Symmetry Medical Q3 2007 Earnings Call Transcript

Nov. 7.07 | About: Symmetry Medical (SMA)

Symmetry Medical, Inc. (NYSE:SMA)

Q3 2007 Earnings Call

November 7, 2007 8:00 am ET

Executives

Carol Ruth - IR

Brian Moore - President and CEO

Fred Hite - SVP and CFO

Analysts

Michael Matson - WachoviaSecurities

Ben Andrew - William Blair

Mark Mullikin - Piper Jaffray

Steve Lichtman - Banc of AmericaSecurities

Beth Senko - Williams Capital

Operator

Good day, ladies and gentlemenand welcome to the Symmetry Medical Third Quarter 2007 General Business Update ConferenceCall. My name is Lacy and I will be your operator for today's call. At thistime, all participants are in a listen-only mode. We will conduct aquestion-and-answer session towards the end of this conference. (OperatorInstructions). As a reminder, this conference is being recorded for replaypurposes.

I would now like to turn the callover to our host, Carol Ruth. Please proceed.

Carol Ruth

Thank you, Operator. Joining uson the call today are Brian Moore, President and Chief Executive Officer, andFred Hite, Senior Vice President and Chief Financial Officer.

By now, you should have receiveda copy of today's press release. If you have not received a copy, please contact[R. J. Pellegrino] at 646-536-7009 and he will fax or e-mail you a copy.

Statements in this conferencecall regarding Symmetry Medical Inc.'s business, which are not historicalfacts, may be forward-looking statements that involve risks and uncertaintieswithin the Safe Harbor provisions of the PrivateSecurities Litigation Reform Act of 1995.

Forward-looking statements arepredictive in nature and are frequently identified by the use of terms such asmay, will, should, expect, believe, estimate, intend, and similar wordsindicating possible future expectations, events or actions. Such predictive statementsare not guarantees of future performance, and actual results could differmaterially from our current expectations.

Factors that could cause orcontribute to such differences include, but are not limited to, the loss of oneor more customers, the development of new products or product innovations byour competitors, product liability, changes in management, changes inconditions effecting the economy, orthopedic device manufacturers or themedical device industry generally, and changes in government regulation ofmedical devices and third-party reimbursement practices.

We refer you to the risk factorsand forward-looking statement sections in the company's most recent AnnualReport on Form 10-K filed with the Securities and Exchange Commission, as wellas the company's other filings with the SEC, which are available on the SEC'swebsite at http://sec.gov.

Before turning the call over toPresident and CEO, Brian Moore, I'd like to emphasize Symmetry Medical's policyof not commenting on, or discussing individual customers or programs. Brian?

Brian Moore

Thank you, Carol. And thank youto everyone for joining us on our third quarter conference call. Because of theongoing audit committee review of the accounting irregularities in our Sheffield,UK facility that we announced last month, we are restricted in our comments andare restricted from publishing complete financial statements until this reviewis completed.

We felt it was important to holdthis call in order to release what information we can and to comment on ouroverall business and operational activity. We will provide you with an updateon the general environment of the orthopedic industry from the Symmetryperspective, our top line activity and our outlook for the fourth quarter.

Let me start with a commentregarding the audit committee review that is presently underway. The improperaccounting issues that occurred in the Sheffield UK facility were uncovered bymanagement and reported to the audit committee of our Board of Directors. As weoutlined in our release, on October the 4th, following management's report, theaudit committee of the Board initiated an independent review and retainedspecial legal counsel and forensic accounting experts to assist in this review.

The audit committee, the outsideadvisors and the company have been working diligently since then, but thesereviews take time and this is months rather than weeks. Our goal is to file allour required documents in time for the 10-K for the fiscal year 2007.

And let's go to the good news,which is the health of our core business. For the third quarter 2007, ourpreliminary revenues were $76.5 million. As we discussed in our second quarterconference call, we believe we are in the midst of a dynamic recovery in ourcore orthopedic business. The market demand for our products continues quiterobust, with order-flow outpacing the monthly sales, indicating a further tickup in business for the remainder of 2007 and into 2008.

