Business Context and Reporting Period
CONMED Corporation is a medical technology company providing surgical devices and equipment for minimally invasive procedures, including orthopedic, general surgery and surgical visualization products. This unaudited Form 10-Q covers the three and six months ended June 30, 2015, compared with the prior-year periods.
Approximately 80% of revenue is derived from single-use products, and international sales represented approximately 51% of revenue in both the quarter and year-to-date periods. CONMED operates as one reportable segment.
Financial Performance and Liquidity
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Net sales | $181.0 million, down 3.8% | $359.0 million, down 3.0% |
| Gross profit | $93.5 million | $185.8 million |
| Gross margin | 51.6%, versus 53.7% | 51.8%, versus 55.0% |
| Income from operations | $12.4 million | $23.4 million |
| Operating margin | 6.9%, versus 8.5% | 6.6%, versus 9.0% |
| Net income | $7.5 million, versus $10.3 million | $13.8 million, versus $18.9 million |
| Diluted EPS | $0.27, versus $0.37 | $0.49, versus $0.68 |
| Operating cash flow | Not separately provided | $25.1 million, versus $24.9 million |
At June 30, 2015, cash and cash equivalents were $62.2 million, compared with $66.3 million at December 31, 2014. Net working capital was $264.4 million. Total debt was approximately $259.8 million, consisting primarily of $254.0 million drawn under the revolving credit facility and a $5.8 million mortgage note.
The amended and restated senior credit agreement provides a $450.0 million revolving facility expiring April 28, 2020. Borrowings initially bear interest at LIBOR plus 1.50%; the rate was 1.69% at June 30, 2015. Available borrowing capacity was $190.6 million, with approximately $5.4 million reserved for letters of credit. The company was in compliance with all covenants.
Six-month investing cash outflows were $13.9 million, including $7.8 million of capital expenditures and $6.1 million for acquisitions. Six-month financing cash outflows were $11.1 million, including $11.0 million of dividends, $16.7 million paid under the MTF distribution agreement, and $2.4 million of EndoDynamix contingent consideration, partially offset by $19.0 million of new borrowings. Capital expenditures were expected to approximate $16.0 million for 2015.
Material Changes Versus the Prior Comparable Period
- Revenue declined primarily because of lower orthopedic surgery and surgical visualization sales, partly offset by growth in general surgery.
- Orthopedic surgery revenue decreased 5.4% in the quarter and 6.2% year to date. General surgery revenue increased 0.5% in the quarter and 2.2% year to date.
- Surgical visualization revenue decreased 12.8% in the quarter and 4.3% year to date, principally due to discontinuation of an OEM video system in the export business.
- In constant currency, excluding the hedging program, revenue decreased 0.4% in the quarter and increased 0.2% year to date.
- Gross margin declined due to unfavorable foreign currency effects, unfavorable production variances, restructuring costs and product mix. The reported impact of foreign currency was 1.6 percentage points in the quarter and 1.5 percentage points year to date.
- Selling and administrative expense decreased 5.9% in the quarter and 5.3% year to date, reflecting restructuring actions, lower medical device tax and benefit costs, and the absence of certain 2014 legal and shareholder-activism costs.
- Research and development expense increased 9.4% in the quarter and 2.0% year to date, primarily due to the timing of development projects.
- The effective tax rate was 32.6% year to date, compared with 37.5% in the prior-year period, partly reflecting New York State tax legislation. The prior-year period included a $2.3 million non-cash write-off of New York State deferred tax assets.
- Comprehensive income declined to $4.9 million year to date from $21.2 million, substantially affected by foreign currency translation losses.
Guidance, Outlook, Risks and Unusual Items
Management expects the Centennial, Colorado manufacturing consolidation to be completed within approximately six months, or by year-end 2015. Remaining 2015 restructuring costs are estimated at $2.5 million to $3.5 million, net of tax. The consolidation is expected to generate $3.5 million to $4.5 million of annual cost-of-sales savings beginning in 2016, although additional restructuring charges will be incurred before those savings are realized.
The company expects to fund the remaining $16.7 million payment under its MTF distribution agreement with cash on hand and available revolver capacity. The remaining EndoDynamix contingent consideration was $7.8 million at June 30, 2015; milestone payments were expected in 2016 and royalty payments between 2016 and 2021.
Key risks include foreign exchange and interest-rate volatility, cyclical hospital and customer purchasing patterns, competition, product development and acceptance, acquisition integration, material availability and cost, indebtedness, litigation and patent claims, allograft tissue supply, and regulatory compliance.
The FDA previously issued a Warning Letter concerning the Centennial facility and later identified eight observations, including three repeat observations, in a 2014 inspection. CONMED has submitted responses and undertaken corrective actions. Remediation costs to date were not material, but future inspections or regulatory actions could result in material costs or operating restrictions.
The company maintains product liability insurance of $25 million per incident and $25 million in the annual aggregate, subject to policy terms. Management stated that pending claims and investigations are not expected to materially affect financial condition, results of operations or cash flows, but cautioned that future matters could do so.
On July 24, 2015, after the reporting period, the company adopted an executive severance plan providing benefits under specified termination and change-in-control circumstances.
Important Facts for Investors to Verify
- Whether orthopedic and surgical visualization sales stabilize and whether general surgery growth continues.
- The extent to which currency effects, production variances and restructuring costs continue to pressure gross margin.
- Progress and final cost of the Centennial facility consolidation, including realization of projected 2016 savings.
- Available revolver capacity, covenant compliance and debt levels following acquisitions, contingent payments and dividends.
- The timing and amount of remaining MTF and EndoDynamix payments.
- Developments in FDA remediation, future inspections and any related regulatory or manufacturing restrictions.
- Execution of the company’s sales-force changes, research and development initiatives and acquisition strategy.
- The effect of foreign currency movements and the company’s hedging program on revenue, margins and accumulated other comprehensive loss.