CONMED Corporation 2018 Q3 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 and general surgery specialties. The filing covers the unaudited three and nine months ended September 30, 2018. Approximately 80% of revenue was derived from single-use products, and international sales represented approximately 48% of nine-month revenue.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Net sales | $202.3 million | $190.1 million | $617.2 million | $573.8 million |
| Gross profit margin | 54.7% | 53.9% | 54.5% | 53.5% |
| Income from operations | $11.5 million | $13.5 million | $45.5 million | $23.8 million |
| Operating margin | 5.7% | 7.1% | 7.4% | 4.1% |
| Net income | $5.8 million | $7.2 million | $25.2 million | $8.8 million |
| Diluted EPS | $0.20 | $0.26 | $0.87 | $0.31 |
- Reported sales increased 6.4% in Q3 and 7.6% for the nine-month period. Management reported adjusted, constant-currency growth of 8.1% and 7.5%, respectively, after adjusting for ASC 606 presentation changes and foreign currency.
- Nine-month sales growth was led by general surgery, up 11.0%, while orthopedic surgery increased 4.5%. Q3 growth was 8.6% in general surgery and 4.4% in orthopedic surgery.
- Nine-month operating cash flow was $50.0 million, compared with $44.8 million in the prior-year period. Capital expenditures were $11.8 million versus $9.2 million.
- Cash and cash equivalents were $29.7 million at September 30, 2018, compared with $32.6 million at December 31, 2017. Net working capital was $198.6 million.
- Total reported debt was approximately $460.9 million, consisting of $18.0 million of current debt and $442.9 million of long-term debt. The company had $147.7 million outstanding on its term loan and $312.0 million on its revolving facility, with $210.0 million of available revolver capacity, subject to approximately $3.0 million reserved for letters of credit.
- The senior credit agreement expires January 4, 2021. CONMED was in compliance with its debt covenants at September 30, 2018. Dividends were $0.20 per share quarterly and $16.8 million for the first nine months.
Material changes versus the prior comparable period
- Gross margin improved by 0.8 percentage points in Q3 and 1.0 percentage point for nine months, primarily due to product mix, favorable foreign exchange for the nine-month period, and lower restructuring costs.
- Q3 operating income and net income declined despite higher revenue, principally because research and development expense increased to $14.1 million from $8.3 million, including a $4.2 million net impairment-related charge.
- Nine-month operating income and net income improved substantially because the 2017 period included significant restructuring and legal costs, including $12.2 million associated with the SurgiQuest-Lexion litigation.
- Selling and administrative expense was 42.0% of sales in both the Q3 and nine-month 2018 presentation, versus 42.5% and 45.2%, respectively, in the comparable periods. The comparison benefited from the absence of most 2017 litigation costs but included a $1.1 million vacant-lease charge in 2018.
- Interest expense increased to $15.1 million for nine months from $13.3 million, reflecting higher borrowing rates. The nine-month weighted average borrowing rate increased to 4.23% from 3.44%.
- ASC 606 was adopted January 1, 2018 using the modified retrospective method. It had no material effect on net income or EPS, but shifted certain group purchasing organization fees from selling and administrative expense to a reduction of revenue, reducing reported 2018 revenue by $2.4 million in Q3 and $6.3 million year to date.
Outlook, commentary, risks and unusual items
- Management expected 2018 capital expenditures to approximate $15.0 million and believed operating cash flow, cash on hand and available revolver capacity would fund working capital, debt service, capital expenditures and potential repurchases in the foreseeable future.
- CONMED paid $12.3 million, including post-judgment interest, on July 10, 2018 to resolve the SurgiQuest-Lexion judgment.
- The company recorded a $4.2 million net research and development charge, mainly for impairment of an in-process research and development asset, partially offset by release of previously accrued contingent consideration. It also recorded a $1.1 million vacant-lease charge.
- CONMED halted development of the EndoDynamix clip applier and is defending litigation seeking accelerated contingent and revenue-based acquisition payments. The company stated that it could not assure a favorable outcome.
- Tax Reform accounting remained provisional. The company recorded a $0.2 million tax benefit during Q3 and continued evaluating the deemed repatriation toll charge, foreign tax credits and GILTI treatment.
- The company identified risks from competition, product development and acceptance, regulatory and FCPA compliance, foreign exchange and interest rates, tariffs, cybersecurity, litigation, product liability, availability of allograft tissue, acquisition integration and future indebtedness.
- CONMED planned to adopt the lease standard on January 1, 2019 and expected a material balance-sheet increase from recording operating lease assets and liabilities, but no material effect on net income, EPS or cash flow.
Important facts for investors to verify
- Whether general surgery growth and new-product momentum, including AirSeal, continue to offset higher research and development spending.
- The sustainability of the improved gross margin and the effect of foreign exchange, product mix and ASC 606 presentation changes.
- Revolver utilization, interest-rate exposure, covenant headroom and the company’s ability to reduce leverage while maintaining dividends and potential repurchases.
- The final accounting and tax effects of Tax Reform, including GILTI and the deemed repatriation calculations.
- The outcome and potential financial exposure from the EndoDynamix litigation and any other product liability, patent, regulatory or FCPA matters.
- The effect of the 2019 lease adoption on reported assets, liabilities and leverage metrics.