We are also seeing an increase incustomer product launches which we believe will contribute to the growth insales, operating efficiencies and better capacity utilization and as a result,this will flow through to improved gross margins.

We are currently recruitingpersonnel at most of our manufacturing sites to meet this demand. As we said inour last call, we believe we are in an excellent position to benefit fromupturn based on the relationships and our infrastructure, which we maintainedin place during the slower times.

And another good news front, ourMalaysian facility which we expect will play a key role in servicing the Asianmarket is progressing with its ramp up. We recently received BSI 3485certification during the third quarter, which signals as an important step inour growth strategy towards the Asian Pacific region. This certificationreaffirms to our customers, worldwide, our long-term and long-standingcommitment to supply quality medical products from all of our manufacturing sitesthroughout the world.

We continue to believe this certificationwill allow us to fully implement our total solutions model and address theneeds of the Asian market. We continue to be encouraged by all of ouracquisitions to-date, including the latest of SSI and Ultra Containers ofAmerica, as there will be 1,000 new local customers and 10,000 new productlines.

The cross-selling opportunitiesand new product development synergy is very exciting, and we remain active inreviewing other acquisition targets for Symmetry.

Our new Chief Operating Officerof Europe, John Hynes, is now on-board, and heis actively involved in overseeing our European operations.

John joins us with significantexperience in operational management, having achieved leadership roles inplanning and implementation of many major operational and manufacturingprograms. Though his early days, John has already taken charge of the Sheffield facility, and he is reviewing operations at ourother European facilities. We are confident that John's proven track record inthe manufacturing sector will only add to our growing strength in the Europeanmarketplace.

Now, let me turn the call over toFred for some additional comments on the financial front.

Fred Hite

Thank you, Brian. As Brianmentioned, because of the ongoing investigation, we are unable to publishcomplete financial statements. However, we can report that our preliminarythird quarter revenue is $76.5 million and our cash balance as of the end ofSeptember 2007 was $6.6 million.

As we stated on our secondquarter conference call, we expect fourth quarter revenue to be higher than ourthird quarter revenue.

As previously reported, thedisclosure of the Sheffield UK investigation resulted in a default under ourprimary credit facility. Since then, we've entered a forbearance agreement withthe lenders, under which they'd agree to refrain from any acceleration of ourfinancial obligations under the current loan agreement until January of 2008.We continued to stay in close communication with the banks.

We expect to file Form 12b-25 onNovember 8th which provides us with a five day extension to file our 10-Q forthe third quarter. However, we will not complete the Q within this five daywindow.

At this time, we expect that ourfull year 2007 financials will be impacted by the expense of the investigation,which we estimate to be between $1.5 million and $2.0 million.

As Brian mentioned, based on thecurrent order flow and the momentum we are experiencing at all of ourfacilities, we expect continued revenue growth in the fourth quarter of 2007and continued strength into 2008.

Brian Moore

Thanks, Fred. Hopefully, you canunderstand the limitations of our ability to fully communicate both the detailsof the investigation and therefore our complete financial statements. We aredoing everything we can to support the investigation and assure completion ofour restatements as soon as it is practically possible.

The main reason for holding thiscall is to let you know that the market has turned, but Symmetry is benefitingfrom a strong second half performance in 2007, and we are also expecting thismomentum to carry-forward into 2008, as a result of the increased order intake.

So, with that, we'll turn thecall open to any questions.

Question-and-Answer Session

Operator

(Operator Instructions). And ourfirst question comes from the line of Michael Matson with Wachovia Securities.Please proceed.

Michael Matson - Wachovia Securities

Hi, thanks for taking myquestion. I guess, it's great that the revenue picked up, we were kind ofexpecting that. I think everyone was. But I guess the bigger question in mymind has been around the margins in the second half. And I understand that youcan't give us a detailed EPS number, but what can you do to kind of give usconfidence that the margins are really, kind of, stepping up to the degree thatwas built into your guidance and in the consensus estimates?

Brian Moore

Mike. We are under pretty strongadvice not to comment on that until the investigation is fully completed.

Michael Matson - Wachovia Securities

Okay.

Brian Moore

It's unfortunate, but that's justthe way it is.

