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MDCI > SEC Filings for MDCI > Form 10-Q on 2-Aug-2013All Recent SEC Filings

Show all filings for MEDICAL ACTION INDUSTRIES INC

Form 10-Q for MEDICAL ACTION INDUSTRIES INC


2-Aug-2013

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. The forward-looking statements relate to (i) the expansion of our market share, (ii) our growth into new markets, (iii) the development of new products and product lines to appeal to the needs of our customers, (iv) the retention of our earnings for use in the operation and expansion of our business and (v) our ability to avoid information technology system failures which could disrupt our 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 our 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 our ability to effectively integrate acquired companies, our ability to maintain its gross profit margins, the ability to obtain additional financing to expand our business, our failure to successfully compete with competitors that have greater financial resources, the loss of key management personnel or the inability 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 our 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, 2013.

The forward-looking statements are based on current expectations and involve a number of known and unknown risks and uncertainties that could cause our actual results, performance and/or achievements 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 us or any other person that our objectives or plans 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. Our internal structure supports 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 61% of our products are sold through two large national distributors.

We have supply agreements with substantially every major GPO and IDN in the country including Novation, LLC ("Novation"), Premier Purchasing Partners, L.P. ("Premier") and MedAssets Supply Chain Systems, LLC ("MedAssets"). The supply agreements with GPOs and IDNs set forth the major terms and conditions, including pricing, by which their members may purchase our products, and typically have no minimum purchase requirements with terms of one to three years that can be terminated on ninety days advance notice. A majority of our acute care facility customers are members of at least one GPO. The supply agreements we have been awarded through these GPOs designate us as a sole-source or multi-source provider for substantially all of our product offerings. 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 us. Acute care facility orders purchased through our supply agreements with the three largest GPOs in the healthcare industry, Novation, Premier and MedAssets, accounted in aggregate for $56,111 or 52% of our total net sales for the three months ended June 30, 2013.

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.


Hospital utilization, economic pressure on acute care facilities and volatility in commodity prices continue to impact our revenues, average selling prices and gross profit. We have addressed these conditions by evaluating our product lines, investing in our sales and marketing teams, reducing our operating costs and differentiating ourselves in the market by emphasizing our ability to add value to our customers by improving their patient outcomes. Additionally, we have made concerted efforts to evaluate our profitability within product lines and in certain markets which may result in temporary reduction in revenues in favor of increased profit margins. 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 June 30, 2013 and 2012, we reported revenues of $107,241 and $112,237, respectively. Our net income (loss) and earnings (loss) per basic and diluted share during the three months ended June 30, 2013 and 2012 amounted to $279 or $0.02 per diluted share, and ($137) or ($0.01) per diluted share, respectively. Net income during the three months ended June 30, 2013 was partially offset by $408 in interest expense, net of applicable taxes, related to the write-off of deferred financing costs associated with the repayment of all amounts owed under the Prior Credit Agreement.

THREE MONTHS ENDED JUNE 30, 2013 COMPARED TO THREE MONTHS ENDED JUNE 30, 2012:

The following table sets forth net sales by market for the three months ended
June 30, 2013 and 2012:

                                                           Increase (decrease) due to
                            June 30,      June 30,
                              2013          2012         Price/Mix          Volume/Mix
Clinical Care Market        $  71,187     $  69,963     $       440       $           783
Patient Care Market            38,845        45,502            (736 )              (5,921 )
Sales Related Adjustments      (2,791 )      (3,229 )           773                  (336 )
Total Net Sales             $ 107,241     $ 112,237     $       477       $        (5,474 )

The increase in our clinical care market was primarily attributable to higher domestic market penetration associated with our custom procedure trays and minor procedure kits and trays product categories. This increase was partially offset by declines in our operating room products.

The decline in our patient care market was primarily attributable to lower domestic market share associated with our containment systems for medical waste, patient bedside plastics, laboratory and protective apparel product categories. A significant portion of the reduction in domestic market share was the result of our strategic decision to discard certain business that conflicted with our profitability improvement initiatives.

Gross profit was $17,721 and $16,945 during the three months ended June 30, 2013 and 2012, respectively. Gross profits as a percentage of net sales was 16.5% during the three months ended June 30, 2013 and 15.1% during the three months ended June 30, 2012. The improvement in gross profits was attributable to a decline in the cost of raw materials and products sourced from overseas vendors and a change in the mix of products sold.


