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Symmetry Medical (NYSE:SMA)

Q1 2010 Earnings Call

May 06, 2010 05:00 am ET

Executives

Carol Ruth - IR, The Ruth Group

Brian Moore - President, CEO and Director

Fred Hite - SVP, CFO and IR Officer

Analysts

Matt Miksic - Piper Jaffray

James Sidoti - Sidoti

Michael Matson - Wells Fargo Securities

Operator

Operator: Good day ladies and gentlemen and welcome to the first quarter 2010 Symmetry Medical Incorporated earnings conference call. My name is Michael and I will be your coordinator for today. At this time all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. [Operator Instructions]. As a reminder this call is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's conference Ms. Carol Ruth of the Ruth Group. You may proceed.

Carol Ruth

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

Statements made in this conference call regarding Symmetry Medical 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 non-frequently identified by the use of terms such as may, will, should, expect, believe, anticipate, plan, may intend and similar words indicating possible future expectations, events or actions.

Such predicative 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 risk in the forward-looking statements sections of the company's most recent annual report on Form 10-K, filed with the Security 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 President and Chief Executive Officer, Brian Moore, I'd like to emphasize Symmetry Medical's policy of not commenting or discussing individual customers or programs. Brian?

Brian Moore

Thank you, Carol and thank you everyone for joining us on our first quarter 2010 investor conference call. We're pleased to report that our first quarter 2010 results came in ahead of our expectations and this reflects the improved orthopedic industry demand and our cost control initiatives. Our sequential revenue growth rates of a 11% from the prior quarter demonstrates continuous stabilization for our operations driven by stronger order flow in our core orthopedic business and robust growth from our SSI direct sales efforts.

Looking forward, we're cautiously optimistic as inventory corrections move behind us and larger OEM customers increase their sales and marketing activity. As you are aware the slow or (inaudible) environment over the last several quarters gave us an opportunity to strengthen our strategic customer relationships while maintaining our global infrastructure and capacity. This strategy has provided us with a competitive advantage with enhanced services and the ability to quickly respond to any rapid return in demand.

Given the encouraging start to 2010, we are increasing full year revenue guidance to a range of $330 million to $340 million up from $320 to $330 million and then EPS range of $0.45 to $0.50 up from $0.43 to $0.50. Our facility rationalization is on track and we expect to complete the consolidation of our oven case and trade operation to other existing case and trade facilities by the end of second quarter 2010 when we start to realize the majority of our anticipated $2.2 million cost savings per annum run rate.

As outlined on last quarter's call, these consolidation steps are expected to achieve annualized cost savings in the order of $3.4 million beginning in second half of 2010.

As we move through 2010, we will continue to deal all aspects of our operation to drive increased profitability and achieve further operating leverage as our customer demand improves. In addition to improvements in our core orthopedics business, we have made notable progress in expanding our non-orthopedic direct sales operation at SSI (inaudible).

The team with SSI is doing an excellent job building on brand recognition to establish a global distribution network supported by a US direct sales force. This aggressive approach led SSI to achieve record sales during the first quarter. We expect this momentum to continue following our launch of a dedicated website in the second quarter that will enable SSI to sell directly to our global customer base.

On our fourth quarter 2009 call, we mentioned new investments in sales, marketing and our new product line.

During the first quarter we started to increase our expansion in this area and recently appointed [José Hernández] as new SVP of new product development to spearhead our new product development activities. He will lead a focused team responsible for new product creation to complement all parts of our operation with an emphasis on products and intellectual property creation. José is an industry veteran who join Symmetry with multiple years of new product development experience within the orthopedic and spine market.

His direct and relevant industry experience will be a vital resource for our future expansion.

We've also hired a dedicated general manager to drive and penetrate further into the spine market. We are currently accelerating activities to our dedicated spine operation in the [villa] to increase our presence and meet growing customer demands in this high growth sector.

Our goal is to accelerate current spine industry growth rates through investment in new product development, sales and engineering, additional resources and high precision and specialized manufacturing equipments. On the international front, production ramp at our Malaysian operation is progressing very well and on track to achieve our targeted 300% increase in sales at this facility for the full year 2010.

This aggressive acceleration is a priority as we look to increase our local marketing presence and manufacturing capability in Asia. Our Malaysian facility is developing a standalone reputation with the capability to serve both local customers as well as our major international OEM customers. Several of our large OEM customers have visited our Malaysian operation and are eager to work with us to utilize the facility to support and expand their existing Asian presence and operations.

During the first quarter of 2010, we are also pleased with the significant progress at our Sheffield facility which achieved profitability during the month of March and our organizational changes have driven further efficiencies and we are confident that the facility will return to targeted profitability levels as we advance through the remainder of 2010.

