Symmetry Medical Inc. (NYSE:SMA)
UBS Global Healthcare Conference Call
May 20, 2013 09:30 ET
Tom Sullivan - President and Chief Executive Officer
Good morning, everyone and welcome to the 2013 UBS Global Healthcare Conference. My name is Terrence (indiscernible), and it’s my pleasure to be your host for this session. Our next presenter will be Mr. Tom Sullivan from Symmetry Medical and a breakout session will follow immediately in Liberty rooms 1 and 2 just down the hall. Thank you very much.
Well, good morning everybody. My name is Tom Sullivan from Symmetry Medical. Thank you for taking some time to meet with us today and to learn a little bit more about our business. I am pleased to give you an overview of our organization, and as Terrence had alluded to I will be happy to take any specific direct questions during the breakout immediately following this session, of course, our disclaimer statement as a publicly-held company, and I call to life our forward-looking statement.
So, there is four key takeaways that I would like to talk to you today about Symmetry Medical, and I’ll give you additional color on each of these as I progress through the agenda. But the first is that at our core, we are a market leading supplier to the orthopedics industry. So, we are a manufacturer that sells products to the bluest of blue chip names in healthcare. We consider it quite a great place to be, particularly in orthopedics. The long-term demographics are encouraging and the opportunities for growth from a perspective of share, from a perspective of increased outsourcing and new product launches, we believe it’s a great place to have the core of our company be homed in. However, also we have a direct-to-hospital subsidiary, which we call, Symmetry Surgical, that brings some of our technologies directly to the healthcare marketplace. We like that space, because it diversifies our overall revenue, and it also has a significantly more fragmented customer space than being an OEM supplier. And I’ll tell you a great deal more about Symmetry Surgical and the value to us both tactically and strategically in a moment.
Thirdly, we remain committed as an organization and we have the resources to continue to diversify our portfolio. One of the things when you look at our stock over time you will see that it is rather lumpy from a revenue perspective. If you go back to when we went public in 2004, you will see that the revenue will go up and come down fairly significantly. And the reason for that is that a large piece of our sales, our OEM customers are capital purchases by our OEM customers in support of product launches. And consequently, when they are launching a product, you will see a spike in our revenue. And when that product launch is over, you will see the erosion of the revenue, and 2009 is probably the best possible example, I call your attention to. We believe that diversifying our revenue base to mitigate the highs and lows of these peaks and valleys is the appropriate step, and we continue to look at efforts to diversify as an OEM supplier, as well as our direct-to-hospital business.
And then finally for a company that is committed to long-term, we believe innovation remains the cornerstone of our long-term success, innovation as a contract manufacturer and innovation as a direct-to-hospital supplier. We invest a little over 1% of our revenue in research and development. And we have had some significant success recently in developing intellectual property that we are working hard to commercialize into new products. And I will speak to how innovation comes to life in our organization in a moment.
So, one of the things about Symmetry Medical just before I speak to the actual business side is how we behave as a company. We are in this for the long-term. We try to mitigate obviously our performance over the short-term and continue to meet shareholder expectations, but we believe the best solution for the long-term shareholder value is to remain committed to a long-term horizon and to do behavior in a way that will make us happy not only about winning, but the way in which we won. So, we have internally what we call our promise statement, and it speaks clearly to our priorities of fulfilling our promises to our customers, be they be a OEM customer or a patient, our promise to our teammates around the world, and with nearly 3,000 associates throughout Symmetry’s sites around the world, fulfilling that promise keeps those employees engaged and a vital part of our long-term success. And then ultimately if we do it right for our customers and right for our teammates, we know that they will reward us and reward you, our shareholders with long-term growth in our organization.
A little bit of the facts about Symmetry, roughly 35 years old today. We grew out of a small instruments shop in Warsaw, Indiana. Those of you that aren’t familiar with Warsaw, it is the orthopedic capital of the world. And Othy manufacturer is our parent organization from a long time ago opened up as an instrument supplier to the large companies in town there. Over the years Othy grew through acquisition and in 2004, we were taken public by Olympus Partners and brought together the best of Othy and the best of Mettis. Mettis was a forge shop more on the metals side of the business on implants. Today, that organization has grown to 17 locations around the world, approximately 3,000 associates as you can see. We are present in the United States, in the UK, Ireland, France, Germany, as well as in Malaysia. And in the United States, we have sites in both the Northeast and the Midwest as well as Nashville, Tennessee for our Symmetry Surgical location.