Resin-related product lines which include containment systems for medical waste, patient bedside plastics and laboratory represent approximately 33% of our revenues for the three months ended June 30, 2013. 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, natural gas and other factors. Our gross profit during the three months ended June 30, 2013 as compared to the three months ended June 30, 2012 was favorably impacted by $209 due to lower resin prices.

During the three months ended June 30, 2013, we imported approximately $11,925 of finished goods and certain raw materials from overseas vendors, principally those in 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.

While we do not directly purchase unfinished cotton, it is the primary raw material utilized by our overseas vendors in the production of our operating room towels and laparotomy sponges. Our gross profit during the three months ended June 30, 2013 as compared to the three months ended June 30, 2012 was favorably impacted by $758 due to lower costs of products sourced from overseas vendors.

Selling, general and administrative expenses amounted to $15,612 and $15,944 during the three months ended June 30, 2013 and 2012, respectively. The decrease is primarily related to a $325 reduction in professional services and a $191 reduction in sales commissions, which were partially offset by an increase of $184 in all other selling, general and administrative expenses.

Distribution expenses, which are included in selling, general and administrative expenses, amounted to $2,076 and $2,140 during the three months ended June 30, 2013 and 2012, respectively. The decrease is primarily due to a reduction in labor-related costs, principally overtime expenses.

Interest expense amounted to $1,656 and $1,224 during the three months ended June 30, 2013 and 2012, respectively. The increase in interest expense of $662 was due to the write-off of deferred financing costs associated with the Prior Credit Agreement.

Income tax expense (benefit) amounted to $174 and ($86) during the three months ended June 30, 2013 and 2012, respectively. Income tax expense (benefit) as a percent of income (loss) before income taxes was 38.4% and (38.6%) during the three months ended June 30, 2013 and 2012, respectively.


Liquidity and Capital Resources

Borrowing Arrangements

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 and cancel 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 secured 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 ourselves 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) after financial statements are delivered for the month ending July 31, 2013, 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 (such financial covenant, the "EBITDA Covenant"), 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 headquarters (which took place on July 16, 2013).

As of June 30, 2013, our Excess Availability under the New Credit Agreement was approximately $10,505 and as a result, we became subject to the EBITDA Covenant. We are in compliance with the EBITDA Covenant because our (loss) earnings before interest, taxes, depreciation and amortization were: (1) ($405), for the one month period ending April 30, 2013, (2) $2,181, for the two month period ending May 31, 2013 and (3) $2,772, for the three month period ending June 30, 2013. As of June 30, 2013, we had not drawn a Delayed Draw Term Loan and were in compliance with the EBITDA Covenant and therefore we (1) were not subject to any other financial covenants under the New Credit Agreement and (2) were in compliance with all applicable covenants under the New Credit Agreement.

Borrowings under the New Credit Agreement are collateralized by substantially all of our assets and are fully guaranteed by us and our subsidiaries. The New Credit Agreement contains certain restrictive covenants, including, among others, covenants limiting our ability to incur indebtedness, grant liens, guarantee obligations, sell assets, make loans and investments, enter into merger and acquisition transactions and declare or make dividends. Please see Note 7 of our condensed consolidated financial statements for additional information regarding the New Credit Agreement.

Cash Flows

Cash and cash equivalents changed as follows during the three months ended June
30:

                                                    2013          2012
Cash provided (used in) by operating activities   $ (744 )   $  10,836
Cash used in investing activities                 $ (351 )   $    (564 )
Cash provided by (used in) financing activities   $  663     $ (14,703 )
Decrease in cash and cash equivalents             $ (432 )   $  (4,431 )

Historically, our 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 used in operating activities during the three months ended June 30, 2013 was primarily comprised of decreases in accrued expenses and other liabilities of $701 and increases in other assets of $5,240 and accounts receivable of $2,192. These were partially offset by net income from operations of $279, an increase in accounts payable of $2,588, a decrease in inventories of $2,414, amortization of $1,567 and depreciation of $1,213. Approximately $662 of the total amortization was attributable to a non-recurring write-off of deferred financing costs associated with the repayment of amounts owed under our Prior Credit Agreement.

