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Symmetry Medical, Inc. (NYSE:SMA)

Q1 2013 Earnings Call

May 2, 2013 8:00 am ET

Executives

Carol Ruth – IR, The Ruth Group

Tom Sullivan - President & CEO

Fred Hite - SVP & CFO

Analysts

Matt Miksic - Piper Jaffray

Kayla Crum - William Blair

James Terwilliger - Benchmark

Jim Sidoti - Sidoti & Company

Operator

Good morning and welcome to the Q1, 2013 Symmetry Medical Incorporated Earnings Conference Call. My name is John and I will be your operator on today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded.

I will now turn the call over to Carol Ruth. You may begin. Carol Ruth.

Carol Ruth

Thank you, operator. Joining us on the call today are Tom Sullivan, President and Chief Executive Officer, and Fred Hite, Senior Vice President and Chief Financial Officer.

Statements in this conference call regarding Symmetry Medical’s business which are not historical facts may be forward-looking statements that involve risks and uncertainties within the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are predictive in nature and are frequently identified by the use of terms such as “may,” “will,” “should,” “expect,” “believe,” “anticipate,” “plan,” “estimate,” “intend,” and similar words indicating possible future expectations, events or actions.

Such predictive statements are not guarantees of future performance and actual results and outcomes could differ materially from our current expectations. Factors that could cause or contribute to such differences include, but are not limited to, the loss of one or more customers, the development of new products or product innovation by our competitors, product liability, changes in management, changes in conditions affecting the economy, orthopedic device manufacturers, or the medical device industry in general and changes in government regulation of medical devices and third party reimbursement practices.

We refer you to the risks in the forward-looking statements section of the company’s most recent annual report on Form 10-K, filed with the Securities and Exchange Commission, as well as the company’s other filings with the SEC, which are available on the SEC’s website at www.sec.gov.

Before turning the call over to Tom Sullivan, President and Chief Executive Officer, I'd like to emphasize Symmetry Medical’s policy of not commenting or discussing individual customers or programs. Tom?

Tom Sullivan

Thank you, Carol, and thank you everyone for joining us today for Symmetry Medical’s first quarter 2013 conference call. I will begin today’s call with a quick review of the financial highlights for the first quarter and then provide an operational update.

Total revenue for the first quarter was $98.9 million, down 2% year-over-year and 7% sequentially. Reported revenue in our OEM Solutions business was up 4% year-over-year reflecting the stable orthopedic procedural growth reported by our customers and some initial benefit from increased capital spending on instruments and cases to support new product launches. Sequentially reported sales were down 2%.

In our Symmetry Surgical segment sales decreased 17% year-over-year as a result of transition-related sales disruptions with certain U.S. customers and international distributors related to the integration of the Codman surgical instruments business into Symmetry Surgical.

On a sequential basis, Symmetry Surgical sales were down 22% or 13% excluding a one-time purchase in the fourth quarter 2012. Excluding the impact of a Symmetry Surgical customer who transitioned to Symmetry Medical OEM Solutions in 2013, OEM Solutions revenue was up 2% year-over-year and down 4% sequentially. Symmetry Surgical sales were up 13% year-over-year and 6% sequentially.

Gross margin in the first quarter 2013 was 25.4% up from 25.0% in the first quarter of last year. The year-over-year increase was driven by our continued focus on improving operational efficiency in the OEM Solutions segment partially offset by lower percentage of revenue from our higher margin Symmetry Surgical segment and higher than expected short-term cost associated with growth opportunities in the OEM Solutions segment. On a sequential basis gross margin declined by 1.7 percentage points due to decline in Symmetry Surgical sales in the aforementioned cost.

Our as adjusted EPS was $0.06 down from $0.09 in the same period last year in addition to revenue weakness the medical device excise tax and higher than expected SG&A costs weakened EPS. Cash flow from operations for the quarter was $11.4 million and our leverage ratio ended at 3.3 times.

Despite the greater than expected weakness in the Symmetry Surgical segment, we remain confident in the long-term outlook for our direct to hospital business. We have already implemented corrective actions in the United States that have yielded promising initial results and believe our international business will move forward as our distributor partners become more established with our product lines. We expect to gradually reinvigorate this business over the course of the year.

In our OEM Solutions segment with a solid first quarter and are well positioned to benefit from new product launch activity, potential improvements in orthopedic procedure growth rate and our proactive initiatives to improve our operating efficiency. Accordingly, we are reiterating our full year 2013 revenue and EPS guidance.

I would now like to provide some additional details on the OEM Solutions and Symmetry Surgical segments beginning with OEM Solutions.

