fiscal 2012 and $362,494 during fiscal 2011, representing an increase of $74,827 or 20.6%. Approximately $56,998 of the increase is attributable to the impact of a full year of custom procedure trays added as a result of the AVID acquisition. Our remaining products generated $17,829 in additional sales compared to fiscal 2011. The increase in net sales, excluding custom procedure trays, was comprised of $16,993 in higher volumes and $835 in higher average selling prices. The increase in volumes was predominantly attributable to higher domestic market penetration of our patient bedside products, operating room disposables and sterilization products and minor procedure kits and trays. The increase in average selling prices resulted principally from net price increases of $1,426 on operating room disposables and sterilization products. These were partially offset by $591 in lower pricing on patient bedside products and containment


systems for medical waste.
Gross profit was $64,941 during fiscal 2012 and $63,879 during fiscal 2011, representing an increase of $1,062 or 1.7%. Gross profit as a percentage of net sales was 14.8% during fiscal 2012 and 17.6% during fiscal 2011. Approximately $8,836 is attributable to the impact of a full year of custom procedure trays added as a result of the AVID acquisition. Our remaining products generated $7,774 less in gross profit compared to the prior fiscal year due to a decline in average selling prices, the mix of products sold, an increase in costs of raw materials resulting from rising global commodity prices and production inefficiencies.
Resin-related product lines which include containment systems for medical waste, patient bedside disposable products and laboratory products product lines, represented approximately 36% of our fiscal 2012 revenues. The primary raw material utilized in the manufacture of these products is plastic resin. In recent years, we have consistently increased the amount of resin used in production due to higher market penetration, a reduction in outsourcing and a change in the mix of products produced. During fiscal 2012, we used over 52 million pounds of resin in production. The average purchase price of the resins used in production has increased significantly since fiscal 2010. Our gross profit during fiscal 2012 as compared to fiscal 2011 was unfavorably impacted by $4,954 due to higher resin prices.
During fiscal 2012, we imported approximately $74,806 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 have produced in China include plastic resin and cotton as raw materials. During the latter part of fiscal 2011, we incurred significant increases in the cost of products purchased due to currency fluctuations and rising commodity costs. The costs within the global market for cotton, while still volatile, have declined from their peak in March 2011. We do not directly purchase unfinished cotton and convert the material into finished goods; however, cotton is the primary raw material utilized by our vendors in the production of our operating room towels and laparotomy sponges. Notwithstanding the decline in cotton prices, we have not seen a corresponding decline in the cost of our finished goods cotton products, which are primarily sourced from China-based vendors. The volume of cotton included in our products is estimated to be approximately 11 million pounds per annum. Our gross profit during fiscal 2012 was unfavorably impacted by $4,964 due to higher costs of products sourced from overseas vendors.
In response to the increase in material costs during fiscal 2011 we implemented price increases on certain cotton and resin based products. We have been limited in our ability to pass all raw material price increases on to our customers. Due to competitive market conditions, we passed on price increases that we believe will be sustainable. Net sales during fiscal 2012 include approximately $4,322 of price increases to our customers.
Selling, general and administrative expenses amounted to $59,372 and $51,978 in fiscal 2012 and 2011, respectively. The increase of $7,394 or 14.2% is primarily attributable to the impact of a full year of certain selling and administrative expenses added as a result of the AVID acquisition. These expenses were partially offset by declines in legal and consulting fees which were higher in fiscal 2011 due to the professional services incurred during the due diligence and integration of the AVID acquisition. A decline in bonuses which was precipitated by the failure to meet certain operational performance objectives also partially offset the increase in selling, general and administrative expenses.
Distribution expenses, which are essentially warehousing, storing, packing and certain shipping costs, are included in selling, general and administrative expenses and amounted to $7,474 and $7,276 in fiscal 2012 and 2011, respectively. The increase was primarily due to higher labor costs, principally medical and overtime expenses. We do not classify any


expenses as distribution related in our Toano, VA facility added in the AVID acquisition as we utilize a third-party logistics provider for that facility's supply chain management functions. Such expenses are deemed to be freight-out and are included in cost of sales.
Interest expense amounted to $4,571 and $2,888 in fiscal 2012 and 2011, respectively. The increase in interest expense was attributable to a net increase in average principal loan balances outstanding and an increase in interest rates under our Prior Credit Agreement.
During fiscal 2011, we incurred an extraordinary pre-tax loss of $1,455 relating to inventories damaged as a result of weather-related water damage. The inventories damaged were predominantly patient bedside disposables and did not negatively impact our service levels with respect to this product line. During fiscal 2012, we negotiated a settlement with our insurance broker for reimbursement of these damaged inventories in the amount of $700. This reimbursement has been categorized as an extraordinary gain in our consolidated statement of operations.
Income tax expense amounted to $1,517 and $3,204, inclusive of the applicable taxes resulting from the aforementioned extraordinary items for fiscal 2012 and 2011, respectively. Income tax expense as a percentage of income before income taxes was 127.5% and 42.4% for fiscal 2012 and 2011, respectively. The change in our effective tax rate in fiscal 2012 was primarily due to the recording of a valuation allowance against certain state net operating loss carry-forwards.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flows

