Symmetry Medical Inc. F1Q08 (Qtr End 3/29/08) Earnings Call Transcript

Jun.24.08 | About: Symmetry Medical (SMA)

Symmetry Medical Inc. (NYSE:SMA)

F1Q08 Earnings Call

June 24, 2008 8:00 am ET

Executives

Brian Moore – Chief Executive Officer

Fred Hite – Chief Financial Officer

Analysts

Ben Andrew - William Blair

Michael Matson - Wachovia Capital Markets

Mark Mullikin - Piper Jaffray

Operator

Good morning ladies and gentleman, and welcome to the first quarter 2008 Symmetry Medical Incorporated Earnings Conference call. My name is Shequana, and I will be your coordinator for today. (Instructions). I would like to turn the presentation over to your host for today’s call, Ms. Carol Ruth. Please proceed.

Carol Ruth

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

By now, you should have received a copy of this morning’s press release. If you have not received a copy, please call R.J. Pellegrino at 646-536-7009, and he will fax or e-mail you a copy.

Statements in this conference call regarding Symmetry Medical’s business which are not historical facts maybe forwarding-looking statements that involve risks and uncertainties within the Safe Harbor Provision of the Private Securities Litigations Reform Act of 1995. Forward-looking statements are predicted in nature and are presently identified by the use of terms such as “may,” “will,” “should,” “expect,” “believe,” “anticipate,” “plan,” “estimate,” “intent,” 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 expectation. 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 innovations by our competitors, product liability, changes in management, changes in conditions affecting the economy, orthopedic device manufacturers, or medical device industry generally, and changes in government regulation of medical devices and third party reimbursement practices. We refer you to the risks, factors, and forward-looking statement sections in the company’s most recent annual report on Form 10-K filed with the Securities and Exchange Commission as well as the company’s other filings with the SEC which are available on the SEC’s website at www.sec.gov. Before turning the call over to 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 Moore

Good morning, and thank you, Carol. Thank you to everyone for joining us on our first quarter 2008 investor conference call. We’re very pleased with record quarterly revenues generated in first quarter which demonstrate the strong demand we are experiencing throughout our daily business, but we are, however, looking forward to improved bottom line performance. Quarter one profitability was reduced by two factors: Net losses at out Sheffield UK operating unit and the residual costs of the Sheffield investigation. We are aggressively addressing the operational issues at Sheffield and believe that a number of our initiatives are showing results. Fred and I will both comment on each of the factors throughout our comments this morning. We are encouraged by the industry environment, the successful integration of our acquisitions and the positive momentum we are seeing.

Our revenue for the first quarter was $101.9 million, 57.4% growth rate over last year with organic growth of 33%. We believe the demand for new product launches by our major customers should fuel revenue for the reminder of the year and into 2009. We expect this positive momentum will further expand our gross margins as we improve operating efficiencies and as the volumes impact on our fixed cost base. Our ability to respond well to this demand reinforces our strategic decision to maintain our infrastructure and fixed costs during slower sales periods, and we are in an ideal position to respond to our customer’s requirements.

Our recent acquisitions continue to perform well and are driving revenues and adding new customer relationships, and also producing synergistic effects and cross-selling opportunities that we expected. The acquisition of SSI in August 2007 was a key achievement of our diversification strategy. It provides us with a distribution network and wider market access for a broad range of new medical instruments in areas such as neurology, cardiology, and laparoscopy. It also allows us to have access into hospitals through niche product areas where SMA has had limited presence. It not only provides additional marketing benefits, it also provides us with important intelligence on the end market. SSI Q1 sales of $5.9 million are ahead of last year.

The New Bedford Massachusetts orthopedic manufacturing facility acquired from DePuy has also performed exceptionally well in a short period of time. Progress and speed of the integration is exceeding our expectations and has resulted in the plant operating at record levels of output within a few months. New Bedford has further solidified our leadership position in the orthopedic instrument industry, reinforced a major established customer relationship, and is providing a major opportunity to leverage their capacity at a very opportunistic time. We particularly appreciate the performance of the New Bedford team led by [__________] as they have embraced joining SMA in a very positive and results oriented way. We look forward to New Bedford facility playing a much larger role within the group and in particular supplying a broader base of SMA customers.

Let me now address the situation at Sheffield and some of the actions we have taken to improve its operational and financial performance. For the first quarter 2008, Sheffield represents approximately 15% of our overall revenues. However, margins at Sheffield are significantly below our overall corporate performance. Our first action was to replace and upgrade the senior management team, and we are very pleased to have completed that task during the fourth quarter of 2007 and throughout the first quarter of 2008. The accounting restatement process has enabled us to accurately access and evaluate the real performance of this facility. As a result, we identified several areas that required attention to improved profitability.