Michael Matson - Wachovia Securities

All right. In terms of therevenue in the quarter, can you tell us what portion of that came from theSSI-UCA acquisition?

Fred Hite

Mike, I think net on top of myhead, I don't have it in front of me, but I will follow up with you offline andlet you know how much that is.

Michael Matson - Wachovia Securities

Okay.

Fred Hite

But they were approximately $21million to $22 million business and so their normal run- rate would have comethrough for the time that we own them.

Michael Matson - Wachovia Securities

Okay. And then just with regardsto the follow-up on the loans what sorts of remedies do you expect to work outwith the banks on that?

Fred Hite

The standard agreement that wehad obviously says that we can't issue financial statements during the fall,and that's just pretty standard. The forbearance basically gives us time toremedy, that which is to issue a valid financial statement that everybody cancount on and then we just go back into our normal loan agreement.

Michael Matson - Wachovia Securities

All right. And then just givenwhat we're seeing with oil prices, is there any risk that's going to hurt yourmargins, over the next 12 months or so?

Brian Moore

No, we have, the biggest riskcould be on the plastic that we purchased. We have a three year contract thatwe've locked into, and we're one year into that. So we have two years left onthat agreement, so there is no risk of that for the next couple of years.

Michael Matson - Wachovia Securities

All right, that's all I've got.Thanks a lot.

Brian Moore

Thanks, Mike.

Fred Hite

Thank you, Mike.

Operator

And our next question comes fromthe line of Ben Andrew with William Blair. Please proceed.

Ben Andrew - William Blair

Good morning gentlemen.

Brian Moore

Hi, Ben.

Fred Hite

Hi, Ben.

Ben Andrew - William Blair

Just a few quick questions, Iunderstand, again, constrains you are under, maybe you can't answer this, doyou have a sense on when you'd be able to file the 10-Q?

Fred Hite

Yeah, the 10-Q is due in midMarch of 2008. And so our plans are that we get all of our restatements doneprior to that, and get the 10-Q filed on time.

Ben Andrew - William Blair

The Q or the K?

Fred Hite

I'm sorry, the K.

Ben Andrew - William Blair

Okay. So the third quarter 10-Qthough, when would you expect that?

Fred Hite

Sometime, before that.

Ben Andrew - William Blair

Okay. Are there any other sort ofstructural changes, Brian, that have happened since kind of the change inmanagement in the U.K. facility, or other fall-outs from the accountinginvestigation you can talk about at this point?

Brian Moore

The main change is that, JohnHynes is in place now as the COO for Europe, and that's in line with the U.S. operation now, where we effectively have aCOO who looks after Europe and John will carryon doing that. And we would expect that as John gets up to speed, he would runthe European operations on the same structure as the U.S operation

Fred Hite

And we also put a new FinanceDirector in charge of Europe. He started abouttwo months ago.

Ben Andrew - William Blair

Okay. Good. And then you talkedabout the expense of a $1.5 to $2 million for the accounting investigation,when do you expect to recognize that, and would we expect any additionalexpense from this situation kind of folding through into 2008.

Fred Hite

Well, expense to that has beenincurred, and I can't give you a firm date on when it would be completed, but Iwould say the majority of that would be in the fourth quarter of 2007.

Ben Andrew - William Blair

Okay. And then picking up onMike's question about raw materials cost, any other, what commodities,titanium, etcetera, cost going higher. I know it's a relatively small component,overall, of your cost structure, but anything there we should be watching foron the cost of goods side?

Brian Moore

We're seeing that the situationis relatively stable on titanium at the moment, and we have some long-termagreements in. One other thing just happening literally at the moment, is we'rereviewing goals of our agreements for that, and we have coverage through wellinto next year for titanium cobalt chrome.

We do have a new global procurementspecialist on the payroll, and she's been working in this area, and we expectover the next few months to pull together the expertise that we already have inthe company.

John Hynes is bringing a lot ofexpertise in terms of supply chain and management of the company, and with ourglobal procurement specialist, it's this scenario that we're targeting at. Wedon't expect any meteoric rises or impact on the business unless the marketsuddenly changes away from where we think it will be at the moment.

