Synergetics USA F2Q08 (Qtr End 01/31/08) Earnings Call Transcript

| About: Synergetics USA, (SURG)

Synergetics USA, Inc. (NASDAQ:SURG)

F2Q08 (Qtr End 01/31/08) Earnings Call

March 11, 2008 5:00 pm ET

Executives

Pamela Boone - CFO

Gregg Scheller - President and CEO

Dave Dallam - EVP of Marketing & Sales

Analysts

John Reuter

Barney Harris

Stan Manne

Operator

Welcome to the Synergetics USA teleconference, in which we will be discussing operating results for 2008 second fiscal quarter and six months ended January 31, 2008.

I would also like to note that Synergetics USA news release providing these operating results was posted to Business Wire this afternoon and the company's Form 10-Q was filed with the Securities and Exchange Commission this afternoon.

As is customary, I will now take a moment to review the required Safe Harbor statement. Some statements in the press release and these prepared comments may be forward-looking statements for the purposes of the Private Securities Litigation Reform Act of 1995.

In some cases, forward-looking statements can be identified by words, such as “believe,” “expect,” “anticipate,” “plan,” “potential,” “continue,” or the negative of these terms and similar expressions.

Such forward-looking statements include risks and uncertainties, and there are important facts that could cause actual results to differ materially from those expressed or implied by such forward-looking statements. These facts, risks and uncertainties will be discussed in our Annual Report on Form 10-K for the year ended July 31, 2007. There have been no significant changes to these risks during the current quarter, and these risks will be updated from time to time in our filings with the Securities and Exchange Commission.

By way of introducing today's speakers, Pamela Boone, Chief Financial Officer of Synergetics USA will first provide operating results for the second fiscal quarter and six months ended January 31, 2008.

Following Ms. Boone's remark, Gregg Scheller, President and CEO of Synergetics USA will review company operations for this period and current business development.

Following Mr. Scheller's comments, we'll open the call for questions and ask that you first identify yourself before asking your question.

And now I would like to turn this call over to Pamela Boone, Chief Financial Officer of Synergetics USA.

Pamela Boone

Thanks Christine. Synergetics net sales for the second quarter of fiscal 2007 were $11.6 million, a record second quarter for the company. Although this represents growth of only 2.5% over the comparable quarter of the prior years, our sales were heavily impacted by the lack of sales to our OEM partners, as Stryker sales were down over 80%, and Codman sales were down 31.6%, both representing approximately $0.5 million in [sales piece].

Our core businesses in ophthalmology grew 15.2%, and neurosurgery grew 20%. Combined sales generated gross margins of $6.8 million or 58%. These margins were up 0.6 of a percentage point from the comparable period last year, primarily due to a selling price increase at the beginning of the fiscal year, partially offset by change in mix toward higher international products during the current quarter.

Our operating income was $238,000 or 2%, as compared to the second quarter last year when operating income was $182,000 or 1.6%. SG&A increased $263,000, primarily due to increased selling expenses of about $800,000 on a 12.5% increase in selling headcount.

Selling expense increases were offset by general and administrative decreases as legal costs decreased $333,000, and directors fees decreased to $113,000 as the cost of their options are now being expensed pro-ratably throughout the year. These G&A costs decreases were partially offset by an increase of $127,000, and amortization of the intangible assets acquired under our settlement agreement with Iridex.

Our net loss was approximately $54,000 or breakeven per diluted share, as compared to the second quarter last year when net income was $182,000 or $0.01 per diluted share. EBITDA generated from these earnings was approximately $746,000, and reconciliation to this number will be posted to our website shortly.

As compared to the sequential quarter of October 29, 2007, sales were up 11.1%, and gross profit margin was down 4.3 percentage point, primarily due to the mix of international sales and a decrease in our disposable capital mix.

SG&A increased $528,000, primarily due to $179,000 increase in selling costs, and a $99,000 increase in G&A salaries. R&D increased $248,000, as cost of newly introduced products increased, and spending on 29 major active R&D projects increased.

