CONMED Corporation Form 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. The filing covers the three and nine months ended September 30, 2016, compared with the corresponding 2015 periods. The interim financial statements are unaudited.
On January 4, 2016, CONMED acquired SurgiQuest for $257.7 million in cash. SurgiQuest’s AirSeal system contributed $17.3 million of revenue in the third quarter and $48.5 million for the first nine months of 2016.
Financial Performance and Key Metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Net sales | $184.8 million | $169.2 million | $559.4 million | $528.2 million |
| Gross profit | $101.2 million | $93.5 million | $301.4 million | $279.3 million |
| Gross margin | 54.8% | 55.3% | 53.9% | 52.9% |
| Income from operations | $13.8 million | $14.8 million | $25.1 million | $38.2 million |
| Operating margin | 7.5% | 8.8% | 4.5% | 7.2% |
| Net income | $7.3 million | $8.9 million | $8.0 million | $22.6 million |
| Diluted EPS | $0.26 | $0.32 | $0.28 | $0.81 |
Reported sales increased 9.2% in the quarter and 5.9% year to date. On a constant-currency basis, sales increased 11.2% and 8.4%, respectively. Excluding SurgiQuest, sales declined 1.0% in the quarter and 3.3% year to date, primarily because of unfavorable currency effects.
- General surgery sales increased 29.2% in Q3 and 22.4% year to date, mainly due to SurgiQuest.
- Orthopedic surgery sales declined 3.5% in Q3 and 4.3% year to date.
- Surgical visualization sales declined 4.3% in Q3 and 5.0% year to date.
- Approximately 80% of revenue comes from single-use products; international sales represented approximately 47% of nine-month revenue.
Gross margin decreased modestly in the quarter because of unfavorable currency and product mix, partly offset by the absence of prior-year restructuring charges. Year-to-date gross margin improved by one percentage point, driven by favorable production variances and product mix, partly offset by currency.
Selling and administrative expense increased to $79.0 million in Q3 and $251.7 million year to date, including SurgiQuest acquisition and integration costs of $3.3 million and $17.4 million, respectively. Research and development expense increased to $8.4 million in Q3 and $24.6 million year to date as the company increased product-development and regulatory spending.
Interest expense increased to $3.9 million in Q3 and $11.4 million year to date because of additional acquisition-related borrowings and higher rates. The effective tax rate was 26.5% in Q3 and 25.5% year to date, compared with 33.5% and 32.9%, respectively, in the prior-year periods.
Cash Flow, Debt and Liquidity
- Cash provided by operating activities was $24.6 million for the first nine months of 2016, compared with $38.7 million in 2015.
- Cash used in investing activities was $261.7 million, including $256.5 million for the SurgiQuest acquisition and $10.4 million of capital expenditures, partly offset by $5.2 million of facility-sale proceeds.
- Cash provided by financing activities was $191.4 million, including $175.0 million of term-loan proceeds and $61.7 million of net revolving-credit borrowings.
- Cash declined from $72.5 million at December 31, 2015 to $26.9 million at September 30, 2016.
- Total debt was $500.3 million at September 30, 2016, compared with $270.8 million at year-end 2015.
- Debt included $168.4 million outstanding under the term loan, $328.0 million under the revolving facility and a $4.5 million mortgage note.
- The revolving facility had $192.2 million of available borrowing capacity, with approximately $4.8 million reserved for letters of credit.
- Management stated that cash flow, cash on hand and available borrowing capacity should be adequate for anticipated operating needs, debt service and capital expenditures. The company was in compliance with its debt covenants at September 30, 2016.
Material Changes, Outlook and Unusual Items
The principal change during the period was the SurgiQuest acquisition, which expanded general surgery offerings but materially increased debt, interest expense, amortization and integration costs. Goodwill increased to $398.4 million from $260.7 million, and net intangible assets increased to $424.2 million from $308.2 million.
- CONMED expected the AirSeal system to generate approximately $62 million to $67 million of revenue in 2016.
- Capital expenditures were expected to approximate $15 million for 2016.
- The company discontinued its Altrus product offering and recorded $4.5 million of primarily non-cash inventory charges during the first nine months.
- Restructuring and other expense included $19.6 million in selling and administrative expense year to date, including acquisition costs, restructuring costs and a $1.9 million gain on the sale of the Centennial, Colorado facility.
- Management planned to continue evaluating additional operational and administrative restructuring, but could not estimate the related costs. Additional employee termination and exit costs may be incurred.
- The FDA closed the warning letter related to the Centennial facility on August 1, 2016.
- CONMED entered into an Iran distribution agreement and expected sales beginning in the fourth quarter; anticipated revenue and net profit were not expected to be material.
Key risks include integration of SurgiQuest, elevated leverage and interest-rate exposure, foreign-exchange movements, competition and technology changes, product liability and patent litigation, regulatory compliance, availability of allograft tissue, restructuring execution and the possibility that future claims or investigations exceed reserves or insurance coverage.
A SurgiQuest-related lawsuit brought by Lexion Medical remained in discovery, with trial anticipated in 2017. Lexion sought $14.8 million for alleged lost profits, $18.7 million for alleged corrective advertising costs and an unspecified amount for disgorgement. CONMED stated that it believes the claims lack merit and intends to defend them vigorously.
Important Facts for Investors to Verify
- Whether AirSeal revenue reaches the company’s $62 million to $67 million 2016 expectation and whether SurgiQuest achieves anticipated synergies.
- The effect of acquisition-related amortization, integration costs and restructuring charges on recurring operating margins and earnings.
- Debt reduction, covenant compliance, interest expense and available revolving-credit capacity.
- Inventory growth, working-capital needs and the decline in operating cash flow versus 2015.
- Progress and potential exposure from the Lexion litigation and other product liability, patent and regulatory matters.
- Whether sales excluding SurgiQuest recover from the reported year-to-date decline and how foreign-exchange movements affect results.
- The timing and cost of any additional restructuring and the sustainability of reported gross-margin improvements.