Reported sales in our OEM Solutions business were up 4% year-over-year reflecting solid results in implants, instruments and cases partially offset by a slight decrease in aerospace sales. On a sequential basis, implants and instruments were down 2% and 6% respectively following a strong fourth quarter in these categories. Cases were up 18% driven primarily by new product launch related volume. Aerospace was down 21% sequentially from a particularly strong fourth quarter 2012 results.

In March, we attended the American Academy of Orthopedic Surgeons Annual Meeting in Chicago. This meeting gave us an excellent opportunity to meet with customers and get a feel for the state of the industry. The general tone at the meeting included a stable outlook for hip and knee procedures in 2013, which has been confirmed by the first quarter results reported by our OEM customers. While this is consistent with our guidance, we believe many smaller customers remain in a wait and see mode before investing in discretionary capital spending.

In addition, many AAOS attendees were interesting in learning more about the knee platforms launched by two of our larger customers. As we indicated on our year-end call, it is our expectation that while these launches will include significant investments in instruments and cases, these investments will be spread out over several years to support a more gradual and measured rollout as compared to previous large joint launches. We believe that individual customers have confirmed this rollout strategy in their public communications and we are still early in the launch for both products.

Accordingly, it is still difficult to predict the timing of the volume, the insource outsource decisions of our customers and the share opportunity we may win. However, as we have previously confirmed, Symmetry is participating in both launches with both instrument and case component. While I cannot detail our involvement in these programs, we remain comfortable with our guidance, which includes an incremental $3 million to $15 million for new product launches in 2013 as compared to prior year launch volumes.

The double AAOS meeting also gave us an opportunity to showcase the innovative instrument and case technology that we have developed. We are encouraged by the markets receptivity to recently launched products including our direct anterior approach instruments, Cup Impactors, Reamer Drivers, [HipArth] arthroscopy hand instrument and QUAD-LOCK cases. Not only do these instruments and cases represent advances in functionality they also accelerate OEM customer speed to market in areas, where they may not be make an internal R&D investment. These total solutions approaches to their need continue to be a Symmetry Medical competitive advantage.

We are encouraged by an uptick in the number of supplier consolidation packages that have the potential to materialize in 2013. As previously discussed, we believe Symmetry is strategically positioned to benefit from supplier consolidation by our OEM customers based on our leadership position in the industry and sophisticated quality and regulatory systems. Over the long-term, we believe our OEM customers will consolidate their supplier base and several of them have made this a stated goal. We may also be seeing the initial effects of the recent requirement from all that all contract manufacturers register with the FDA, which may accelerate consolidation as smaller suppliers do not register.

During the quarter, we continued to focus on improving our operational efficiency, which is primarily driven by implementation of the Symmetry business system. This includes deployment of our companywide ERP platform, automated quality and regulatory assurance systems, lean manufacturing, best practices and management protocols designed to advance overall operational efficiency.

We continue to benefit from the 2012 implementation of WinSPC real-time statistical process control software across our CNC machining centers. More than 100 WinSPC workstations are installed our global facilities enabling us to collect real-time manufacturing data so that we can ensure our manufacturing reliability and quality and improve material and operator efficiency. The WinSPC program is complemented by our Enterprise Quality Management Software which provides our global manufacturing infrastructure with a single quality system.

During the first quarter, we completed the migration of our U.S. implant facilities into our Unified ERP Platform without disruption further enhancing our information flow and planning capabilities. Our next goal is to complete the migration of our U.S. case facilities which will bring all of our U.S. manufacturing onto the same Unified ERP Platform in the third quarter of this year.

As a result of this progress first quarter OEM Solutions’ gross margin improves several hundred basis points versus year ago despite downward pressure associated with short-term cost we incurred to capitalize on growth opportunities. While sequentially we were somewhat weaker because of these same costs, we believe there is additional upside potential as we strive towards an aspirational goal of volume neutral 100 basis points to 200 basis points improvement in OEM Solutions gross margin this year. This is in addition to potential gross margin benefit from increased revenue which could be driven by customer new product launches or increased procedural volumes, both of which drive increased capital spending on instruments and cases.

Turning to Symmetry Surgical, we had a difficult and disappointing first quarter with sales coming in below our expectation. This was the result of transition-related sales disruptions with certain U.S. customers and international distributors related to the integration of the Codman Surgical Instruments business into Symmetry Surgical.

In Symmetry Surgical adjusted for the customer now purchasing direct from OEM Solutions segment domestic sales of $19.4 million were up 9% versus a year ago and 2% sequentially. International sales were $2.6 million and up 35% versus year ago and 29% sequentially.