Cash and cash equivalents changed as follows for the fiscal years ended March
31:

                                                     2013         2012         2011
Cash provided by operating activities              $  19,748     $ 4,013     $   5,174
Cash used in investing activities                  $  (1,468 )   $  (779 )   $ (66,163 )
Cash provided by (used in) financing activities    $ (23,106 )   $   459     $  57,039
Increase (decrease) in cash and cash equivalents   $  (4,826 )   $ 3,693     $  (3,950 )

Historically, our primary sources of liquidity and capital resources have included cash provided by operations and the use of available borrowing under our credit 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 fiscal 2013 was primarily comprised of net loss from operations of $54,856, a non-cash goodwill impairment charge, net of income taxes of $56,978, depreciation of $5,048, amortization of $3,942 and increases in accounts payable of $2,228 and accrued expenses of $7,510 and a decrease in inventories of $811. This was partially offset by an increase in accounts receivable of $1,785.

Cash used in investing activities during fiscal 2013 consisted primarily of $1,472 in capital expenditures. The majority of the capital expenditures related to machinery and equipment for our injection molding facility located in Gallaway, Tennessee. Our Prior Credit Agreement contained certain covenants and restrictions, which included limitations on capital expenditures. We were permitted under the terms of the Prior Credit Agreement to spend up to $4,000 on capital expenditures per annum. During fiscal 2013, 2012 and 2011, we spent $1,472, $907 and $3,642, respectively, on capital


expenditures. Our New Credit Agreement contains certain restrictive covenants but does not limit the amount of capital expenditures per annum. On an annual basis, management expects to make capital expenditures on machinery and equipment to improve efficiencies at our manufacturing facilities.

Cash used in financing activities during fiscal 2013 consisted primarily of $22,970 in net payments under the Prior Credit Agreement. During the fiscal year ended March 31, 2013, our borrowings under our term loan decreased $8,000 while borrowings under our revolving credit facility decreased $14,970.

Financial Position

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

                             March 31,      March 31,
                               2013            2012


Cash and Cash Equivalents   $       558     $    5,384
Accounts Receivable, net    $    32,615     $   30,845
Days Sales Outstanding             27.0           26.0
Inventories, net            $    53,014     $   53,825
Inventory Turnover                  6.3            6.3
Current Assets              $    92,338     $   98,183
Goodwill                    $    30,021     $  107,801
Working Capital             $    52,163     $   60,621
Current Ratio                       2.3            2.6
Total Borrowings            $    66,351     $   89,457
Stockholders' Equity        $    94,909     $  148,807
Debt to Equity Ratio               0.70           0.60

Total borrowings outstanding were $66,351 with a debt to equity ratio of 0.70 to 1.0 at March 31, 2013 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 March 31, 2013 were $558 and we had $18,826 available for borrowing under our Prior Credit Agreement. In addition, as of March 31, 2013, we were in compliance with all covenants and financial ratios under the Prior Credit Agreement. Working capital at March 31, 2013 was $52,163 compared to $60,621 at March 31, 2012 and the current ratio at March 31, 2013 was 2.3 to 1.0 compared to 2.6 to 1.0 at March 31, 2012. The decrease in working capital was primarily due to the decrease in cash and increases in accounts payable and accrued expenses.

On May 17, 2013, we entered into our New Credit Agreement. A portion of the proceeds of our New Credit Agreement was used to repay all amounts due under the Prior Credit Agreement. Upon such repayment, the Prior Credit Agreement was terminated. The New Credit Agreement provides for a maximum borrowing capacity of $65,000, consisting of the following loans; (1) a $11,505 secured term loan fully drawn by us on May 17, 2013, (2) $5,000 in unsecured delayed draw term loans and (3) up to $53,495 in secured revolving loans, which may be reduced by the amount of any outstanding delayed draw term loans drawn by us. The revolving loans are used to finance the working capital needs and general corporate purposes of our Company and our subsidiaries and for permitted acquisitions. If our Excess Availability (as defined in the New Credit Agreement) falls below a specified amount, we will be required to comply with specified financial covenants relating to; (1) a


minimum fixed charge coverage ratio of 1.00 to 1.00, measured on a month-end basis and (2) until financial statements are delivered for the month ending July 31, 2013, minimum earnings before interest, taxes, depreciation and amortization for certain month-end periods, including negative $800 for the one month period ending April 30, 2013, $700 for the two month period ending May 31, 2013 and $3,000 for the three month period ending June 30, 2013. If we draw a delayed draw term loan, we will be required to comply with a maximum leverage ratio covenant ranging from 3:00 to 1.00 to 3.25 to 1.00, measured on a month-end basis. In addition, we had committed to certain post-closing conditions, including providing monthly financial statements, annual updates of financial projections and the filing of a mortgage on our Brentwood, New York corporate . . .

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