CONMED Corporation — Q2 2017 Form 10-Q Summary
Business Context and Reporting Period
CONMED is a global medical technology company providing surgical devices and equipment for minimally invasive procedures in orthopedic, general surgery, gynecology, neurosurgery and gastroenterology applications. The filing covers the three and six months ended June 30, 2017; financial statements are unaudited. Approximately 80% of revenue is from single-use products, and international sales represented approximately 49% of second-quarter revenue and 48% of first-half revenue.
CONMED reports as a single operating segment with two product lines: orthopedic surgery and general surgery. SurgiQuest, acquired in January 2016, contributed AirSeal technology to the general surgery portfolio.
Financial Results and Key Metrics
| Metric | Q2 2017 | Q2 2016 | Six Months 2017 | Six Months 2016 |
|---|---|---|---|---|
| Net sales | $197.2 million | $193.4 million | $383.7 million | $374.6 million |
| Gross profit | $104.7 million | $102.4 million | $204.5 million | $200.2 million |
| Gross margin | 53.1% | 52.9% | 53.3% | 53.4% |
| Operating income | $12.8 million | $7.7 million | $10.3 million | $11.2 million |
| Operating margin | 6.5% | 4.0% | 2.7% | 3.0% |
| Net income | $6.1 million | $2.9 million | $1.6 million | $0.6 million |
| Diluted EPS | $0.22 | $0.10 | $0.06 | $0.02 |
| Dividends per share | $0.20 | $0.20 | $0.40 | $0.40 |
- Q2 sales increased 1.9% as reported and 3.0% on a constant-currency basis. First-half sales increased 2.4% as reported and 3.3% on a constant-currency basis.
- General surgery sales increased 4.6% in Q2 and 6.7% for the first half, driven primarily by AirSeal, smoke-management and endoscopic technologies. Orthopedic surgery sales declined 0.3% in Q2 and 0.9% for the first half as reported, largely because of lower capital-equipment sales.
- Single-use product sales increased 3.4% in both Q2 and the first half, while capital product sales declined 4.1% and 1.3%, respectively.
- Q2 selling and administrative expense declined 3.3% year over year, improving the operating margin. First-half selling and administrative expense increased 3.4%, primarily because of litigation-related charges and higher costs supporting growth.
- Interest expense increased to $4.4 million in Q2 and $8.5 million for the first half, reflecting higher borrowing rates. Average borrowing rates increased to 3.43% in Q2 and 3.32% for the first half.
- The effective tax rate was 26.8% in Q2 and 10.0% for the first half; the first-half rate benefited from state tax and stock-option-related tax benefits.
Cash Flow, Debt and Liquidity
| Metric | June 30, 2017 | December 31, 2016 |
|---|---|---|
| Cash and cash equivalents | $40.1 million | $27.4 million |
| Current assets | $340.3 million | $330.5 million |
| Total debt | $496.5 million | $498.5 million |
| Total liabilities | $753.0 million | $748.4 million |
| Shareholders’ equity | $582.4 million | $580.6 million |
- First-half operating cash flow was $31.3 million, compared with $1.4 million in the prior-year period. The improvement reflected working-capital effects and the absence of the prior-year SurgiQuest acquisition cash outflow.
- Investing cash usage was $7.3 million, including $5.5 million of capital expenditures and $1.8 million for business and asset acquisitions. Management expected 2017 capital expenditures to approximate $15.0 million.
- Financing activities used $13.7 million, including $4.4 million of term-loan repayment and $11.1 million of dividend payments. Net revolving-credit borrowings increased by $3.0 million during the first half.
- The company had $161.9 million outstanding on its term loan and $332.0 million outstanding on its revolving facility. Revolver availability was $189.0 million, with approximately $4.0 million reserved for letters of credit.
- The senior credit agreement expires January 4, 2021, is collateralized by substantially all personal property and assets, and requires financial-ratio compliance. CONMED reported full compliance as of June 30, 2017. Management stated that cash, operating cash flow and available borrowing capacity should meet foreseeable operating, debt-service, capital-expenditure and repurchase needs.
Material Changes, Unusual Items and Outlook
- The most significant unusual item was the Lexion Medical litigation arising from the SurgiQuest acquisition. A jury awarded $2.2 million of compensatory damages and $10.0 million of punitive damages in April 2017. CONMED recorded $12.2 million of related costs in the first six months and was evaluating whether to appeal.
- First-half selling and administrative expense also included $18.954 million of acquisition, restructuring and other expense, including $16.714 million of legal matters. The filing states that $12.2 million related specifically to the Lexion verdict.
- Restructuring costs declined versus 2016, when CONMED recorded a $4.5 million non-cash charge associated with discontinuing the Altrus product offering. The company continues to review operations and administrative functions and may incur additional severance and exit costs.
- CONMED completed a cash acquisition on July 3, 2017 for $4.4 million and was still assessing the accounting treatment at the filing date.
- The company faces an EndoDynamix-related claim seeking approximately $12.7 million of accelerated contingent and royalty payments. CONMED disputes the claimed acceleration and expects to defend the action.
- No formal revenue or earnings guidance is provided in the filing. Management expected capital expenditures of approximately $15.0 million for 2017 and stated that liquidity was adequate for foreseeable needs.
- Risks include foreign-exchange and interest-rate exposure, competition and technology changes, product and regulatory risks, acquisition integration, litigation, potential FCPA or other regulatory enforcement, availability of allograft tissue, materials costs and future indebtedness.
- CONMED adopted certain accounting standards in 2017, including inventory measurement and share-based-payment guidance. The company expected the new revenue-recognition standard, to be adopted January 1, 2018 using the modified retrospective method, to have no material impact, subject to ongoing review.
Important Facts for Investors to Verify
- Assess the ultimate cost, appeal status and cash-payment timing of the Lexion litigation judgment.
- Monitor the EndoDynamix litigation and any potential contingent-payment exposure.
- Reconcile reported first-half profitability with the $12.2 million litigation charge and other acquisition, restructuring and legal costs.
- Track debt balances, interest rates, revolver availability and compliance with credit-agreement covenants.
- Evaluate whether general-surgery growth and single-use product growth offset continuing weakness in capital-equipment sales.
- Confirm the treatment and financial impact of the July 3, 2017 acquisition and the upcoming revenue-recognition adoption.
- Review the company’s $200.0 million share-repurchase authorization, including the $37.4 million remaining authorization and the fact that no repurchases occurred in 2017 through June 30.