More specifically, in the U.S. despite our successful ERP migration from Johnson & Johnson late last year, we had struggled with some customers who inadvertently continued to attempt to purchase our products from the previous owner. With thousands of products in customers and multiple origin order points within customers the magnitude of the customer behavioral change has proven to be greater than we expected, especially those customers who still rely on facsimile or telephone to place orders.

This has led to missed opportunities, unfilled orders which may have been lost the competition or delayed orders which have distracted our sales force from the regular focus on market share growth and execution. Once we identified these issues we immediately implement corrective action to help our customers update their purchasing protocols and reengage them with Symmetry Surgical.

Although our Transition Services Agreement with Johnson & Johnson has ended in the U.S. we continue to collaborate with them as well as other service providers such as the Global Healthcare Exchange. We are pleased with the initial progress of these efforts and believe that we are on track to gradually reinvigorate the Symmetry Surgical business.

That said, the process will require attention additional attention from our sales force and will impact our ability to meet with other customers and potential new customers. This combined with a strong first nine months we experienced in 2012 we’re operating under a TSA with Johnson & Johnson will put pressure on year-on-year growth through Q3.

On a positive note, we have seen good initial results from the Symmetry Surgical ERP consolidation that we complete in 2013. This is the first quarter with the entire business on the same order to cash system and we achieved measurable improvements in the internal execution.

In addition, we completed the harmonization of the Symmetry Surgical sales force on April 1st. With these two actions our full sales team is now selling the entire Symmetry Surgical product line giving us the opportunity to cross-sell the former SSI product line into former Codman surgical instrument customers and vice versa.

With sales force harmonization now completed we have larger revenue territories yet smaller geographic footprints that will enable our sales force to get closer to customers on a more frequent basis. We believe that our customer engagement at the recent double AORN meeting, the strength of our sales force and our customer’s reaction to our focus on innovation are encouraging signs for the future.

Turning to Symmetry Surgical International, sales to our distributors were significantly lower than expected as they worked to transfer regulatory authorization, establish awareness with their hospital customers and ramp up country-specific marketing and sales activities. While the year-on-year percentage reduction is significant and concerning we recognized a significant change our international business has experienced in the past six months. Specifically we operated under the transition of services agreement with Johnson & Johnson throughout 2012 with only eight countries migrating to our distributors in the first nine months. That means there's very little disruption during this period.

In the past two quarters, we have heavily migrated countries from Johnson & Johnson as and today have a network of 59 distributors serving 120 countries. These initial conversions and start up inventories can mask performance in the short term as we have not yet experienced the weakness we saw this quarter. However, we are now focused on enabling them to drive growth across the total scope of our portfolio. We do not expect our international business to grow during 2013 but we continue to believe it is a critical component of our strategy and we continue to invest for the future and expected to convert the remaining nine countries operating under a transition services agreement by year-end including counties such as Vietnam, Peru and Indonesia.

Before I turn the call over to Fred, I also want to provide an update on the recent FDA inspection at our Louisville, Kentucky facility where we manufacture Olsen instruments for Symmetry Surgical. We had a nine-day inspection by the FDA from April 3rd to April 17th as a follow up to an FDA inspection in 2010 prior to our acquisition of Olsen Medical in 2011.

We greatly appreciated the inspector’s time and efforts to help us improve. While we were pleased that we had successfully cleared down all items from the previous inspection of the site during our integration process, we did receive a Form 483 with six observations; all observations were local, plant specific procedural related and we have already implemented corrective action. We are following with FDA and expect to be able to formally clear down these observations in the next 60 to 90 days as part of their regular response period. We do not envision any impact to the business and consider our performance to be another indication of the strength of the overall focus on and commitment to quality at Symmetry Medical.

With that, I would now like to turn the call over to my colleague our Chief Financial Officer, Fred Hite, for his financial review. Fred?

Fred Hite

Thanks Tom. Total revenue for the first quarter 2013 was $98.9 million compared to a $100.7 million in the same period 2012. Foreign currency exchange rates had a negative impact of approximately $100,000 on the year-over-year revenue comparison. The year-over-year revenue decrease was driven by lower sales in the company's Symmetry Surgical segment which came in at $22.2 million in the first quarter of 2013 compared to $26.7 million in the first quarter 2012. This was partially offset by 3.6% growth in the company’s OEM Solutions segment which came in at $76.7 million in the first quarter 2013 compared to $74.0 million in the first quarter of 2012.

On a sequential basis total revenue was down 7.2% compared to the fourth quarter of 2012 with OEM Solutions revenue down 1.8% and Symmetry Surgical revenue down 22.1% compared to the fourth quarter 2012. The sequential decline includes approximately $300,000 of unfavorable foreign exchange.

