CONMED Corporation Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2019. CONMED is a medical technology company providing surgical devices and equipment for minimally invasive procedures, with orthopedic surgery and general surgery product lines. The financial statements are unaudited.
Business Context and Reporting Period
- Approximately 79% of revenue is derived from single-use products; international sales represented approximately 46% of six-month 2019 revenue.
- CONMED acquired Buffalo Filter and Palmerton Holdings on February 11, 2019 for approximately $365.0 million in cash. Buffalo Filter provides smoke evacuation technologies complementary to general surgery.
- Buffalo Filter contributed reported sales of $13.5 million in the second quarter and $19.5 million year-to-date.
Financial Results and Key Metrics
| Metric | Q2 2019 | Q2 2018 | Six Months 2019 | Six Months 2018 |
|---|---|---|---|---|
| Net sales | $238.3 million | $212.8 million | $456.6 million | $414.9 million |
| Gross profit | $131.2 million | $116.3 million | $252.6 million | $225.8 million |
| Gross margin | 55.1% | 54.6% | 55.3% | 54.4% |
| Income from operations | $18.7 million | $16.7 million | $30.3 million | $34.0 million |
| Operating margin | 7.8% | 7.8% | 6.6% | 8.2% |
| Net income | $5.7 million | $8.7 million | $6.7 million | $19.4 million |
| Diluted EPS | $0.19 | $0.30 | $0.23 | $0.67 |
| Net cash from operating activities | Not provided for the quarter | Not provided for the quarter | $17.7 million | $45.6 million |
- Q2 sales increased 12.0% as reported and 12.8% in constant currency. Six-month sales increased 10.1% as reported and 11.1% in constant currency.
- Q2 general surgery sales increased 19.3% to $122.5 million, while orthopedic surgery sales increased 5.1% to $115.8 million. Six-month increases were 16.1% and 4.7%, respectively.
- Research and development expense increased to $11.8 million in Q2 and $22.4 million for the first six months, representing 5.0% and 4.9% of sales, respectively.
- Interest expense increased to $11.8 million in Q2 and $21.2 million year-to-date, primarily because of acquisition-related borrowings and the convertible notes.
- Effective tax rates were 12.4% for Q2 2019 and negative 47.9% for the first six months, reflecting discrete tax benefits associated primarily with stock options and other federal tax items.
Liquidity, Cash Flow, Debt and Capital Resources
- Cash and cash equivalents were $22.5 million at June 30, 2019, compared with $17.5 million at December 31, 2018.
- Net cash provided by operating activities declined to $17.7 million from $45.6 million, primarily due to lower net income, higher inventory supporting product introductions and sales growth, and higher commission and incentive compensation payments.
- Investing cash outflows were $373.9 million, including $364.9 million for the Buffalo Filter acquisition and $9.0 million of capital expenditures. Management expected approximately $17.0 million of 2019 capital expenditures.
- Total debt was $809.7 million at June 30, 2019, including $262.0 million outstanding on the revolving facility, $260.0 million of term debt, and $287.2 million carrying value of convertible notes.
- The company issued $345.0 million of 2.625% convertible notes due 2024 and entered into a new credit agreement with a $265.0 million term loan and a $585.0 million revolving facility.
- Available revolving credit capacity was $320.5 million, with approximately $2.5 million reserved for letters of credit. The company was in compliance with all debt covenants at June 30, 2019.
- Management stated that operating cash flow, cash on hand and available borrowing capacity should be adequate for working capital, debt service, capital expenditures, dividends and share repurchases in the foreseeable future.
- The company paid quarterly dividends of $0.20 per share. Its $200.0 million repurchase authorization had $37.4 million remaining, and no shares were repurchased under the program during 2019 through June 30.
Material Changes Versus the Prior Comparable Period
- Revenue growth was strong, led by general surgery and the Buffalo Filter acquisition.
- Gross margin improved by 50 basis points in Q2 and 90 basis points year-to-date, primarily from improved manufacturing performance, partly offset by Buffalo Filter inventory adjustment charges.
- Despite higher sales and gross profit, year-to-date operating income declined 10.8%, net income declined 65.3%, and diluted EPS declined from $0.67 to $0.23.
- Operating expenses increased due to Buffalo Filter acquisition, integration and amortization costs, while research and development spending also increased.
- Debt increased substantially to fund the acquisition, resulting in significantly higher interest expense and lower earnings margins.
- Goodwill increased by $215.8 million and acquired intangible assets increased by approximately $140.0 million from the Buffalo Filter transaction.
- CONMED adopted the new lease accounting standard on January 1, 2019, recording $17.9 million of right-of-use assets and lease liabilities without a material impact on net income, EPS or cash flow.
Guidance, Outlook, Commentary, Risks and Unusual Items
- The filing does not provide specific full-year revenue or earnings guidance. Management indicated that 2019 capital expenditures were expected to approximate $17.0 million and that liquidity should be sufficient for anticipated needs.
- Reported results included Buffalo Filter acquisition costs of $0.5 million in cost of sales and $2.5 million in selling and administrative expense in Q2; year-to-date amounts were $1.2 million and $9.7 million, respectively.
- Other expense for the first six months included $3.6 million of lender commitment fees and a $0.3 million loss on early extinguishment of debt.
- Key risks include regulatory or FCPA enforcement, product liability, patent and other litigation, cybersecurity, foreign exchange and interest rates, tariffs and trade restrictions, supply and sterilization constraints, environmental compliance, competition, product acceptance and acquisition integration.
- The company faces litigation related to contingent payments under the 2014 EndoDynamix acquisition. Management disputes the asserted acceleration of approximately $12.7 million and expects to defend the matter; the filing states that there can be no assurance of success.
- Product liability insurance is $30 million per incident and $30 million in annual aggregate coverage, which management believes is adequate, although future claims could exceed coverage.
Important Facts for Investors to Verify
- Whether Buffalo Filter delivers the expected revenue synergies, operating efficiencies and cost savings assumed in the acquisition valuation.
- The effect of increased leverage, variable-rate debt and the 2024 maturity of the convertible notes on future interest expense, liquidity and dilution.
- Whether operating cash flow improves from the first-half level of $17.7 million and supports debt repayment, dividends, capital expenditures and repurchases.
- The sustainability of gross-margin improvement after excluding acquisition-related inventory charges.
- The magnitude and duration of acquisition integration costs and incremental amortization.
- Potential dilution from the convertible notes and related warrants if CONMED’s share price exceeds the applicable conversion and warrant strike prices.
- Developments in the EndoDynamix litigation and any regulatory, FCPA, product liability, environmental or intellectual-property matters.