Ben Andrew - William Blair

Okay. And last question kind ofmore strategically with the investigation in the issues with the banks here inintermediate terms, Brian, does it constrain your ability to pursue additionalacquisitions, given kind of banks and need for debt to finance those over thenext, it sound like maybe, four five months ?

Brian Moore

We haven't stopped any of ourpursuit activities and reviews and discussions, and targeting funding, thisclearly is an issue. So we will take the view that hopefully we will be out andwe are focusing on finding and identifying targets at the moment and then wewill take a view on the funding when we have targets that we want to proceedwith.

Ben Andrew - William Blair

So should we not expect to seeany meaningful acquisitions north of $5 million or $10 million until thisinvestigation is wrapped up?

Fred Hite

Well that would be a matterbetween us, the banks, and the investigation, and I wouldn't like to comment onthat.

Ben Andrew - William Blair

Okay.

Fred Hite

Depends how the investigationgoes and how the banks are comfortable with that.

Ben Andrew - William Blair

Okay. Thank you.

Operator

And our next question comes fromthe line of Mark Mullikin with Piper Jaffray. Please proceed.

Mark Mullikin - Piper Jaffray

Yes, the market growth rate thisquarter looked relatively steady, compared to the last couple of quarters, andI would just like to get maybe qualitative comments from you, as far as whatyou think is driving the acceleration in your business?

Brian Moore

Well, two three things. First ofall, if you look at the major OEMs, they are becoming more aggressive in theircompetitive dynamics, and are developing more large programs that period to begetting ready for a fairly buoyant 2008. We are starting to move into theperiod when the [IOS] show, which is in March, is a big showpiece for theindustry.

So, we know of quite a few biglaunches that are coming along, so that's the OEM aspect being driven. And wealso, as you know from our previous calls, are focusing on other parts of yourtrading industry and indeed other parts of the medical sector, and we areseeing that we are able to grow and penetrate in these areas as well. So, weare seeing all of those things happening. And we are also seeing that the largeand medium size OEMs are starting to burn off the inventory. We track thatnumber. So, they have been leaving off inventory for probably the last 12months, and that's getting to lower levels. And they are doing a bit ofreplenishment.

Mark Mullikin - Piper Jaffray

And what are the areas where youare seeing some of the new areas you are expanding, and to where are you seeinggrowth?

Brian Moore

Well, I have said, SSI isexciting of course, because that has doubled our number of customers and it hasdoubled our range of products. And one of the things that we are able to do nowis that they are looking and focusing on specialty instrumentation. We have alot of firepower in the company to design and develop these products. So, byconnecting, if you will, the traditional design development and operationalbenefits of Symmetry, with what is effectively a very good marketing operation,that is a good opportunity for us.

And then, if we also add to thatthe opportunities in international sourcing, then we can built on that. We arealso seeing that endoscopy, trauma, and particularly spine,those markets are growing very aggressively. We've seen a lot of opportunitiesin spine, lot of large contracts adds industries, and we are looking tohopefully benefit from some of those.

Mark Mullikin - Piper Jaffray

Okay. And thenhas there been any material change in the pricing on your contracts?

Brian Moore

No. Thepricing is always an issue. Everybody we deal with wants a good deal. But whencustomers get busy, they revert to their number one priority, which isavailability of products and quality. And if we position ourselves as a qualitysupplier of products, we are not the low-cost sort of part of the market. So,we are not seeing any violently aggressive, across the board, pricepressure at the moment. But clearly, this is a factor in our business.

Mark Mullikin - Piper Jaffray

Okay. Thank you.

Brian Moore

You are very welcome.

Operator

(Operator Instructions). Our nextquestion will come from the line of Steve Lichtman with Banc of AmericaSecurities. Please proceed.

Steve Lichtman - Banc of America Securities

Good morning, guys.

Brian Moore

Hi, Steve.

Steve Lichtman - Banc of America Securities

Are you able to give us whatpercentage of sales are your top five customers?

Brian Moore

No.

Steve Lichtman - Banc of America Securities

Okay. Just in terms ofqualitatively, on the large OEMs, can you talk about, are they consolidating interms of their -- who they are using or using some of your smaller competitors,still kind of falling by the wayside?