Excluding the transition of our customers' direct purchases from Symmetry Medical’s OEM Solutions in 2013, the OEM Solutions revenue was up 1.7% year-over-year and down 4.3% sequentially. And Symmetry Surgical sales were up 12.4% year-over-year and 5.9% sequentially.

First quarter 2013 revenue in the OEM Solutions segment by category was as follows. Instrument revenue was $28.2 million compared to $27.0 million in the same period last year, up 4.2%. Higher instrument revenue in the first quarter 2013 was driven by stable capital purchases and increased customer product launch relates to demand compared to the prior period. Instrument revenue was down 6% compared to the strong fourth quarter 2012.

Implant revenue was $26.0 million compared to $24.8 million in the same period last year up 4.7%. The year-over-year increase was driven by improved procedural growth and implant revenue was down 1.9% compared to a strong fourth quarter 2012.

Case revenue was $16.4 million compared to $15.9 million in the same period last year, up 3.4%. The year-over-year increase in case revenue was driven by stable customer demand in the orthopedic market and by new product launch related volume. Case revenue was up 18% compared to the fourth quarter 2012 driven by new product launches related to two new launches of our customers.

Other revenue was $6.1 million down 3.2% as compared to $6.3 million in the same period last year and down 20.8% compared to a very strong fourth quarter 2012.

Symmetry Surgical revenue was $22.2 million down 16.9% compared to $26.7 million in the same period last year. On a sequential basis, Symmetry Surgical revenue was down 22.1% compared to $28.5 million from the fourth quarter 2012. The year-over-year and sequential decreases were primarily due to the transition-related sales disruptions with certain U.S. customers and transitions to distributorships and the rest of the world related to the integration of the Codman surgical instrument business into Symmetry Surgical. As Tom discussed, these disruption impacted both the U.S. and international sales during the quarter.

Our largest customer accounted for 34% of our first quarter 2013 revenue and our largest customer accounted for 30% of our first quarter 2002 revenue.

Gross margin for the first quarter 2013 and our first quarter 2012 was $25.1 million. Gross margin percentage for the first quarter 2013 was 25.4% compared to 25.0% in the first quarter 2012. The increase in gross margin despite the decrease in revenue from our higher margin Symmetry Surgical segment was a result of improvements to be OEM Solutions gross margin due to increased leverage of overhead costs on slightly higher sales volume, improvements in scrap and consumables, and efficiencies resulting from the Symmetry Business System. This was partially offset by higher than expected short-term costs associated with growth opportunities in the OEM Solutions segment.

SG&A expenses in the first quarter 2013 were $20.0 million compared to $17.8 million in the same period last year. The increase in SG&A expenses in the first quarter 2013 was primarily due to the increase in infrastructure cost in the Symmetry Surgical segment and some higher cost in other lines in the SG&A. The first quarter 2013 also included a $600,000 increase in healthcare cost, $300,000 for the medical device excise tax, and a $500,000 increase in acquisition related expenses. This is partially offset by a $200,000 reduction in the amortization expenses.

Operating income for the first quarter 2013 was $3.9 million compared to $6.1 million in the same period last year. Operating margin for the first quarter 2013 was 3.9% compared to 6.0% in the same period last year. Excluding the amortization and intangible assets amortization of debt issuance cost, stock-compensation expense, management transition cost, acquisition related cost, SEC related legal cost, facility closure severance cost, operating income for the first quarter 2013 was $7.4 million, a decrease of 26.1% compared to $10.0 million in the same period last year.

Income tax benefit for the first quarter 2013 was $0.3 million compared to income tax expense of $0.5 million in the year ago period. This was driven by a decrease in pre-tax income as well as the January 2013 reinstatement of the Federal R&D tax credit which is in effect retrospectively for all of 2012.

Net loss for the first quarter of 2013 was $300,000 or $0.01 per share compared to a net income of $800,000 or $0.02 per diluted share in the same period last year. On an as adjusted basis net income for the first quarter of 2013 was $2.3 million or $0.06 per diluted share compared to $0.09 per diluted share last year and $0.17 in the fourth quarter of 2012.

I like to refer you to our press release issued this morning for a reconciliation of the GAAP to as adjusted amounts.

Earnings per share for the first quarter of 2013 reflect a weighted average of 36,275,347 diluted shares outstanding compared to a weighted average of 36,238,010 shares outstanding in the year ago period.

Now turning to our balance sheet, cash at the end of the first quarter 2013 was $14.9 million, up from $9.8 million at the end of 2012. During the first quarter of 2013, we generated $11.4 million of cash from operation and we used $3.3 million for capital expenditures; another quarter of strong positive cash flow.