If you look at our businesses we have grown predominantly through acquisition. The most notable is in the end of 2011, when we acquired the surgical instrument business Codman from Johnson & Johnson that was $165 million acquisition. They transformed our SSI business, our little direct-to-hospital distributorship into $100 million global medical device business that today represents 25% of our revenue. So, as you step back and look at our 2012 results you will see revenue of approximately $411 million, 75% of that is in our contract manufacturing business. As an OEM supplier to the bluest of blue-chip names in healthcare, and then the balance is in our direct-to-hospital business.
And if you peel the onion back a little further, on our OEM supplier business we have four main segments, 40% of that business is instrumentation that we sell to the OEMs predominantly instrumentation used to the implantation of an orthopedic prosthesis. So, these are custom made instruments that we make for the manufacturers that they then provide on a loaner basis to hospitals to implant their hips, their knees, their shoulders, their trauma plates, their spinal implants, etcetera.
A third of our revenue in OEM supplier comes from our implant business. This is products that we forge, cast or machine all the way through finished, pack and sterilization for the OEM. So, this is the actual implant itself. We supply about $100 million of parts into that device industry and the industry is worth about $8 billion in cost of goods sold, so for us significant market share opportunities that I will speak to.
And then finally our surgical cases and trays business are exactly what the name would imply. These are the trays that are used to carry the surgical instruments into the operating theatre to enable sterilization of them. Our cases and trays business is actually very well diversified selling not only to orthopedic companies, but the companies in endoscopy surgical instrumentation and a range of other medical device specialties. In fact our cases and trays business sells into approximately one-third of the $360 billion global medical device industry. And then finally you will see other represent as well others approximately 7% of our revenue that is aerospace machining, although strategically we are a medical device company, the regulatory demand, the manufacturing demand to do precision machining for the aerospace industry is very similar to orthopedic implants.
And our facilities in the UK and in Michigan actually supply as a Tier 2 or Tier 3 parts that go into high efficiency engines for the aerospace industry. We are particularly encouraged by that because the high efficiency engine is a long-term growth platform in the aerospace industry with a very long run way ahead of it, no pun intended. So, our OEM business, we believe has some nice diversification with aerospace in cases, but it’s still a significant concentration in surgical instruments sold into the orthopedic marketplace. And then as I had mentioned approximately 25% of our revenue is in our direct-to-hospital subsidiary Symmetry Surgical headquartered in Nashville, Tennessee. We do business in over 120 countries around the world, but obviously the super majority of the sales are in the United States.
Let me tell you a little bit more about each of our business segments and give you a look at our products here. Here you can see our surgical instruments there and again these take two forms. For the OEM side of the business, they are instruments that we make that enable the implantation of an orthopedic implant for an OEM customer. So, it’s everything from cutting devices, grinding or grading devices, reaming devices that will enable orthopedic procedure to be done. It also has surgical instruments of course that we sell direct-to-hospital. You can see a bipolar, a monopolar forcep there and a variety of other reusable general surgical instruments. And I emphasize the word reusable, so we make metal instruments that are meant to be used multiple times.
On our orthopedic implant business we do everything from hip, knee, shoulder, trauma, spine, ankle, elbow and any of the other joints that are involved in the body. For us, our technology start and implant comes to life as either a forged item or a cast item. We are both a forge house and a casting house, and then we machine it subsequent to that operation. The majority of orthopedic implant manufacturing is in-sourced by our OEM customers, I had alluded to earlier it’s an $8 billion industry. We believe approximately $7 billion is in-sourced in this space, so a significant opportunity for increased outsourcing. And then finally, our sterilization cases and trays business, and as you can see, it’s a combination of metal and plastic trays. And cases meant to carry the product, to sterilize the product and protect the product prior to use it in a surgical procedure.