Operating income decreased $547,000, from $785,000 to $238,000 due to these factors. Net income was impacted by these factors, and decreased to a loss of $54,000 or breakeven per diluted share, from the net income of $397,000 or $0.02 per share in the sequential quarter of October 29, 2007.

Synergetics net sales for the first six months of fiscal 2008 were $22.1 million. Although this represents growth of only 4% over the comparable period of the prior year, again our sales were heavily impacted by the lack of sales to Stryker and Codman, with Stryker sales being down about 85.6%, and Codman sales down about 30%.

Reported margins for the six months, 60% for fiscal 2008, were unfavorable to the prior period by approximately 0.3 percentage point, primarily due to the change in mix toward higher international sales, and lower OEM sales from Stryker and Codman.

Operating income increased from $900,000 in the first six months of fiscal 2007 to about a $1 million for the first six months of fiscal 2008, as SG&A increased $617,000 and R&D decreased $284,000, as costs associated with newly introduced products decreased during the six months period.

SG&A increases were due to increased selling expenses of $1.6 million on a $12.5 million increase in selling headcount, and our continued investment of $592,000 in our sales force as we expand both the domestic and international distribution.

Legal costs decreased $686,000, primarily associated with the settlement of the Iridex patent litigation, our Directors fees decreased to $114,000, and our amortization expense increased $291,000 on those intangibles acquired and business settlement with Iridex.

Net income decreased from $558,000 or $0.02 per diluted share for the first six months of fiscal 2007 to $343,000, or $0.01 per diluted share for this six months period. EBITDA generated from these earnings was approximately $2 million.

As of January 31, the company had approximately $153,000 in cash and $18.3 million in interest-bearing debt. The increase in debt of $763,000 over the prior year was primarily increased borrowings under our revolving credit line and equipment line.

The borrowings under these revolving credit facilities increased due to our working capital needs as we built Stryker generators in advance of the shipment date and to finance approximately $400,000 of the cost of expansion of the R&D facility.

Our working capital ratio is 1.73 to 1. As of today, we have our working capital revolving credit facility which provides for borrowings of up to $9.5 million and has availability of approximately $2.4 million. In addition, we have $895,000 available under our foreign receivables credit line and $242,000 available under our equipment line of credit, for a total availability of approximately $3.5 million.

As of January 31, 2008, our leverage ratio was 3.17, versus a max of 3.75, and our fixed charge coverage ratio was 1.31 times, versus a minimum of 1.1 times. Cash flow utilized in operations was $530,000 for the six months ended January 31, 2008. Borrowing the majority [of it] we expect to finance our ongoing working capital, capital expenditures and debt service needs for the next 12 months through our cash flow from operations and these available borrowings.

I'll turn it over to Gregg now to address our operations and current business development.

Gregg Scheller

Thanks, Pam. As Pam said, our growth rate for the second ended January 31, 2008 was 2.5% over the comparable prior quarter, and 11.1% over the sequential quarter ended October 29, 2007.

Reduced sales to OEM customers, Stryker and Codman, impacted sales dramatically. Stryker sales were off as compared to the prior year quarter by over 80%, or over $1.5 million. Codman sales were off 28.3%, or approximately $1.5 million. However, the growth in sales across our core businesses was healthy, with ophthalmology increasing 15.2%, and neurosurgery increasing 20%.

I am pleased with the quarter-over-quarter growth of 35.8% across our international product lines, with ophthalmology growing 25.4%, and neurosurgery sales growing at 94%. We have invested an additional $277,000 in our international distribution during the second quarter compared to last year. Establishment of these entities has been an expensive, but it is providing a foundation for future growth.

Gross profit margin of 58% in the second fiscal quarter of 2008 was impacted by lack of OEM sales and our increased mix of international sales. We have also started to implement corporate-wide cost savings initiatives. We expect a number of these ideas to positively impact the cost structure in the months and the years ahead.

I am optimistic about the remainder of fiscal 2008 sales and profitability, because the OEM orders for our products are already in hand, and we have paid for the parts and some of the labor. We expect to begin shipments to Stryker in Q3. We believe that we will see our traditional levels of sales growth by the end of the fiscal year. We have reprioritized R&D lists, and are focusing on 29 major R&D projects which I believe will produce new opportunities across all of our product platforms, both capital and disposable.