As of March 31, 2013 our total net debt was $211.7 million and our debt ratio was approximately 3.3 times our LTM EBITDA equal to the debt ratio at the end of 2012 and down from 4.3 at the end of the first quarter of 2012. As Tom mentioned, we remain committed to leveraging the strong cash flow from our business along with utilizing Lean tools to reduce the inventory days on hand, pay down debt and lower our leverage ratio.

Now, turning to our guidance. For the full year of 2013 despite the temporary customer disruption in our Symmetry Surgical segment in the first quarter we are reiterating our full year guidance. We anticipate revenue to be in the range of $420 million to $440 million, and this represents stronger than previously expected OEM Solutions revenue offsetting softer than previously expected Symmetry Surgical [revenue] that’s approximately 7% growth for total Symmetry Surgical.

As a reminder, our 2013 revenue numbers include approximately $5 million of sales which we recorded in Symmetry Surgical which will be recorded in the OEM Solutions for 2013 and forward as we transition an OEM customer between the two segments.

Our full year GAAP and as adjusted diluted earnings per share guidance is expected to be as follows. We anticipate full year 2013 GAAP EPS to be in the range of $0.35 to $0.47, and the full year as adjusted EPS to be in the range of $0.64 to $0.76. The GAAP and as adjusted EPS both include anticipated impact of the medical device tax which we expect to decrease our 2013 net income by approximately $0.03 per share and we anticipate recording approximately $1.5 million of annual expense for this medical device exercise tax in the SG&A line on the P&L starting in the first quarter of 2013.

Excluding the impact of the medical device exercise tax, our as adjusted EPS is expected to grow between 18% and 39% on a projected revenue growth of between 2% and 7%. The as adjusted EPS guidance excludes all amortization expense, a non-cash item of approximately $0.16, restricted stock, a non-cash item of approximately $0.08, and acquisition-related cost, severance cost and other expense of approximately $0.05. Together these items are expected to negatively impact full year 2013 GAAP EPS by approximately $0.29. We also continue to expect to generate approximately $60 million of cash from operations and spend approximately $12 million on capital expenditures.

I will now turn the call back over to Tom.

Tom Sullivan

Thank you, Fred. In closing, in the first quarter we continue to make progress in our OEM Solutions segment and had a setback with Symmetry Surgical. We remain confident in the long-term outlook for both segments of our business and we remain proactive in our efforts to improve the OEM Solutions operating efficiency and drive growth in Symmetry Surgical.

The key areas of focus for the remainder of the year are: one, position Symmetry Medical OEM Solutions to gain market share and benefit from supplier rationalization, increased outsourcing, new product launches and of course any potential increase in patient volume. Two, improving OEM Solutions gross margin through the Symmetry Business System and other internal initiatives such as our ERP consolidation. Three, reinvigorating growth in the Symmetry Surgical segment including leveraging the harmonized U.S. sales force to capitalize on cross-selling opportunities. And four, enhancing cash flow generation and profitability to lower our debt and position us to retire our high interest debt by year-end.

If we accomplished these goals we will believe that will translate into sustainable long-term revenue growth and market share gains, a more diversified innovation driven company with improved profitability, strong cash flow and reduce leverage and ultimately enhance shareholder value.

We’d now like to turn the call over to our operator and then open it up for your questions. John?

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) And our first question is from Matt Miksic from Piper Jaffray. Please go ahead.

Matt Miksic - Piper Jaffray

That's it, thank you. Can you hear me okay?

Tom Sullivan

Sure can, good morning.

Matt Miksic - Piper Jaffray

Okay, good morning, sorry for some of the background noise here, but a follow-up on some of the comments you made on Symmetry Surgical. I guess was there something that you can quantify in the fourth quarter and just maybe you’re in the first quarter and looking forward in terms of sort of the stocking effect if there was one in the transition? That's the first question I have and a couple of quick follow-ups.

Tom Sullivan

Not too specifically, Matt. I think there is two different issues. The U.S. issue is associated with how customers have ordered this product for the last 40 years and our efforts to change them. We send out over 30,000 customer notifications over multiple iterations, we made over 5,000 outbound phone calls but there is always a fax machine somewhere a part of a hospital that we might not have gotten to. So we've seen an opportunity for orders to not get to us. So that's the disruption. We have a pretty good sense of where it’s occurred and we’ve taken corrective action, but it clearly had an impact. We don’t want to be anymore specific than that because it basically gives competition a roadmap of where to go.

Outside the U.S., the stocking orders that really didn’t have an impact on the revenue line per se as much as it did it just confused where were things working and where were they not working and what are the issues in each country. And as I said earlier, there is over a 100 countries that we've changed, different regulatory authorizations in each country, each of those distributors are establishing relationship with their customers and on a micro level experiencing somewhat what we saw in the U.S. So, we believe we've identified these issues, we believe we’ve taken corrective action. We’re a little further along in the U.S. and that's understandable given that we have more data in the U.S. but we believe that we started a change back from that on a sequential basis.