First priority for management in the Sheffield team who have worked tirelessly throughout Q1 was to improve customer service and clear orders that were past due. This has been largely achieved and has significantly improved the confidence of customers in the Sheffield operation. We are very encouraged that the work of our European management team led by John Hynes and Mark Brooks has resulted in our major customers being very supported. These customers have indicated that they intend to place additional work at our Sheffield facility in recognition over the improved service levels and a much more responsive customer service attitude at Sheffield. This did, however, result in premium operating costs being incurred during the first quarter.

Our efforts to return Sheffield’s profitability are being tackled as a group exercise with considerably resources being deployed from both internal and external sources, but in these difficult situations, opportunities always exist, and we consequently have identified several initiatives that result in a fairly quick improvement in performance. These include greater efficiency in material procurement, and we have added a specialist executive to our team to focus on this; some price increases to recover significantly higher costs that have incurred over the recent years that are being passed on; plus several internal operating efficiency improvements that are being led by new operations executive Gordon Owen. This improvement process will, of course, include a review of our people and regretfully will lead to some layoffs at this facility. All of these actions are being addressed very aggressively. Our improvement plan has already identified and targeted several million dollars per annum of benefits which will impact Q3 results and progressively improve our results at this facility thereafter.

Our first priority to increase output in order to meet customer needs resulted in incremental increase in Sheffield revenues from Q1 2007 of $13.8 million to $15.5 million in the first quarter 2008, which also represents a 5% sequential increase from Q4 2007 of $14.7 million. After cost reductions and efficiency improvements are implemented, we expect further improvements that will result in a smaller loss in the second and third quarter. By the fourth quarter of 2008, we expect Sheffield to be profitable. We plan to report progress on this activity separately for the rest of 2008.

The other impact of Q1 results was the professional service costs incurred as the Sheffield investigation closes down. In Q1, we incurred $2.2 million of costs largely comprising of legal and accounting fees. Whilst we still await the final outcome of the informal enquiry from the SEC, we anticipate that these costs will significantly reduce from Q2 onwards. However, we do have to await the reviews of the views of the SEC with regard to if any further work is required.

So in summary, we have an excellent top line performance which we will develop and build on. Sheffield will turn around and its profit will improve throughout the year, and the investigation costs are expected to reduce, and the management team has a very high level of confidence that we are able to deliver improvements in both of these areas. Consequently, our expectation has reflected in our finance guidance with a ramp-up of company profitability for the rest of 2008, a trend we expect to continue into 2009.

With that, I would like to hand over the call to Fred for a more in-depth analysis of our financial performance.

Fred Hite

Thank you, Brian. Let me underscore that we are very pleased with our top line performance for the quarter and look forward to increasing profits going forward. During the first quarter of 2008, we achieved record revenue of $101.9 million, up $37.1 million or 57.4% from the first quarter of 2007 revenue of $64.7 million. This includes revenue of $1.8 million from TNCO which we acquired in April 2007, $5.9 million from SSI which we acquired in August 2007, and $7.7 million from the New Bedford manufacturing facility which we acquired from DePuy on January 25, 2008. Excluding acquisitions, revenue grew by $22 million during the first quarter, representing organic growth of 33% year over year. This growth is driven by many large projects as well as a return of base load as our customers have used inventory in 2007.

First quarter 2008 revenues by business segment were as follows: Implant revenue was $30.3 million, up 33.6% from the first quarter 2007 revenue of $22.6 million. Instrument revenue was $39.3 million, up 123.4% from the first quarter 2007 revenue of $17.6 million. Instrument revenue includes $7.7 million from New Bedford, $5.9 million from SSI, and $1.8 million from TNCO. Excluding acquisitions, we achieved 33% organic growth in the instrument segment.

Case revenue was $21.5 million, up 22.9% from the first quarter 2007 revenue of $17.6 million. Other revenue was $10.8 million, up 16.7% from the first quarter 2007 of $9.2 million.

Segmented by geography, first quarter 2008 revenue breaks down as follows: Revenue from the United States was $67.9 million, up 75.5% from the first quarter 2007. Revenue from the United Kingdom was up 39.5% to $16.6 million compared to the first quarter of 2007. Revenue from Ireland was $8.6 million, up 48.3% compared to first quarter 2007, and revenue from other foreign countries increased 7.3% to $8.8 million.