I also believe you will see at least one new product platform emerge out of these ideas. We continue to work on our margins through selling price increases and cost savings ideas, and on our SG&A costs through our cost savings ideas.

On the R&D front, Synergetics has produced and introduced over 15 new Catalog Numbers over the first six months of fiscal 2008. New products, which we define as products introduced within the last two years, were responsible for approximately $3.3 million in sales, or 15.1% of our total sales for the company on a consolidated basis for the six month. Highlights include multiple disposable accessories for virtually every one of our technology areas of instrument, illumination, laser, power ultrasound, and electrosurgery.

Synergetics now has 33 patents, with several dozen more pending. Our intellectual property is very important to us and we intend to vigorously defend our IP position. Synergetics is a company who has close to 20% plus growth for the past six years including the past 2.5 years as a public company. The company has had growth of over 15% every single year since its inception.

I am excited about the future and our opportunities. I look forward to Q3 and Q4 and I expect sales to return to more robust levels as the new Stryker model is introduced. I also look forward to the expected impact that our new EVP of Sales and Marketing Dave Dallam will have on our business. You will see some major cost savings initiatives introduced and some impact of meaningful new product introduction in Q3 and Q4. As it is the end of our prepared remarks, I'll now turn it back to the operator so that we can take your questions.

Question-and-Answer Session

Operator

Thank you. We'll now begin the question-and-answer session. (Operator instructions). The first question comes from [John Reuter]. Please go ahead.

John Reuter

Good afternoon. It would appear from the numbers that you are making progress on the international fund where you went through quickly from longer transition from a having agents to having a direct sales force. Could you talk about what's going on internationally?

Gregg Scheller

Yeah. Sure. John thanks. This is Gregg. What's going on right now internationally is we are transitioning from an independent to a direct sales force in ophthalmology, but we are also laying the foundation for a similar transition in neurosurgery. In other words, some of the management that's been put in place there, we believe, will probably have a role to play when we begin to look at neurosurgery. The differences that you have seen thus far are largely a result of direct efforts in Germany and Italy, and Italy hasn't had as big an impact as Germany has yet. But we are also direct in France, I think starting the 1st of March, and we expect Italy to come online, and we're also working in some other major markets as well. So what we think you are seeing is the tip of the iceberg there, as far as our international growth goes. There is a lot of leg work that needs to be done from a legal and accounting and inventory standpoint internationally, prior to us realizing the benefits in a given country, and so, I really think that we're just sort of scratching the surface there.

John Reuter

Okay. Thank you.

Gregg Scheller

You're welcome.

Operator

The next question comes from [Barney Harris]. Please go ahead.

Barney Harris

Hello everybody.

Pam Boone

Hi, Barney.

Barney Harris

Hi, Pam. Is there any more news on some of the products you have talked about last time that are in the final stages that are being introduced?

Gregg Scheller

Barney, this is Gregg.

Barney Harris

Hi, Gregg.

Gregg Scheller

Hi. What you have seen is sort of a pullback from some of these efforts, relative to informing you guys, prior to a new product introduction and so. We've gone ahead and we've introduced certain new products on a limited basis, and the press releases that you saw from us previously have been curtailed somewhat, because it didn’t seem to be meaningful to the investor base, and it was informing our competition too early in the new product introduction.

Barney Harris

I thought you had mentioned this was the one that Jerry is working on?

Gregg Scheller

Yeah, there are some new products in that mix, not a lot, but there are some substantial -- I wouldn't just call them substantial contributions right now. But there are some products in there that we think will probably contribute substantially as we go forward. And I think that as those become a meaningful part of the numbers, we will probably include those and introduce those formally to the investor base.

Barney Harris

Okay.

Operator

(Operator Instructions). The next question comes from Stan Manne. Please go ahead.

Stan Manne

Yeah, good afternoon. Your regular is shifting from distributor to direct sales in Europe. How will that affect our gross margins and our net margins after the increased costs of the direct sales?