Matt Miksic - Piper Jaffray

Okay, all right, that's helpful and I understand that you are not wanting to go into great detail on the U.S. I guess the stocking question was more directed towards OUS. Just on what you mentioned about some of these orders just not coming in, does that -- again not get too specific but does that suggest that there were orders that needed to come in in the first quarter didn’t get to you and maybe didn’t get to you until the second quarter in terms of sort of replenishing supplies in the U.S.?

And then the OUS side, again not to push too hard but given what happened in the first quarter and the fact that there are some transitional elements underway there maybe give us a sense of what, where does your confidence come that we’re not going to see sort of more disruption potentially over the next couple of quarters?

Tom Sullivan

Sure. Regarding the first part of your question, no I don’t think it's a shift in volume from Q1 to Q2. Again these orders -- an average in this business handful of lines of $1,000 but they add up quickly. So, it's the question of the customer placing an order for something and not being fulfilled then we -- it might get to us, it might get to competition, it might be something that we still haven’t gotten to yet. So, there is all of the above but it's not a question of us shifting volume from Q1 to Q2 as it relates to the U.S.

Outside the U.S., as I mentioned earlier in the call, we had eight countries that we've converted in the first nine months of the year, and then we had obviously significantly more in the last six months. In those first eight countries whereas we had some greater stability and we have the regulatory authorizations enabling us to sell the full portfolio of our product, we are seeing much better results than we are seeing in the countries that have just gone over. So, we’re encouraged at the value proposition our consolidated portfolio brings to these distributors and we’re encouraged with their reception of the opportunity to drive Symm Surg sales. So for us it's going to be about working more closely with those distributors.

We have a fully deployed regional support network in Asia, Europe and in Latin America that does work with them; we’re doing training in countries throughout the world. So, we believe it's a longer term time-out than it is in the U.S., but it's still a vital area of growth for us and one that we’re going to invest in till we invigorate that particular channel.

Matt Miksic - Piper Jaffray

Okay, and then if I could just one quick one on the OEM side. Your guidance sort of assumes slightly better performance in the year out of OEM and slightly softer performance on the surgical side. Can you sort of talk about examples of where the confidence comes there in terms of where you were say a few months ago when you laid out guidance for the year?

Tom Sullivan

I think the confidence level comes from a couple of things. One is we were worried that the first quarter might have slower than it was. So, our guidance was that 2% or 3% growth for the full year, little bit less than the demographic growth. We think the first quarter we see the same data that you folks see is a little bit softer than the fourth quarter was, but we think that there is a general tone at AAOS continues to be positive and is right now the risk of a downside disruption from a procedural volume or a customer reactions of that seems to be less. So that gives us a little bit of confidence although we do believe there is a degree of latency out there from some of the smaller customers.

Also, we had the customers -- the two large customers officially launched their large new knee initiatives at AAOS. So, it’s great to see those are getting marketing receptivity and them starting to deploy product into that marketplace. So, it’s just a question of there is a little bit more clarity on some of the things that we had incorporated into our guidance, and at this juncture it really becomes the question of procedural growth in the balance of the year and then what happens specifically on those launches. So, from a volume standpoint from an insource and an outsource standpoint and then from our ability to win a share of what is chosen to be outsourcing.

Operator

Our next question is from Matt O'Brien from William Blair.

Kayla Crum - William Blair

Hi guys, this is Kayla in for Matt. Thanks for taking our question.

Tom Sullivan

Hi Kayla, good to hear from you.

Kayla Crum - William Blair

Thank you. Good to hear, good to speak with you. In light of the relatively soft Symmetry Surgical results, should we be expecting somewhere around the low end of your previously issued guidance range? And if not, can you give us an idea of how we can get to that $0.70 at the midpoint of your range?

Tom Sullivan

We’re not giving any guidance, Kayla, beyond the reiteration of the guidance that Fred had described. Clearly, there is a shift in volume between Symm Surg and Symmetry Medical OEM Solutions, but we’re not being anymore specific than what Fred has already given in the script.

Kayla Crum - William Blair

Okay.

Fred Hite

Yeah, the one thing I would say that that would help us a little bit in 2013 as the R&D tax credit. So, we got the full benefit of the 2012 R&D tax credit now showing up in 2013 that was probably $200,000. That will show up in 2013 as well as all of 2013 R&D tax credit as well.