So, if you look at our two channels, again the top half of this graph represents our OEM channel, 75% of our revenue. We are very pleased to do business with the bluest of blue chip names in healthcare. The reason that’s important is we are a strategic supplier to those organizations. And for us, the exciting thing is that those organizations buy an awful lot of other stuff. So, one of our challenges is to look at what else can we do as a company that will enable us to sell other things to these companies since we are already a strategic supplier in a time and age when all of them are looking to reduce their number of suppliers.
And then down on the lower half of the chart you can see the brand names that we bring to life through Symmetry Surgical. These are names in many ways equivalent to Kleenex in the general surgical instrument space. If you go into an operating room and you ask for a surgical retractor for open surgery, you’re probably just going to ask for the Bookwalter. That is a brand name that Symmetry Surgical owns and sells directly to the hospitals. And then the presence that we have in some of the greatest healthcare organizations in the United States, we believe is where the synergy comes back to life. We have sales reps in the OR everyday in these great hospitals. They’re seeing what hospitals are dealing with. They’re hearing what’s on the minds of OR nurses and OR directors. They bring those insights back to us and we use that to drive our innovation processes that generate the ideas that we bring to our OEM customers. And we believe that to be one of our unique competitive advantages that we are the only contract manufacturer that also sells direct-to-hospitals in the surgical instrument space.
I had mentioned earlier that our core, we are an orthopedic OEM manufacturer. The reason we’re excited about this space is four simple growth oriented reasons. The first is of all these different medical device categories, orthopedics is one of the largest, but today, there is no cure for the degenerative disease of arthritis that causes the hip, knee, shoulder, elbow, or ankle replacement. As far as the eye can see, the long-term demographic growth for that procedural state is about five percentage points, that growth rate historically over the last number of years has been somewhat constrained because these are elective procedures. If a patient can delay having their knee replaced or their hip replaced, they will because clearly there is a rehab associated with it, they are worried being off their job. So, since 2009, we’ve seen procedural growth rates of flat to slightly negative. But over the long-term, we believe that the long-term demographic is approximately 5%. So, you’re starting from a core that will have a long-term as far as the eye can see growth rate.
The second thing as I had mentioned, the industry is about $30 billion, about $8 billion is in cost of goods sold of metal and plastics to the actual hips, the knees, the shoulders, etcetera. Today that marketplace is only approximately $7 billion in-sourced, about $1 billion is outsourced. We represent about 10% of what is outsourced. We believe the OEMs as they continue to face pricing pressures from their customers, we’ll look at ways to radically re-engineer their supply chain. And that they are going to turn to industry such as high-tech or retail that have moved to a model that is 95% plus outsourced. If the orthopedic companies look to outsource the implant manufacturing, we believe we are well-positioned as a highly regarded, trusted, regulatory provider to them today. So, we are actively working with orthopedic companies to look at how can we extend what we do for them in orthopedic manufacturing.
The third is that the instruments segment of this business is highly fragmented. There are over 1000 companies that make surgical instruments for the orthopedic industry, that historically was accepted, but in today’s day of FDA risk, the OEMs are looking closer and closer at whether or not they want to be in the business with thousands of mom-and-pop suppliers. A number of them have stated goals already to reduce their supplier base by tens of thousands. And as they look at eliminating these small mom-and-pops, little – $0.5 million to $3 million a year in revenue, we believe they’re going to turn to strategic partners such as Symmetry Medical to move that outsourcing to. So, we see an opportunity for market share gains as they rationalize their supplier base.
Additionally, last year in October, FDA required all contract manufacturers to register on the (indiscernible) database. This is a first time in the industry where FDA has said if you’re a contract manufacturer, you must register with us. We believe that ups the ante on OEMs looking more closely at who they choose to work with from a supplier perspective. And we believe we will be a catalyst to the acceleration of rationalization of their supplier base.
And then finally, the last part of our business is that instrument and case business that it’s highly sensitive to new product launches. Two of the largest orthopedic companies in the world Johnson & Johnson and Zimmer have announced the release of a new knee platform this year. We expect this product launch will take place over the next four to five years and could result in an investment in instrumentation and cases north of $250 million each to the industry. So, that is a significant amount of new capital coming into the orthopedic space. And obviously as a contract manufacturer, we would like to do our part to get a piece of that opportunity.
