CONMED Corporation 10-Q Summary
Business Context and Reporting Period
CONMED is a medical technology company providing surgical devices and equipment for minimally invasive procedures across orthopedic surgery, general surgery and surgical visualization. This unaudited report covers the three months ended March 31, 2016, compared with the same period in 2015.
Approximately 80% of revenue is generated from single-use products, and international sales represented approximately 47% of first-quarter 2016 revenue. On January 4, 2016, CONMED acquired SurgiQuest, Inc., maker of the AirSeal system, for $257.7 million in cash.
Key Financial Metrics
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Net sales | $181.2 million | $177.9 million | Up 1.8% |
| Gross profit | $97.7 million | $92.3 million | Up $5.5 million |
| Gross margin | 53.9% | 51.9% | Up 2.0 percentage points |
| Income from operations | $3.5 million | $11.0 million | Down $7.4 million |
| Operating margin | 1.9% | 6.2% | Down 4.3 percentage points |
| Net income (loss) | $(2.3) million | $6.3 million | Declined $8.6 million |
| Diluted EPS | $(0.08) | $0.23 | Down $0.31 |
| Cash flow from operations | $(17.3) million | $14.8 million | Down $32.1 million |
| Capital expenditures | $2.8 million | $4.1 million | Down $1.3 million |
Gross margin benefited primarily from favorable production variances, partly offset by unfavorable foreign currency effects. Selling and administrative expense increased to $85.9 million from $74.8 million, including $9.0 million of SurgiQuest acquisition and integration costs. Research and development expense increased to $8.3 million from $6.5 million.
The company recorded $2.9 million of other expense related to debt refinancing, consisting primarily of a $2.7 million charge and a $0.3 million loss on early extinguishment of debt. Interest expense increased to $3.8 million from $1.5 million due to higher borrowings and rates. The effective tax rate was 29.9%, resulting in a $1.0 million tax benefit, compared with a 33.5% tax expense rate in 2015.
Revenue and Segment Trends
| Product line | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Orthopedic surgery | $93.4 million | $98.6 million | Down 5.2% |
| General surgery | $75.9 million | $66.1 million | Up 14.9% |
| Surgical visualization | $11.9 million | $13.3 million | Down 10.7% |
Excluding SurgiQuest, sales declined 5.3% to $168.5 million; on a constant-currency basis excluding the hedging program, sales increased 5.0%. SurgiQuest contributed $12.7 million of reported sales during the quarter. Single-use product sales increased 3.4% to $144.9 million, while capital equipment sales declined 4.0% to $36.3 million.
Liquidity, Cash Flow and Debt
Cash and cash equivalents declined to $19.9 million at March 31, 2016 from $72.5 million at December 31, 2015. Net cash used in operating activities was $17.3 million, primarily reflecting the net loss, working-capital requirements and acquisition-related effects. Net cash used in investing activities was $259.2 million, including $256.4 million paid for SurgiQuest. Financing activities provided $223.2 million, primarily from new borrowings.
At March 31, 2016, current assets were $367.9 million and current liabilities were $103.2 million, producing reported net working capital of $264.8 million. Long-term debt was $511.6 million and the current portion of long-term debt was $10.1 million. Borrowings included $172.8 million under the term loan and $344.4 million under the revolving facility. Revolving availability was $175.5 million, with approximately $5.1 million reserved for letters of credit.
The amended credit agreement provides a $175.0 million term loan and a $525.0 million revolving facility, both maturing January 4, 2021. The agreement is secured by substantially all personal property and assets and includes financial covenants. CONMED reported full compliance with the covenants as of March 31, 2016. Management stated that operating cash flow, cash on hand and available borrowing capacity should meet anticipated working-capital, debt-service and capital-expenditure needs in the foreseeable future.
Material Changes, Outlook and Unusual Items
- The SurgiQuest acquisition materially increased goodwill by $136.4 million and added $130.8 million of acquired intangible assets. The purchase-price allocation remained preliminary.
- Management expected the acquired AirSeal system to generate approximately $55 million to $60 million of revenue in 2016.
- Acquisition-related costs, refinancing charges, higher interest expense and restructuring costs caused earnings and operating cash flow to deteriorate despite higher sales and gross margin.
- Restructuring costs totaled $3.7 million in the quarter, including $0.9 million in cost of sales and $2.8 million in selling and administrative expense. The company expects additional restructuring activities but had not estimated their costs.
- Capital expenditures were expected to approximate $16.0 million for 2016.
- The company continued to evaluate the impact of new revenue-recognition, lease and share-based-payment accounting standards. The filing states that the impact of the revenue-recognition and lease standards had not yet been determined.
Risks and Contingencies
- Integration and execution risks related to SurgiQuest, including the ability to achieve projected revenue synergies, cost savings and product acceptance.
- Higher leverage, interest-rate exposure and covenant restrictions under the amended credit agreement.
- Foreign exchange volatility, competition, customer purchasing patterns, technology changes, material costs and regulatory requirements.
- An outstanding FDA warning letter related to the Centennial, Colorado facility. Further inspections or regulatory actions could result in material costs, fines or other remedies.
- Potential product-liability, patent, environmental and regulatory claims. Management did not expect currently pending matters to materially affect financial condition, results or cash flows, but noted that future matters could do so.
- Reliance on the availability and quality of allograft tissue used in certain sports-medicine offerings.
Investor Verification Checklist
- Verify SurgiQuest integration progress, AirSeal revenue performance and whether the $55 million to $60 million 2016 revenue expectation was achieved.
- Reconcile reported revenue growth with the underlying decline excluding SurgiQuest and assess constant-currency performance.
- Monitor operating cash flow, cash balances, inventory growth and available revolving-credit capacity.
- Review leverage, debt maturities, interest rates and compliance with financial covenants.
- Track acquisition-related, restructuring and refinancing costs and their effect on normalized margins and earnings.
- Follow developments regarding the FDA warning letter and remediation of the Centennial facility.
- Assess whether additional restructuring charges or costs associated with the preliminary acquisition accounting arise in subsequent periods.