Gregg Scheller

Stan, as you probably know, in Europe especially, the value of the euro versus our dollar is in our favor, and we feel like our products are relatively inexpensive there. So one of -- Dave Dallam's in the room by the way as well as Kurt Gampp, I think he was introduced at the beginning -- they were both introduced at the beginning. One of the things that Dave is looking at is trying to get as much for our products as we reasonably can in the European market. And so what we've seen thus far is that the product mix has affected gross profit margins, but not to the extent that we would expect it to internationally. In other words, I think we are probably giving a fairly fair price for our products internationally. That will continue to be looked at as the dollar-euro continues to shift or shifts back the other way.

And we will attempt to maximize our profits there. But if you look at our international mix in this quarter, I would have, probably last quarter, expected it to have affected gross profits in a greater way than it did. So -- and that sort of combined with the fact that we bought a bunch of parts for the Stryker, we had supplier agreements, essentially blanket purchase orders that we couldn't shut off. We expected to be shipping Stryker by now, and so we took a bunch of inventory, parts inventory, into our warehouses and we didn’t realize sales off of that ,and still with that we realized that a gross profit improvement over last year's second quarter. So, I am not looking for a major impact as our gross profits shift internationally.

Stan Manne

So, net-net, it will be similar for a while?

Gregg Scheller

That's what it looks like. Yes.

Stan Manne

Okay, second question. The Iridex settlement and effects on the company, how -- what have been the effects, sales, et cetera, in this quarter and future quarters, if any?

Dave Dallam

Sales wise? Sales in the second quarter were close to zero. We had some start-up hiccups with them, and we are now shipping to them on a regular basis as of today. But they, I believe, there was some poor communication between the two companies starting that process, and I think they probably depended upon their previous supplier longer than we had anticipated them doing. But today, those are at a regular run rate, and I don’t know what that run rate is. It's not a material impact on our business, I don't believe, but I'm sure that those numbers will show up in Q3, and we'll be perhaps more prepared for that question, but there aren't really any significant numbers in Q2.

Stan Manne

Okay. And your sales to the OEMs, do you expect them to grow over prior year, as that would be to Stryker and to Codmans?

Gregg Scheller

I do not expect Codmans to grow. I believe that last year, what you are seeing is the effects of them building inventory within Codman last year. And this year, these sales are probably more normal, if you will, but certainly the Stryker business is going to come back and come back strong. We've got orders in hand for Q3 and Q4, and we expect to start shipping Stryker units in Q3. And if you recall, we have a contract with Stryker that requires them to buy 300 units on a calendar year basis, and we expect to fill -- well in fact we have orders for all of those 300 units.

Stan Manne

Well, how many have we shipped so far in this year of the 300?

Gregg Scheller

Zero.

Stan Manne

Zero? And they are valued at what per unit, approximately?

Gregg Scheller

I'm not sure that Stryker would, that may violate some confidences that we have with Stryker, but 300, well, let's say that our budget for Stryker for this year is about $2.5 million.

Stan Manne

Okay, so that's sufficient, and Codman is going to stay flat?

Gregg Scheller

I believe these are normal run rates for Codman.

Stan Manne

And how has the new Malis Advantage unit affected them in their sales in the field?

Gregg Scheller

Well, certainly the sales of Malis Advantage units have increased during this Q2, and we continue to see increases. So it does impact it, because in the United States there are virtually no competitors for those products, and so you can almost, each time we sell on directly, you can almost subtract that from the OEM business for Codman. But I know that Codman's business is still growing, and so we are looking at a [net offset of Euro]. So, we expect Codman's business to return to prior levels, which is about what Valley Forge was doing with them, which is I don't know $4 million, $4.5 million, $5 million a year.

Stan Manne

Okay, thank you.

Gregg Scheller

You are welcome. Thank you.

Operator

(Operator Instructions) At this time, there are no additional questions. Please go ahead with any concluding comments.

Pamela Boone

Thank you very much.

Operator

Thank you for participating in today's conference call. This concludes your conference call for today. You may all disconnect at this time.

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