Our top ten customers represented 70% of our revenues for the first quarter 2008, up from 68% in 2007, primarily as a result of the New Bedford acquisition. Our two largest customers accounted for 32.2% and 10.8% of our first quarter 2008 revenue while they accounted for 16.5% and 12.1% of our first quarter 2007 revenue. Gross profit for the first quarter 2008 was $23.9 million, 104.4% increase from gross profit of $11.7 million in the first quarter of 2007. Gross margin for first quarter 2008 was 23.5% compared to 18.1% for the first quarter 2007. Gross margin for the first quarter 2008 was unfavorably impacted by negative gross margin incurred at the company’s Sheffield UK operating unit due to excess time, effort, and resources required to increase customer responsiveness as well as the impact of higher raw material costs during the first quarter 2008.

I’d stated on our last earnings conference call that I expected first quarter 2008 gross margins to be around 25%. While we did fall a little short of this, it is because of the unexpected negative gross margin at Sheffield, and I’m very pleased to report that excluding Sheffield the businesses achieved 28.2% gross margin, and this compares to 24.1% gross margin for the business excluding Sheffield in the first quarter of 2007.

As Brian mentioned, we anticipate significant improvements in the operational and financial performance at our Sheffield UK operating unit throughout 2008 and into 2009. These improvements are being driven by the upgraded management team in place at Sheffield as well as support from other non-Sheffield based executive within Symmetry Medical. This collaborative effort across the group will deliver savings in four major categories: Material purchases, selective price increases, efficiency improvements, and targeted payroll reductions.

First quarter of 2008 selling and general administrative expenses were $14.4 million compared with first quarter 2007 SG&A of $7.6 million. The year-over-year increase was primarily driven by the inclusion $2.7 million of acquisition-related expenses and $2.2 million in professional fees and other expenses incurred with connection of the review of accounting irregularities at the company’s Sheffield UK operating unit. This increase was also due to initiatives at the Sheffield UK operating unit to improve overall efficiencies, meet customer demand, and drive increased sales.

Operating income for the first quarter 2008 was $9.6 million, a 135.4% increase over operating income of $4.1 million for the first quarter of 2007. Income before taxes for the first quarter 2008 was $5.8 million compared with $2.1 million for the first quarter of 2007. For the first quarter of 2008, we reported net income of $4.0 million or $0.11 per diluted share, compared to a net income $1.6 million or $0.05 per diluted share for the first quarter of 2007. Included in the first quarter 2008 results was $2.2 million pretax or $0.04 per diluted share in professional fees and other expenses incurred in connection with the review of the accounting irregularities at the company’s Sheffield UK operating unit and the effects of a net loss at Sheffield of $1.9 million or $0.05 per diluted share.

Foreign exchange had a favorable impact on our first quarter 2008 results. The impact to revenue was a favorable $1.8 million and the impact to net income was a favorable $0.3 million. We ended the first quarter of 2008 with $9.3 million of cash, and we had a net cash used in operating activities of $8.5 million. This was driven by the build-up of receivables at New Bedford as we did not purchase any receivables with the acquisition, as well the overall increase in sales across the business drove up receivables at the end of the first quarter.

The weighted average number of diluted shares outstanding during the first quarter of 2008 was 35,335,000. As Brian mentioned, our focused team in Europe is working diligently to bring Sheffield’s financial performance in line with the entire group. While we do have a long ways to go, we are pleased to report that we’ve made some positive financial and operational improvements since the first quarter.

As it relates to our relationship with our lending group, we have our covenants by reporting our first quarter 2008 results before the June 20th deadline, and we fully expect to be back on a normal financial reporting schedule with the release of our second quarter 2008 financial results during the first or second week of August 2008.

Now, I will briefly discuss our guidance for the full year 2008. Our guidance is based on current order flow and the customer demand we are seeing at our facilities. As stated in our press release, we are increasing full year revenue guidance to a range of $395 million to $405 million up from the previously stated range of $350 million to $360 million. On the bottomline, we expect full year 2008 earnings per share of between $0.75 to $0.77.

I would also like to reiterate that we continue to anticipate ending the year with gross margins around 27%. The increase from the first quarter 23.5% will come from two areas: The first area is the significant improvements at our Sheffield site. We’ve already made nice progress, and we have plans in place to deliver significant improvements before year end. The second area will be continued improved profitability at our non-Sheffield sites as they continue to improve execution.

I will now turn the call back over to Brian for comments.

Brian Moore

Thank you very much Fred. At this time, we’d like to open the call for any questions, and we’ll be very happy to deal with them. Thank you very much.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Ben Andrew with William Blair.