Cash used in investing activities during the three months ended June 30, 2013 consisted of $511 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. Our New Credit Agreement contains certain restrictive covenants but do 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 provided by financing activities during the three months ended June 30, 2013 consisted primarily of $706 in net borrowings on our Credit Agreement. During the three months ended June 30, 2013, borrowings under our term loan decreased $137 while borrowings under our revolving credit facility increased $843.

Financial Position

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

                              June 30,         March 31,
                                2013             2013
                             (Unaudited)

Cash and cash equivalents   $         126     $       558
Accounts receivable, net    $      34,237     $    32,615
   Days sales outstanding            28.2            27.0
Inventories, net            $      50,249     $    53,014
   Inventory turnover                 6.7             6.3
Current assets              $      91,345     $    92,338
Goodwill                    $      30,021     $    30,021
Working capital             $      54,617     $    52,163
   Current ratio                      2.5             2.3
Total borrowings            $      67,014     $    66,351
Stockholder's equity        $      95,431     $    94,909
   Debt to equity ratio              0.70            0.70

We are 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. We believe that anticipated future cash flow from operations, coupled with our cash on hand and available funds under our New Credit Agreement will be sufficient to meet working capital requirements for the next twelve months. Although we have borrowing capacity under our New 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 downturns and adverse developments in our business.


Contractual Obligations

Certain contractual cash obligations and other commercial commitments will
impact our short and long-term liquidity. At June 30, 2013, such obligations and
commitments are as follows:

                                                          Less than 1      2 - 3        4 - 5       After 5
                                             Total           Year           Years       Years        Years
Principal payments of long-term debt       $  53,406     $       1,370     $ 3,288     $ 48,748     $      -
Capital lease obligations                     27,920             1,526       3,144        3,271       19,979
Purchase obligations                          17,040            17,040           -            -            -
Operating leases                               2,098               970       1,107           21            -
Defined benefit plan payments                    772                57         126          142          447

Total contractual obligations              $ 101,236     $      20,963     $ 7,665     $ 52,182     $ 20,426

There are approximately $602 of estimated liabilities related to unrecognized tax benefits that have been excluded from the contractual obligation table because we could not make a reasonable estimate of when those amounts would become payable.

Related Party Transactions

As part of the assets and liabilities acquired from the AVID acquisition, we assumed a capital lease obligation for the AVID facility located in Toano, Virginia. The facility, which includes a 185,000 square foot manufacturing and warehouse building and approximately 12 acres of land, is owned by Micpar Realty, LLC ("Micpar"). AVID's founder and former CEO, is a part owner of Micpar and subsequent to the acquisition of AVID, he was elected to our board of directors. As of August 2012, he no longer serves on our board of directors. As of June 30, 2013, the capital lease requires monthly payments of $127 with increases of 2% per annum. The lease contains provisions for an option to buy in January 2014 and January of 2016 and expires in March 2029. The effective rate on the capital lease obligation is 9.9%. Total lease payments required under the capital lease for the five-year period ending June 30, 2018 is $7,941. During the three months ended June 30, 2013, we recorded interest expense of $336 under the lease agreement.

The gross amount and net book value of the assets under the capital lease are as follows:

                                 June 30,       March 31,
                                   2013           2013
Capital lease, gross             $  11,409     $    11,409
Less: Accumulated amortization      (1,740 )        (1,586 )
Capital lease, net               $   9,669     $     9,823


A current member of our board of directors is currently a minority shareholder of Custom Healthcare Systems (CHS), an assembler and packager of Class 1 medical products. CHS is a supplier to our AVID facility located in Toano, Virginia for small kits and trays. They also purchase sterile instruments from our facility located in Arden, North Carolina. CHS sold approximately $437 and $436 in small kits and trays to us during the three months ended June 30, 2013 and 2012, respectively and purchased approximately $213 and $263 of sterile instruments from us during the three months ended June 30, 2013 and 2012, respectively. As of June 30, 2013 and March 31, 2013, $237 and $265, respectively, was due to us from CHS. As of June 30, 2013 and March 31, 2013, $34 and $45, respectively, was due to CHS from us.

Off-Balance Sheet Arrangements

We do not maintain any off-balance sheet arrangements, transactions, obligations or other relationships with unconsolidated entities that would be expected to have a material current or future effect upon our financial condition or results of operations.

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