Kayla Crum - William Blair

Okay, perfect. And then assuming the higher mix of OEM Solutions revenue, how should we think about gross margin going forward? I know that there is some improvements that we’ve been seeing there but as compared to your previously issued guidance that would assume a higher mix of the Symm Surg results, how should we think about gross margin going forward?

Tom Sullivan

Yeah good, great question. And clearly with a lower mix of the higher margin Symm Surg business it will put downward pressure on gross margin. What we do believe is that gross margin will improve sequentially each quarter throughout the year from where we are in Q1.

Operator

(Operator Instructions). And we have a question from James Terwilliger from Benchmark.

James Terwilliger - Benchmark

Hey Tom, can you hear me?

Tom Sullivan

Yes, we can, James. Good morning, sir.

James Terwilliger - Benchmark

Good morning. Thank you for taking my questions I’ve got two real quick questions and they may have been discussed previously. You had a nice turnaround in your cases business. Do you have any comments in terms of that business is kind of struggled we’ve talked about may be loss of market share and that actually was a strong point this quarter, do you have any additional comments on what the turnaround in the cases business of what was driving that?

Tom Sullivan

I appreciate you’re recognizing that and certainly we were very pleased with the 18% sequential growth and do see a restoration of year-on-year growth in that business. We do believe that the quote activity has picked up in that business and customers that may have not given us an opportunity in 2010 and the first half of 2011 when our performance wasn’t meeting our expectations we believe they are turning back to our Symmetry Medical Case business. The volume in 2013 in the first quarter so far is impacted by large new product launches that are out there and additional our efforts to win back some business, but I wouldn’t call a market share shift of business that we might not have benefited from over the last couple of years as much as I’d say it’s the impact of product launches.

James Terwilliger - Benchmark

Okay, excellent. And then just real quickly and you may have said this before, with the transitional issues in Symmetry Surgical, how should we look for the revenue growth year-over-year for that business? Is that going to be a mid to high single-digit type of revenue growth range?

Tom Sullivan

I don’t think at this juncture, James, I think that the growth in Symm Surg will be flat year-on-year and we don’t envision growth to be really reinvigorated until the back half of late third and fourth quarter. But right now, certainly it would a original guidance that we gave reflecting growth faster than market, we don’t believe it will be realized in that business because of the issues that we’ve identified.

Operator

Our next question is from Jim Sidoti from Sidoti & Company.

Jim Sidoti - Sidoti & Company

Good morning. Can you hear me?

Tom Sullivan

Yes, we can, Jim. Good morning.

Jim Sidoti - Sidoti & Company

Great. Still couple more on Codman; I just wanted to go through one more time. If you look at your historical surgical business, did you have the similar kind of declines in that or was it primarily in the Codman business?

Tom Sullivan

The historical business did not experience the same effects.

Jim Sidoti - Sidoti & Company

Okay. So, it was primarily this change in distribution, in the U.S. --

Tom Sullivan

Yeah. Sorry, James, it was the two different things, in the U.S. it was the transition related and customer purchasing habits.

Jim Sidoti - Sidoti & Company

Right.

Tom Sullivan

In OUS, it was associated with the change to the distributors and regulatory authorizations and local market issues.

Jim Sidoti - Sidoti & Company

So, in the U.S. sales are now through your direct sales people, correct?

Tom Sullivan

Yeah, they always were through Symmetry Surgical sales force which included some of our former reps, some of our acquired reps, and then select distributors in certain markets. But what we had in each of those distinct sales forces were only selling products in that particular bag and they were placing orders in different ERP system. We’ve now harmonize that the entire sales force across the U.S. Every rep carries every product in our line and we’ve also implemented the consolidated ERP that now our customer can place some order for any one of our products across the breadth of your line and get one order one invoice, one shipment in the like. So really we are now, as of April 1st, positioned to truly cross-sell and drive growth.

Jim Sidoti - Sidoti & Company

Okay. I guess what I'm confused about is if we went back a year ago and a customer wanted to order what has changed? Didn't he have to call the same people a year ago that is calling now or have the – has the – how has that process changed?

Tom Sullivan

That’s great, Jim, I appreciate you asking me to clarify that. Up through September of last year customers that were buying the products formally sold by Codman would call Johnson & Johnson to place an order, as they had done for the last 40 years. We converted that business over to ours in the third quarter, so they called then Symmetry Surgical in the third quarter but it was a different call center a different ERP system than our Symmetry Surgical customers were calling still. We converted this historical Symmetry Surgical customers in the first quarter of this year to the same system the same customer service rep so now we can take orders across the breadth of the business. And what we are seeing is customers because they had placed orders the same way for 40 years and they had fax machines that were coded to send orders to that location throughout their ORs customer breaking those habits have proven to be more difficult than we had expected.