Fred Hite

Yeah. As a general trend alongthe large OEMs, they are looking for larger suppliers who are able to give themeconomies of scale and international supply. And we are seeing in most of ourlarger OEMs this trend continuing. And we hope to be one of the mainbeneficiaries of that, because of our size and our global positioning. Most ofour main competitors are in the United States and are limited to the UnitedStates.

And I think we have a much moresubstantial presence in Europe and obviously now it is starting to be in Asia, where we have our own facility. And we are in aprocess of creating a lot of capacity in Asia. We plan, next year, to putfacilities for instrumentation and for forging. We already have casemanufacturing work in there. And we are working with the local government inMalaysia. In fact, I am over there next week to accelerate that.

So, we see Asia and Europe as main building blocks for us. And of course, wehope to get benefits as a result of currency versus the dollar, with the dollarbeing a bit weak in the moment than money we earn in Europe, Asia, than it'sbetter for our bottom line.

Steve Lichtman - Banc of America Securities

As you think about the thirdquarter, coming on the top line ahead of your expectations, where would you saythe biggest sort of upside came, versus your expectations? Was it in the corecustomers, from the acquisitions, or from new customers, any kind ofqualitative comments?

Brian Moore

Well the good news is that it'sacross the board, Steve. I mean, we're seeing the whole. When we went down inthe middle of '06 we were been asked, what was the cause and we would sort of abit ambivalent, while the same answer now is that, we don't have a real goodreason why it's going up.

We are a business that's fairlyrisk adverse, which the good news is that we've track the industry, but the badnews is we don't have a quick fix. So we're seeing all of our major customersincreasing their activity. We are seeing a lot of the smaller customersincrease in the activity. And we're increasing as per-global reach, and that'sworking very well for us.

Steve Lichtman - Banc of America Securities

And then, in the press release,you mentioned also on the call in terms of the capacity utilization. So are wealready seeing that increase in capacity utilization, so obviously you can'tcomment on the numbers, but are we already starting to see that benefits on thegross margin line, which will hopefully continue/

Brian Moore

We are expecting, and wouldexpect to see over the next several quarters that the utilization of our fixedcosts, as a percentage of sales, will reduce, as the result of the increasedvolume where we, as you know, kept the capital in place. And we are now justincreasing the labor particularly in areas where we're doing cases andinstrumentation, where we have a lot of capital available to meet demand.

So we would expect to seefinancial benefits as the increased sort of volume goes through on the fixedcapital base. And we are not, at the moment, seeing any dramatic increases forcapital expenditure, which should reinforce our expectation of improvedoperating performance on those volumes.

Steve Lichtman - Banc of America Securities

Great, And then Fred, can youremind us, sort of, when the plans are really running high, where ultimatelyyou think we could be looking at on the gross margin?

Fred Hite

Yeah. We have talked about it inpast, in between that 25% and the 30% range, depending on where we are at onthat utilization curve.

Steve Lichtman - Banc of America Securities

So toward the upper endobviously, as you're increasing that utilization?

Fred Hite

Right.

Steve Lichtman - Banc of America Securities

Okay. All right, thanks guys.

Fred Hite

Thank you, Steve.

Operator

Our next question comes from theline of Beth Senko with Williams Capital. Please proceed.

Beth Senko - Williams Capital

Hi. Good morning, guys. Fred, I'mgoing to try to ask the revenue question a way that you can hopefully detailit. Can you at least break down roughly between the implants, instruments andcases for us?

Fred Hite

No. We're not able to disclosethat at this time.

Beth Senko - Williams Capital

I tried. Thanks.

Fred Hite

Thank you.

Operator

(Operator Instructions). Thereare no questions in queue at this time. I would now like to turn the call backover to Brian Moore for closing remarks.

Brian Moore

Okay. Well, can I just say thankyou to everybody, we appreciate your support. We obviously talked to a lot ofyou offline, and we just want to get through this as quickly as possible, andhopefully at the end of it, we'll have a good story to tell. Thank you verymuch.

Operator

Thank you for your participationin today's conference. This concludes your presentation. You may nowdisconnect. Good day.

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