Before I turn the call over to Fred, let me reiterate our cautious optimism for 2010. We are encouraged by the favorable trends for our orthopedic customers and our order intake over the last two quarters. We are in a position to respond quickly as demand increases with the reacceleration of orthopedic industry growth. I would now like to turn the call over to Fred for a more detailed review of our financial performance.

Fred Hite

Thanks Brian. As Brian mentioned we are encouraged by our sequential revenue growth driven by the ongoing stabilization of our business. Revenue for the first quarter 2010 was $84.5 million, up 10.6% on a sequential basis from $76.4 million reported in the fourth quarter of 2009 and compared to a $101.4 million reported in the same period 2009.

Revenues during the first quarter reflected increased customer demand across all product areas compared to the fourth quarter of 2009, however lower than first quarter of 2009 primarily due to lower launch quantities on instruments. As we have progressed through the second quarter 2010, we remain encouraged by our current customer demand.

First quarter 2010 revenue by business segment was as follows. Instrument revenue was $33.4 million, up 4.4% on sequential basis from $32.0 million in the fourth quarter of 2009 and compares to $46.5 million in the first quarter of 2009. Revenue in the first quarter of 2010 reflects a decrease in the quantity of our customers' new product launch activity as compared to the first quarter of 2009.

Implant revenue was $28.2 million, up 13.7% on a sequential basis from the fourth quarter 2009 and compares to $29.1 million in the first quarter of 2009. First quarter 2010 reflected the workdown of OEM customer inventory in the second half of 2009 and the continued growth rate and procedures.

Case revenue was $17.0 million, up 14.9% on a sequential basis from the fourth quarter 2009 and compares to $18.5 million in the year-ago period. The increase over fourth quarter 2009 was primarily driven by improved demand in the non-core medical markets as well as some stabilization in the orthopedic space.

Other revenues was $5.9 million, up 22.9% on a sequential basis from the $4.8 million in the fourth quarter 2009 and compares to $7.3 million in the same period last year. First quarter 2010 revenue by geography was as follows. $60.7 million in the United States, down 21.1% from the first quarter 2009, $7.2 million in the United Kingdom, down 10.0% from the year-ago period, $8.1 million in Ireland, down 14.8% compared to the first quarter of 2009 and $8.5 million in other foreign countries up 20.7% compared to the same period last year.

Our top five customers represented 60.7% of our first quarter 2010 revenue down from 68.1% in the year ago period. Our largest two customers accounted for 34.2% and 10.6% of our first quarter 2010 revenue compared to 41.9% and 8.8% of our first quarter 2009 revenue.

Gross profit for the first quarter 2010 was $17 million up from $14.0 million reported in the fourth quarter of 2009 and compares to $24.6 million reported in the first quarter of 2009.

Gross margin percentage for the first quarter 2010 was 20.2% compared to 18.3% reported in the fourth quarter 2009 and 24.2% during the same quarter last year. Selling, general, administrative expenses for the first quarter 2010 of $12.6 million was up in the first quarter of 2010 compared to the fourth quarter of 2009 primarily due to increased sales and marketing activity, including exhibiting at AOS in (inaudible), increased commissions and incentive accruals and increased new product development expense.

SG&A was down 4.8% from the $13.2 million of expense in the first quarter of 2009 and the year-over-year decrease was driven by cost control initiatives implemented during the second half of 2009. During the first quarter of 2010 we recorded a pre-tax of $500,000 related to facility consolidation and severance costs. This compares to $100,000 in the first quarter of 2009 and $2.0 million in the fourth quarter of.

Additionally, during the first quarter of 2010 we incurred inefficiencies and therefore higher pre-tax costs at our Manchester case facility related to the transfer of production from our [Autumn Auburn] case facility including personnel training, higher levels of scrap and other operational expenses. We estimate this unfavorable impact to be approximately $600,000 of expense included in the cost of good sold or a negative $0.01 of EPS.

Operating income for the first quarter 2010 was $3.9 million compared to $1.2 million in the fourth quarter 2009 and $11.2 million in the first quarter of 2009. Operating margin for the first quarter 2010 was 4.6% compared to 1.5% in the fourth quarter of 2009 and 11.0% for the first quarter of 2009. Excluding expenses related to the facility consolidation and employee severance payment, operating income for the first quarter 2010 was $4.4 million compared to $3.1 million in the fourth quarter of 2009, an increase of 42%.

As Brian mentioned we are encouraged with the progress of our Sheffield facility which achieved profitability during the month of March 2010 and for the first quarter 2010 Sheffield generated an operating loss of $100,000 compared to a loss of $1.6 million in the first quarter of 2009. We expect further efficiencies to return the facility to profitability as we advance throughout the year.