There is three things that affect what that might be worth to a company such as Symmetry. The first is how quickly they may want to deploy those sets. Historically, an orthopedic company would launch a new product over about six quarters. We believe in today’s environment to launch it over approximately five years. So, we are more drawn now, but we also believe that while they do that, they have to make a decision of what will they in-source versus outsource, and that which they then choose to outsource, how much of that can we win market share on.
We are currently participating in most of these product launches, making instruments and cases or case parts for each of them. And we look forward to the opportunities to serve that very large spend over the next couple of years. Additionally, in addition to those two companies and the launches that they are bringing to marketplace, you have all of the other companies that aren’t going to sit by and idly risk losing market share. One of the ways that they might compete is to put new sets of instruments and cases of their own products out into the field. And clearly, we would look to benefit of helping produce those products for them as well.
So, we believe there are four excellent catalysts on the growth side on the OEM solutions business. When you couple it to our internal activities in both quality and regulatory as well as the Symmetry business system to improve gross margin, we have communicated to the Street at the beginning of 2012 that we saw an opportunity to improve gross margin between 200 and 500 basis points associated with the Symmetry business system, our version of lean manufacturing. We believe last year we realized approximately 200 and change improvement in gross margin because of the Symmetry business system. And we have committed already to the Street that we would expect to see 100 to 200 basis point improvement in gross margin in that business in 2013 because of our efforts around the Symmetry business system. So, the OEM solutions business we believe is well positioned for both growth as well as margin expansion. Without a doubt, the biggest opportunity for us is better capacity utilization. This business was approximately $400 million in 2009, and we are approximately $300 million today. So, as the growth returns to the industry and returns to a company like Symmetry Medical, we believe we will have opportunities to drive significant improvement in margin and drop a lot of that benefit down to our shareholders.
Our Symmetry Surgical business, as I had mentioned earlier, $100 million direct-to-hospital sells in the United States through a direct sales force and some select distributor partners and territories, where we don’t have direct coverage. And then outside the U.S. sells through a distributor of oriented sales force with a presence in over 120 countries. This business represents the combined portfolios of Olsen Medical which we acquired last year, Codman which we acquired in 2011 from Johnson & Johnson, and our historical SSI business, which are more value-oriented instruments in cases sold to the direct-to-hospital market.
We like this space, because it diversifies our revenue. It puts us in the hospital everyday hearing issues, and general surgical instruments strategically we believe in for two key reasons. One is it’s a product category that none of our OEM customers compete in and we have an internal value system at Symmetry that we will not compete against our OEM customers. So, Sym Surge will never sell anything direct to the hospital that would be deemed as competitive by our OEMs. And if you think of who our OEMs are, Johnson & Johnson, Stryker, Zimmer, Medtronics, Smith & Nephew, Biomet, it doesn’t leave a lot of stuff, because those are such broad and successful categories. But this is one space, it’s $1 billion category, where 10% global market share, and we believe we have a lot of opportunity to bring our capabilities to this field.
The second thing about it is general surgical instruments are not tied to any one type of CMS reimbursement in the world today of pretending Obamacare and price pressures around the world. We know that products that are tied specifically to a procedure often are risk of reimbursement cuts. These are the things that you would find in any OR, anywhere in the world. And as such, they are used in multiple procedures and they are used over periods of years. So, the price sensitivity to these items is more associated with just competitive bidding processes with our competition, as opposed to any reimbursement related issue. So, we believe strategically this is a good business for diversification. It’s a good business for long-term strength and application of our skills. And as I have mentioned earlier, it puts us in the OR everyday hearing about what hospitals are struggling with, so that we can bring that news back to our what’s new process, our innovation process, so that we can be better positioned to help our OEM customers.
I had also alluded to earlier diversifications, Sym Surge is a part of that, but our diversification strategy is also on the OEM side of our business. The majority of our revenue today is in orthopedics. We need to expand outside of orthopedics. So, in particular, we ask ourselves three questions. We say, who are our customers and what else do they do business in, where do we know the regulatory system and where do we know the technologies to bring them value? So, clearly, we have a great company like Johnson & Johnson. They also buy a lot of pharmaceuticals. So, we have good customer synergy there, but we don’t know anything about that side of FDA and we don’t know drug manufacturer. So, the idea that we would move into drug manufacturer or contract manufacturing for J&J is not appropriate.