Jim Sidoti - Sidoti & Company

Okay. So if a customer does call the old Johnson & Johnson call center, what happens?

Tom Sullivan

We had a Transition Services Agreement with Johnson & Johnson for a couple of months after they go live where they would transfer those customers to us, that agreement had expired, which is one of the things that created our weakness here. We are collectively working with Johnson & Johnson and with other service providers such as the Global Healthcare Exchange to ensure that the customers' demand is met. But in the interim period before we identify that there were still orders going there those orders would never have reached us.

Jim Sidoti - Sidoti & Company

Okay, all right. And you think it will take another three to may be five or six months to kind of get that straightened out and get those orders back to your call centers?

Tom Sullivan

Yeah, the most important thing for us is the customer behavior going forward getting them to come to us as opposed to turning to competition. We’re encouraged that the sequential -- in the U.S. the sequential erosion was only 2% in the first quarter versus the fourth quarter, and although its’ down 9% year-on-year we’re pleased to see that the erosion has abated and we’re looking to restoring that to growth as we reinvigorate this customer behaviors and buying directly from us.

Jim Sidoti - Sidoti & Company

Okay, all right, I understand that. Now outside the U.S. you said there were I think 59 distributors in the past six months or so that have changed?

Tom Sullivan

We've changed eight in the first nine months of the year and we’re now at 59 distributors in a 120 countries. So, 51 have converted into fourth quarter and the first quarter this year.

Jim Sidoti - Sidoti & Company

So these 51 distributors now are Symmetry distributors and no longer Johnson & Johnson distributors?

Tom Sullivan

That is correct. They buy directly from us and they sell directly in the market. Up until we converted those countries Johnson & Johnson was our distributor and in most of those markets Johnson & Johnson sold the product directly. So, we've gone from a J&J direct sales force to a distributor sales force with our conversion.

Jim Sidoti - Sidoti & Company

Now, I guess I would have expected may be first the other way because I would have thought these 51 distributors had to build up some inventory. I guess that wasn’t the case?

Tom Sullivan

We had inventory in regional and local markets that we acquired from Johnson & Johnson with the acquisition and that inventory was already on our books and just transferred to the new distributors.

Jim Sidoti - Sidoti & Company

Oh I see.

Tom Sullivan

So there was a degree of a sale to a distributor but the return from our Johnson & Johnson distributor.

Jim Sidoti - Sidoti & Company

So I guess how long do you expect it to take to get these distributor up to the level that Johnson & Johnson was performing then?

Tom Sullivan

I think it’s a longer climb up than the U.S. We're probably three to six months behind the U.S. My expectation is that we’d like to see them performing in the back half of the year similar to what we saw the eight that we’ve converted earlier. Part of the issue is not just execution but it’s also the regulatory authorizations that are required to sell the products. We identified through the transition and in a lot of these countries the products were on mixed licenses with other Codman products that we did not acquire. So, we have country-by-country issues that we’re working to resolve, but where we had seen those issues get resolved we’re encouraged by with the distributors who are doing in those marketplaces.

Jim Sidoti - Sidoti & Company

All right. And would you characterize the shortfall outside the U.S. is greater than shortfall in the U.S. or was it more a U.S. titled?

Tom Sullivan

It’s I would say as a percentage basis outside the U.S. is significantly greater. It’s 30% sequentially and 35% year-over-year. As a dollar volume it's a little bit smaller than the U.S. impact just because the U.S. business is so much larger.

Jim Sidoti - Sidoti & Company

Okay, all right, and then last question on the OEMs, historically a pickup in cases has been precursor to a pickup in instruments and implants over the next couple of quarters. Do you see any reason why that won’t be true this time?

Tom Sullivan

The pickup that we saw in cases was correlated highly to the product launches that everybody is aware of in the industry and our involvement in those. We are involved in both instruments and cases on both the large new launches that are occurring. Our involvement in cases is larger than our involvement in instruments. So, I don’t know if I would extrapolate that directly to our revenue line.

Operator

(Operator Instructions). And Tom, I have no further questions at this time.

Tom Sullivan

Great, thank you, John. And I’d like to extend my thanks to everyone for your great questions today and for the dialog. Appreciate your investing time to learn about our first quarter results. As I had said throughout the call, we’re excited about what we saw on our OEM Solutions business and we’re clearly disappointed with Symmetry Surgical although we do feel though we have actions in place to correct that situation and we look forward to achieving the guidance that we’ve communicated this year and updating you on our progress throughout the year.

With that, thank you very much, John. Thank you to all of our attendees and I wish everyone a great day.

Operator

Thank you. That does conclude today’s call. Thank you for participating. You may all disconnect at this time.

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