First quarter 2010 included a non-cash gain of $300,000 for the mark-to-market of our interest rate derivative compared to a non-cash gain of $400,000 in the first quarter of 2009.

Income tax for the first quarter of 2010 was $800,000 compared to a tax expense of $3.2 million in the year ago period. Net income for the first quarter 2010 was $1.6 million or $0.05 per diluted share up from $600,000 or $0.02 per diluted share for the fourth quarter of 2009 and compared to a net income of $6.9 million or $0.19 per diluted share for the first quarter of 2009. Excluding the one time facility consolidation and severance expenses in the first quarter of 2010, net income for the first quarter of 2010 was $2.0 million or $0.06 per diluted share compared to $0.05 per diluted share for the fourth quarter of 2009.

Earning per share for the first quarter of 2009 reflected a weighted average number of $35,729,115 diluted shares outstanding compared to a weighted average of $35,380,503 shares outstanding in the year ago period.

Turning to our balance sheet, cash at the end of first quarter 2010 remained very strong at $10.5 million and our outstanding debt decreased by $41.9 million or 30.9% compared to the year ago period.

Looking ahead, I'll briefly discuss our guidance for the full year of 2010 based on current order flow and customer demand as well as the expected savings from our facility rationalization. As stated in our press release, we are increasing our full year 2010 revenue guidance to a range of $330 million to $340 million, up from the previously announced range of $320 million to $340 million. We're also raising our full year 2010 earning per diluted share guidance to a range of $0.45 to $0.50, up from the previously announced range of $0.43 to $0.50.

I will now turn the call over to the operator to answer questions you may have.

Question-and-Answer Session

(Operator Instructions). And your first question comes from the line of Matt Miksic of Piper Jaffray.

Matt Miksic - Piper Jaffray

One question on kind of the trend of demands that you are talking about. I guess given what happened last year and sort of the destocking or reduction of inventory that you saw, the slowdown with key customers. Given what you have seen in the first quarter, is this sort of the beginning of several quarters of improving trends or is this I guess how much of improvement have we seen now and is this too optimistic to think about this as a beginning of an improving trend.

Brian Moore

Yeah, we are fairly confident. We've had two quarters now with order intake of in excess of $100 million. We've had $200 million order flow for the last two quarters. We are being told by our customers that this is exactly as you describe it, the beginning of the trend. We've been in the industry for some time, we are naturally cautious. We want to just make sure that the trends establish, but all we can say as a matter of record is that we have received $200 million order in take. We were busy and the demand appears to be increasing almost on a weekly basis.

Fred Hite

And Matt to your inventory question, when I look at the published numbers for the first quarter, it appears to me that the inventory levels are relatively flat compared to the fourth quarter of 2009 and you may recall that there was a significant drop in the fourth quarter as compared to the third quarter. So it feels like the inventory is stabilized.

Matt Miksic - Piper Jaffray

One follow-up just on maybe core hip and knee or maybe non-core customer plus your business, when you look at some of the areas you've been growing into and I am thinking of some of the large manufacturers, both in orthopedics and spine where you have been making some headway. If we think about the impact of that, I am assuming that the front end of those relationships is requiring sort of maybe some degree of investment on your part and not an awful lot of volume, yes, on the plus side.

First of all, when do you get this kind of a breakeven on some of these new relationships or maybe when do you start seeing some of the leverage from some of these new relationships that you have talked about or hinted out in the past?

Brian Moore

I think the principal you explained is correct, that we do obviously have some upfront investment, but we are seeing revenue streams being established pretty early. So if you look at the main one which is our spine activity, we are already pretty well established in spine across the company and if you breakout our total spine activities, it's on a par with most of the dedicated spine competitors that we have. The investment that we would make is probably in the [circa] of $5 million for some more specialized equipment, some marginal spend on enhanced marketing activity; which in our business is running the mill stuff. It's not what I would call a major upfront investment that requires to be recovered with low margins for a period of time. And the only other idea is that we are moving in which is SSI. We have put a big investment into website, but that's behind us and in some of our [forging] activities we are making a headway into areas like fuel burners and we're starting to get some traction with [buoying] parts and these investments were largely done last year and we are now starting to see some of the benefits coming through this year.

Matt Miksic - Piper Jaffray

Okay, and just to be specific I guess I'm speaking less of the understanding that you have a pretty well developed position in spine. In general I'm speaking more sort of the position that you're developing with some of the largest players in spine and I assuming that that's still not a part of your business that hasn't gone where you think it can go yet, is that fair?