Ben Andrew - William Blair

A couple of quick questions, maybe starting on the strategic side, Brian. As you look at the industry dynamics now, obviously revenue performance is improving. What are you seeing competitively and what are you seeing on the pricing side in terms of volume versus price increases that are driving that revenue performance?

Brian Moore

The main thing we’re seeing in the immediate short term is major customers wanting products very quickly, and there are some premium pricing opportunities out there if you can deliver quicker than competition, which although we do have some issues in the main, we are able to deliver with shorter lead times. As a consequence, we have some premium pricing opportunities, but as with everything in our business, we have to watch our prices, we have to ensure we remain competitive, so the main focus is, number one, quality which is always a given, and number two at the moment is demand to meet customers’ requirements and demand from their end-users.

Ben Andrew - William Blair

Is that markedly different you’ve seen in the last year, because I know we’ve seen an upturn in customer demand for product in relatively short time frame, and is it also coming with larger projects?

Brian Moore

Yes, the projects are getting larger, and we’re seeing some of the competitors getting busy, and we took a strategic decision during the slower period not to respond aggressively with price reductions, where some of our competitors appeared to have done that. Now they have their facilities loaded with capacity at lower prices, and that means that they are unable to respond in some areas as well as we are, and the general industry dynamics switch. It’s fundamental economics really. It’s basic demand and supply. As the demand increases, then prices do move up a bit, and as the demand goes down, then the OEMs put more pressure on for price reductions.

Ben Andrew - William Blair

Turning to Sheffield briefly, did that facility previously operate at corporate average gross margins, and do you think you can get back there over time, or is this something where should be thinking that’s going to stay below the 27% target for the end of the year?

Brian Moore

I would be surprised if Sheffield operated at 27% by the end of this year. It should be capable of moving up to that maybe next year or the year after. It typically and traditionally as far as we know, because clearly we’ve been working on those figures, always did have a slight discount to the rest of the group, mainly because it has a predominance of aerospace work in there which is a slightly lower gross margin than the medical sector, but we do expect to see some improvements going forward.

Fred Hite

Ben, in years past, on a restated basis, this facility has broken even. It did have lower gross margin rates than the company average back then on a restated basis, and it has moved into a losing position in 2007 and 2008 because of some significant material price inflation that was occurred over the last two years, and now that we see the real financials, we’ve got the teams in place to be able to address the issues.

Ben Andrew - William Blair

And do you feel like you can pass along those costs to the customers as the new contracts roll on?

Brian Moore

Yes, we’ve already discussed with major customers and got agreements and signup for quite significant price increases which will in the main start impacting July 1st onwards, and our customers have been very understanding because in their world they understand that [inaudible] passed on fundamental raw material costs, which they are experiencing themselves in areas like cobalt chrome, and they also understand the reality of what we’re doing at Sheffield. We’re trying to create a facility that will service their needs, and we’re certainly not being extravagant in terms of passing anything on other than real costs, which have not been passed on in the past.

Operator

(Operator Instructions). Your next question comes from the line of Michael Matson with Wachovia Capital Markets.

Michael Matson - Wachovia Capital Markets

First of all, can you tell us what the currency impact was in the quarter?

Fred Hite

Yes. The currency increased our revenue $1.8 million over prior year and increased net income by $300,000.

Michael Matson - Wachovia Capital Markets

Okay. Given the big price hike like we’ve seen in energy and so forth and given that some of the shipping companies are trying to pass along some of those costs to customers, I was wondering if there was any risk of increased expense there, and just in general in your shipping charges, are you able to pass those on to your customers?

Fred Hite

Yes, when you look at our business, shipping cost is relatively a small portion of our overall costs. Labor obviously, material, and overhead of the factories are the biggest buckets of costs, so yes, we’re seeing a little bit of inflation obviously as everybody else is on our shipping fees as well as in our energy costs, and as Brian was talking about earlier, it all comes down to the economics of the industry and supply and demand, and as we have more demand, we have more opportunity to pass on some of those cost increases. We’re also working on offsetting those increases with efficiency improvements at all the facilities, so it’s not all directly passed on to the customer.

Michael Matson - Wachovia Capital Markets

Okay. Can you give us an update where you are at with capacity? I know I had asked that question, I guess, on your last call, and your revenues were a bit stronger, so I don’t know if you’re giving me those numbers based on what you were seeing at the time or if this was a little bit of upside to that.