But if you were to look at other things that like a Striker or a Smith & Nephew, they are both in the business of endoscopy. We sell their endoscopy divisions cases and trays today. They buy a lot of other things in endoscopy. Maybe we should look at expanding additional value we could bring them in that space. So, we look clearly at our capabilities that you can see there, and we are looking at what additional capabilities would we need to develop or acquire to make us a more attractive supplier in those adjacent spaces. We think that those marketplaces are also right for supplier rationalization. And since we are such a dominant strategic supplier in ortho, we believe it’s a platform that we can expand laterally to these OEMs.
And then finally the future long-term for any organization is all about innovation or risk of commoditization. We have actively worked since I joined the organization two years and four months ago to increase our focus on research and development. We have 27 engineers that are actively working to develop new products. In the last two years, we filed for more patents that in the previous 5-year history of our organization. We had 13 in 2011 and 13 in 2012. We are now actively working to commercialize those patents and intellectual property into products that are very sticky for our customers. In particular, if you look at our instrument and our case businesses, approximately 20% and 30% respectively of the sales in those categories are on products where we own the IP.
Why is that important? As a contract manufacturer, if you own the intellectual property, the OEM can’t source that from another contract manufacturer. So, we would like to continue to drive these margins up closer to 33% of our overall revenue, but clearly it’s about coming up with value-added products that we will be able to develop that sticky relationship with our OEM customers.
The other thing about this business is it does have a proven capability within Symmetry to collaborate with surgeon designers. As our OEM customers have to think more and more carefully about where they put their R&D dollars, they are looking for organizations that can work with their designing surgeons and develop areas that they are not paying attention to. Clearly, they are making choices in their R&D portfolio as to what they can focus on, and what areas they don’t have time or capabilities for. We want them to know that Symmetry Medical is an organization that knows how to collaborate with doctors, that knows how to do it in a way that it’s healthcare-compliant, and can bring ideas back to them an innovation that will bring their portfolios value for years to come. So, innovation is our long-term key to success both as an OEM provider and as a direct-to-hospital organization.
In total, we believe innovation equals branding. So, in today’s world, if you are just making to a print, it is a very low margin commoditizing business. We believe the stronger brand equity that we create both on our OEM side, which is under our banner of Symmetry Medical, wherein our direct-to-hospital side under Symmetry Surgical and the many great brand names there, one of my favorite, the Bookwalter product. Dr. Bookwalter is a designing surgeon for us today. He has retired from practice, but he is a tireless advocate for the improvement of opportunities in the operating room, and he is an expert in retractor systems or systems that give exposure. When you look at the OEM side of our business, one of the greatest opportunities is better exposure for the implantation of an orthopedic prosthesis. We have the world’s expert in exposure developing products for us and we believe that type of synergy and strength across our branded portfolios is a unique differentiator for Symmetry Medical.
So, in conclusion, I’ll invite everyone to join us for the Q&A session in the Liberty room following this. We believe our purpose as a company is to be the trusted global source of innovative medical device solutions for today’s needs and tomorrow’s growth. A couple of words that I will point out is we are in the business of trust. This is a highly regulated industry with great deal of motes around it by regulatory bodies, and the trust of our OEM customers is one of our greatest competitive advantages. We believe in innovation both in the short-term and the long-term and process and in product. So, it’s not only about product design, but how we make those products that is innovative and that innovation is the key to long-term sticky relationships. And we believe that our role is far beyond anyone product, but in fact, a solution and that can be solutions from a standpoint of a technology or it can be solutions from capacity.
And as we look ahead at this industry in the long-term growth opportunities that are out there, we have the infrastructure in place today and the resources to respond to our customers anywhere in the world in a high technology center close to their facilities or in a low cost labor country. And in total, that’s what differentiates Symmetry Medical. And I thank you for your time and attention today, and I’ll invite you to the Liberty room for any questions. Thank you.
[No Q&A session for this event]
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