Brian Moore

Absolutely, we see a lot of benefits from that and we see we have a very distinct competitive advantage in spine because of what we view as fairly advanced quality systems compared to competition. So we know that the larger companies in the spine business, their main emphasis is on quality, performance, regulatory. Price is always important but it's a secondary consideration and certainly we see that the investments we've made largely in people and we feel we have an excellent quality team. It's going to payoff and now that's coming through in order intake from these large customers.

Operator

Your next question comes from the line of James Sidoti of Sidoti.

James Sidoti - Sidoti

First, on the healthcare reform legislation that was recently passed, you are part of that is a tax and devices, but as I understand that that the taxes on sales directly to hospitals. Do you think you'll be impacted at all by that?

Fred Hite

That's a great question. Obviously it's not crystal clear right now but we do sell some products to hospitals obviously the SSI business sells products directly into the hospitals. My assumption is that that would be taxed but the rest of our sales would not be taxed at this time.

James Sidoti - Sidoti

Okay, so the majority of your revenue would not be affected then?

Fred Hite

That's my assumption at this time and the excise tax you're talking about I believe starts right in 2013.

James Sidoti - Sidoti

Right 2013. And then as far as the plant in Malaysia goes, when do you expect to start seeing material shipments out of that plant?

Brian Moore

We've been shipping out of there for yes, last year we did about $5 million this year it's budgeted to do $16 million and we have been shipping fully finished products for probably two years and that is the normal status cornel we expect that to carry on and ramp up very aggressively over the next few years.

James Sidoti - Sidoti

And do those parts generally stay in Asia or are some of those parts being shipped for customers and then used here in North America?

Brian Moore

They go all over the world basically, they go into Japan, they go in to China, they're going to Malaysia, they come back to America, they're going to Europe. So it is a very multi-faceted standalone business that is currently shipping all around the world and also to our internal operations.

Operator

[Operator Instructions]. Your next question comes from the line of Michael Matson of Wells Fargo Securities. You may proceed

Michael Matson - Wells Fargo Securities

Hi, just wondering if the dollar amount of SG&A that we saw this quarter, I think was $12.6 million, is that kind of the run rate that you expect for the remainder of the year?

Fred Hite

Yes, we saw a little extra because of the shows that we had this year, so there is probably $300,000 extra in there for that, but other than that it's probably pretty close.

Michael Matson - Wells Fargo Securities

Okay. And just wondering if you could give us. I don't think I heard this but possibly I missed it. Any kind of cash flow metrics, what was your cash flow from operations and CapEx or free cash flow, how do you want to give it?

Fred Hite

Yes, so cash from operations is around $4 million and CapEx was around $4 million as well. So, as we start growing the business obviously there is working capital build up that is required and that's where some of the cash went, but we're still in good shape and anticipate strong cash for the entire year optically as profitability increases later in the year.

Michael Matson - Wells Fargo Securities

Okay. And then just given that we're seeing in FDA that's gotten a lot more aggressive at expecting facilities and issuing morning letters and those type of stuff. On the one hand that might be positive for you and that you're a bigger player; on the other hand you do a lot of facilities out there, so how do you kind of view that from a risk benefit standpoint?

Fred Hite

Instinctive reaction is, that is extremely positive for business for the simple reason that we believe we have the best-in-class quality systems in our orthopedic outsourcing competitive environments and our customers usually confirm that point to us and they have a better knowledgeable of all our competitors than we do. So, we see it as positive, we see it as a major differentiator and we see it as something we should work hard on to reach the highest levels of standards in order to give our customers an excellent service.

Michael Matson - Wells Fargo Securities

Okay and then just given that with the economy is strengthening here and it seems like materials cost, commodities costs are starting to increase again, how do you view that affecting your business, are you able to pass that through, is it going to actually potentially help revenue for materials costs to go up?

Fred Hite

Well, we are major procurer of titanium, cobalt, chrome and stainless steel. So we have a specialist person who looks after that. We track it. We have locked contracts for several months running to next year so the immediate impact will not hit us. It there are any increases, we believe that we can do better than our competitors because of our purchasing power which is quite often well in excess of our customers and we feel that we cannot only help ourselves on that but might be we have an opportunities to help our customers with the purchasing of these fundamental raw materials.

Operator

This concludes the question-and-answer section. I would now like to turn the call over to Mr. Brian Moore for closing remarks.

Brian Moore

Okay, well thank you everyone and just to reiterate that we are in confident mode. We feel the recovery has started. We're very busy; we are working hard and thank you for your support. Any of you who are interested of course feel free to call Fred and myself for any follow-ups and I will be presenting at the JMP Conference in San Francisco on Monday. So of you in town we're very happy to see you. Thank you very much.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.

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