Brian Moore

Yes. We still have capacity available. New Bedford still has capacity available that is still a massive asset for us. We have some capacity available in the casing business, and we have quite a bit of capacity available in the UK Sheffield where we have invested. One of the things we haven’t banked on or worked on yet is that we have put a major investment in Sheffield in forging capacity which cost us about $10 million. That facility along has the capability of running up another $10 to $15 million in sales in the next 2 or 3 years if we can find and create the sales opportunities, but we are under a degree of pressure as you would imagine when we are operating at record levels, $400 million, and lead times are going out a bit, but we still think we are remaining competitive.

Michael Matson - Wachovia Capital Markets

Okay, and then just capacity utilization?

Fred Hite

Yes, Mike. I would say on our core business, we’re probably in that 80% range plus or minus. There are absolutely areas where we have selective capacity that we can bring on quickly and then obviously within that 80%, there are buckets where we’re running full out on some particular machines, but overall it has obviously increased significantly from where it was probably a year ago, probably down in that 65% range, so we’re moving up the curve nicely.

Brian Moore

And we continue to invest, because although the banking arrangements have inhibited our ability to acquire companies, we have continued with capital expenditure. For example, we just invested in a fairly major sale that produces high-precision spinal parts, so we are building capacity as we go to meet the demands of the business.

Michael Matson - Wachovia Capital Markets

One final question. Can you give us an update on Malaysia? It sounded like things were progressing pretty well there, I guess, on your last call, but just update on square footage, if you have anything you can give us there.

Brian Moore

Yes. We are just in the process of relocating to a 50,000 sq ft facility. That’s underway literally now, and that will do two or three things for us. It will enable us to expand our case production which has outgrown our last facility, and we’re also starting now to commence instruments facility production there, and we’re still continuing to try and engineer it so that we’ve got a design in development. We are very confident that we not only will grow this facility rapidly, but we’re also seeing more demand coming in from our Japanese customers that will be located in the Malaysian facility to serve the wider Asian market.

Operator

Your next question comes from the line of Mark Mullikin with Piper Jaffray.

Mark Mullikin - Piper Jaffray

I just want to clarify on the guidance, the $0.75 to $0.77 per share for the full year. I believe that includes the professional fees for the investigation. Does it not?

Fred Hite

Yes, it does.

Mark Mullikin - Piper Jaffray

Okay, and how does it factor in for that fees?

Fred Hite

$3 million for the year.

Mark Mullikin - Piper Jaffray

The acquired SG&A expenses of $2.7 million in the quarter, do you expect a portion of those to go away?

Fred Hite

No. A lot of it is related to SSI, which as we’ve talked about in the past, is a distribution company that has a different model, if you will, than the rest of our business, so their SG&A costs are roughly 25% of their sales because they have a large sales force selling their product, so there are not a lot of synergies between that sales force and our sales force. That’s what attracted us to the business, so those are costs that are going to primarily be in place going forward.

Mark Mullikin - Piper Jaffray

Finally, can you just give us a little bit more color on the commodity prices? How much are those up year over year and quarter over quarter?

Brian Moore

As a general point, the only commodity that’s showing fairly significant increase at the moment is cobalt chrome which we’re a fairly significant user of it, but it’s not our main material spend. Our main item is titanium, which is fairly stable. Stainless steel is fairly stable, but we have to watch that because world demand particularly from China is increasing, and plastics, we have a long-term agreement which is holding. It’s about 5%. So far, the main increase is on the cobalt chrome, which can be as high as 30-40% year on year, all being passed on to customers.

Mark Mullikin - Piper Jaffray

Quarter over quarter, is cobalt chrome stable?

Brian Moore

Quarter 1 this year to quarter 1 last year, it’s increasing. That’s where the 30-40% increase is coming from.

Mark Mullikin - Piper Jaffray

I’m sorry, I mean sequentially. First quarter ’08 versus fourth quarter of ’07?

Brian Moore

It’s a small increase. Virtually flat.

Operator

At this time, there are no further quarter. I would now like to turn the call over to management for closing remarks.

Brian Moore

Thank you very much, and thank you for the support, particularly from our investors. We see this operation with a great deal of confidence now. We have an excellent top line. The facilities, the management, everything is highly motivated and very positive. We have to two issues we have to clear the decks on. One is the Sheffield profitability. We have fixes, we have confidence, and we have a good management team. That’s a just a function of time. It’s one of those jobs that the management team has done in the past and will confidently do in the next few months, and of course as the investigation costs reduce, we are in fact very confident and would expect a rising trend for the rest of the year. Thank you very much, and hopefully we’ll be seeing quite a few of our investors over the coming weeks for one on one discussions.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect and have a good day!

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